P: New Best Idea (Short)

Takeaway: Elevated Attrition + Peaking Penetration = Declining Users in 2015.


This is a summary of the salient points behind our thesis.  As usual, we will be publishing follow-up notes with incremental analysis, and hosting a call to run through the detail.  In the interim, let us know if you have any questions or would like to discuss in more detail.  



  1. USERS TO DECLINE IN 2015: P has serious retention issues, churning through more accounts than it has retained since 1Q11.  Our survey work suggests that P has already exhausted much of its TAM, so new user growth moving forward will not be able to offset attrition for much longer.
  2. ARPU CAN’T FILL THE VOID: Outside of listener hours, advertising revenue per user (ARPU) is driven by increasing ad load and ad rates.  Any future increases in ad load will likely exacerbate its retention issues, which we belief was the case in both 2013 and 2014.  P’s push into local advertising is a considerable tailwind for ad rates, but unless that can drive accelerating growth (vs. 2014), 2015 estimates are unattainable. 
  3. VALUATION? YOU TELL US: How much do you pay for a company that starts losing users before it generates positive FCF? What happens to the stock the first time P prints declining users? We're not exactly sure, but we believe the stock could easily trade in the $13-$16 range based on 0.5x-1.0x turns of P/S multiple compression on our 2015 estimate of $1.1B (13%-30% downside).  Note that it closed at $16.90 last Tuesday.     



We have previously identified that P has historical retention issues, which we detail in the chart below.  Since 1Q11, P has added more than 160M registered accounts, yet only grew active users by 45M, suggesting total churn of at least 115M accounts, or 72% of its gross account gains during this period.  The bigger issue is that P has already exhausted much of its TAM, particularly the low-hanging fruit.


P: New Best Idea (Short) - P   Attrition 1Q11 3Q14 


Back in August, we ran a survey of 20K US internet users to determine P's actual penetration levels.  Our survey results suggested that P has penetrated roughly 55% of US adult internet users.  That may sound like a ton of runway, but we estimate that roughly 2/3 of P’s remaining adult TAM is over the age of 45, roughly half is over age 55.  Further, we also estimate that P has likely penetrated over 70% of the teenage population.  In short, new user growth will prove more challenging from here.


We estimate that P needs to sustain a run-rate of gross new quarterly account adds of 11M-13M to maintain its active user base given our estimate of mid to high-teens quarterly churn rate.  Even If that run-rate was possible over the long-run, and P could penetrate every internet user in the US, we estimate that P would exhaust its unpenetrated TAM within 7-10 quarters


In a more likely scenario, we expect gross new account adds to slow given the high concentration of older users within P's unpenetrated TAM, which should lead to y/y declines in user and/or listener hour growth sometime in 2015.  See the link below supporting detail and charts on our survey results & TAM analysis. 


P: User Penetration Survey (N=20,000)

08/28/14 04:12 PM EDT

(click here)



Outside of listener hours, advertising revenue per user (ARPU) is driven by increasing ad load and ad rates; we're most concerned about the former.  P’s ad load has steadily risen throughout its history.  However, we suspect that it’s these increases in ad load that are exacerbating its retention issues, particularly its most recent one in late 2013.  


Back in August 2013, P increased its max ad load per listener hour from 4 to 6, but the bigger issue was that P altered its ad feed from 1 every 15 minutes to 2 every 20.  Collectively that translates to as much as a 33%-100% increase in ad load depending on how long the user’s session lasts.  Further, the altered ad feed conditioned the user to expect back-to-back ads, which we suspect may cause some users to end their session prematurely upon hearing the first ad. 


P: New Best Idea (Short) - P   Ad Load Distribution


That said, it shouldn’t be a surprise that in 4Q13, P saw its sharpest deceleration in net user growth in its reported history (from 25% to 14% y/y growth).  We suspect that surge in ad load in 8/13 led to accelerated churn in the following quarter.  Moving forward, we have no reason to expect anything different when/if P increases ad load again: rising ad load will push the user away, especially with a growing wave of options for streaming music online. 


P: New Best Idea (Short) - P   User Growth 3Q14


The one big positive for P is ad rates, specifically its push into the local advertising market, which the company suggests carries rates as high as 2.5x the national average.  However, we do not believe P has the geo-targeting ability to command rates that high (P’s geo-targeting based on the zipcode provided by the user during the registration process).  Regardless, consensus estimates already imply a sharp acceleration in ad pricing; even if the sell-side doesn’t realize it (we’re likely alone in our declining user view). 


In the table below, we’re running a scenario analysis on 2015 revenues; flexing ad-supported listener hours against Ad RPMs (proxy for ARPU).  We have included P’s 2014 YTD performance on both fronts for perspective.  We caution not to read too much into its YTD listener hour growth since that is inflated by the removal of P's mobile listening cap from 2013 (see chart below).  In 2015, we don't believe listener hour growth will exceed double-digits.


That means that consensus estimates for 2015 are unattainable outside of a considerable acceleration in ARPU.  As mentioned above, increasing ad load will come at the expense of listener hours and/or user retention.  So the question is whether its local ad push can produce accelerating pricing growth vs. 2014, and if so, by how much…all things considered, we suspect it won’t be enough.


P: New Best Idea (Short) - P   2015 Scenario


P: New Best Idea (Short) - P   Ad Listener Hours 3Q14


We believe the stock could easily trade in the $13-$16 range (~15%-30% downside) based on 0.5x-1.0x turns of P/S multiple compression on our 2015 estimate of $1.1B.  Note that P recently closed at $16.90 last Tuesday


But the better question is how much do you pay for a company that starts losing users before it generates positive FCF? Or what happens to the stock the first time P prints declining users? Our price target range may be too optimistic.




Let us know if you have any questions, or would like to discuss in more detail. 


Hesham Shaaban, CFA


Cartoon of the Day: This Won’t End Well

Cartoon of the Day: This Won’t End Well - Russia cartoon 12.22.2014


The Gong Show that is Russia continues. The stock market is in a deep hole, down more than 40% this year.


Takeaway: This morning's Existing Home Sales print looks disappointing at first take, but less so when you look at the EHS/PHS dynamic since March.

Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume. 


EHS - RECOUPLING TO PHS - Compendium 12.22.14 


Today's Focus: November Existing Home Sales 

Existing Home Sales dropped -6.1% sequentially from 5.26MM in October to 4.93MM in November, the largest sequential decline since January and the first month below 5MM units SAAR since May.  


However, given the similar temporal dynamic last year, from a rate of change perspective, EHS grew +2.1% YoY, down from the +2.3% reported in October but just the second month of positive YoY growth in the last 13 months.  


A few things to consider:


Soft but Not Surprising:  In the October EHS review we highlighted the emergent divergence between Pending and Existing Home Sales.  Specifically, off the March trough, EHS were up +14.6% while PHS was up just 11.5%.  Further, PHS for October were down -1.1% sequentially, taking the total gain from trough down to +10.5%. 


Given that the two series are invariably tethered, unless we saw sequential strength and/or a significant positive revision to the PHS data, it was unlikely EHS would show similar strength in November. Inclusive of November, the gain since trough for EHS is now +7.4% (vs. +10.5% for PHS). Should PHS for November (released 12/31) come in flat to better sequentially, we'd expect rebound strength in EHS over the next couple months. 


GSE Regulatory Changes:  As we highlighted alongside last week's Purchase application data, the regulatory change for Fannie Mae which reduces the minimum down payment requirement to 3% from 5% took effect on December 13th.   To the extent the change weighed on November or early December demand remains to be seen. We suspect the impact was probably modest - and seasonal distortions in the peri-holiday period will complicate delineating any specific factor in broader demand trends - but we'll get a look at the first week of potential impact in Wednesday's MBA release.   


Seasonality:  The seasonal factor for EHS in the fourth quarter has been getting progressively smaller (ie. getting closer to 1.0) since 2006 which is to say that organic trends, and not seasonal adjustments, have become an increasingly predominate driver of the reported sales figures.  


The October and November seasonal factors (defined here as NSA/SA) have been notable.  The October seasonal factor was well above the trailing 5Y average and above 1.0 for the first time since 2008.  Had the scalar been in-line with the average, seasonally-adjusted EHS in October would have been +5.43MM (vs. 5.26MM reported).  


Conversely, the seasonal factor for November (0.857) was well below the trailing average (0.905), helping support what would have been an even worse sequential decline.  


Normalizing the last two months of data yields a two month average of ~5.05MM, which compares to the TTM average of  4.88MM.   So ongoing, albeit modest, improvement remains the broader trend.  



EHS - RECOUPLING TO PHS - EHS vs PHS Gain since trough 2








EHS - RECOUPLING TO PHS - EHS Inventory Mo Supply





About Existing Home Sales:

The National Association of Realtors’ Existing Home Sales index measures the number of closed resales of homes, townhomes, condominiums, and co-ops. Existing home sales do not take into account the sale of newly constructed homes. Existing home sales account for 85-95% of all home sales (new home sales account for the remainder). Therefore, increases in existing home sales tend to signify increasing consumer confidence in the market. Additionally, Existing Home Sales is a lagging series, as it measures the closing of homes that were pending home sales between 1 and 2 months earlier.



The NAR’s Existing Home Sales index is published between the 20th and the 22nd of each month. The index covers data from the prior month.


Joshua Steiner, CFA


Christian B. Drake

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The Dead Bear Bounce

Editor's note: This is a brief excerpt from Hedgeye morning research. Click here to learn more about how you can become a subscriber to the fastest-growing independent research firm in America.


*  *  *  *  *  *  *


Things that crash…bounce.


Over in the Gong Show that has become Putin's Russia, the RTSI is up +4.2% this morning after being up big on Friday. That said, Russia is still down a monster -42% year-to-date (which means only +72%, from here, to get whoever owned it up there back to breakeven!).


There is massive resistance for the Russian Trading System in the 885-912 range (no support to 623).


No, it's not looking good for Mother Russia.


The Dead Bear Bounce - p9

McCullough: Why I’m Using the Word “Recession” for the First Time This Year


In this excerpt from the Q&A portion of today's Morning Macro Call for institutional subscribers, CEO Keith McCullough says that Fed Chair Janet Yellen could make a move that puts the U.S. in recession.

LEISURE LETTER (12/22/2014)

Tickers: CZR, LVS, MAR, HOT, RCL  

Today's Headline Story

Macau's Gaming Scrutiny To Intensify – On Saturday, Macau’s Chief Executive, Fernando Chui Sai On, said his government would in the spring “undertake a review” of the city’s casino industry. It followed remarks by China’s President Xi Jinping calling for Macau to show “greater courage and wisdom” to “strengthen and improve regulation and supervision over the gaming industry”.  And the country’s president during his visit indicated official concern is not only about cross border money transfer out of China, but also how the prosperity brought to Macau – as the middleman for such high volumes of cash – has created imbalances in local society.

Article HERE

Takeaway: Commentary consistent with a prolonged downturn for Macau GGR.


LVS & 1928.HK – announced Sands China Ltd., received the Macao government approvals needed to complete the construction of its US$2.7 billion Paris-themed integrated resort. The completion of The Parisian Macao will bring Las Vegas Sands' total investment in Macao to more than $10 billion. The Parisian Macao will feature more than 3,000 hotel rooms and suites, more than 490,000 square feet of retail space, diverse food and beverage offerings, new meeting and convention facilities and a 50% scale replica of the Eiffel Tower

Takeaway:  The press release didn't mention a opening date for Parisian but we believe the casino will not open until 2016.


CZR – Caesars Entertainment Operating Company, Inc. ("CEOC"), a subsidiary of Caesars Entertainment Corporation ("Caesars Entertainment") (Nasdaq: CZR), and Caesars Entertainment have reached an agreement with CEOC's first lien noteholder steering committee regarding terms of a financial restructuring plan including a CEOC reorganization under Chapter 11. To implement the balance sheet deleveraging, CEOC expects to voluntarily commence a reorganization under Chapter 11 of the U.S. Bankruptcy Code in mid-January 2015. Under the plan, Caesars Entertainment will contribute up to $1.45 billion in cash to CEOC in support of the restructuring: $700 million to offer to purchase up to 100% of the equity in OpCo from creditors, $269 million to offer to purchase up to 15% of the equity in PropCo, $406 million to fund liquidity and cash recoveries to creditors and a guarantee of up to an additional $75 million of cash, which can be drawn by CEOC under certain circumstances. In addition, Caesars Entertainment has agreed to guarantee OpCo's monetary obligations under the lease to help facilitate the creation of the valuable REIT structure.


CZR also announced that they have entered into a definitive agreement to merge with Caesars Acquisition Company (CACQ) in an all-stock transaction. The successful completion of the merger will position the merged company to support the restructuring of CEOC without the need for any significant outside financing.  The details are HERE.

Takeaway: CZR's restructuring efforts continue. At least now they have some cash to support that process.  

CWN.AU – A challenger for the presidency of Sri Lanka has promised in his manifesto to cancel a casino license – reportedly given to Australia’s Crown Resorts Ltd – if he wins the January 8 vote. Mahinda Rajapaksa, who is seeking a third term as Sri Lanka’s head of state. On October 24, Mr Rajapaksa proposed that in the country’s 2015 budget there should be a US$100 entrance fee for customers using the country’s casinos and that the gaming levy should be 10 percent of turnover.  Currently there is a tax of 5% on local casinos’ gross earnings. In 2013 the government charged a levy of LKR100 million (US$764,234) on casino operators. The Sri Lankan media has previously reported that in 2013 Crown Resorts was awarded a local license to build a US$400 million mixed-use resort including a casino.

Article HERE


0577.HK– Louis XIII Holdings Ltd raised just under HK$1.64 billion (US$211.5 million) via a placement of shares and convertible bonds, the Company said said in a filing on Friday. The company is developing a boutique casino on the border of Cotai and Coloane in Macau. Capital costs of the project were last year estimated at US$800 million. On November 20, Louis XIII Holdings said it was looking to raise some new money – some of which would be used for “design upgrades related to the fit out of the interiors of the hotel development”. Casino Louis XIII will operate 66 gaming tables (50 premium mass and 16 VIP) according to previous regulatory filings.

Article HERE


0577.HK – The crackdown on cross border currency transfers couldn’t be worse for Macau’s Louis XIII hotel-casino development. Hong Kong investment banking and real estate bigwig Stephen Hung has laid out a plan for a facility on Cotai that will cater to China’s 1%, with the property’s ritziest room costing HK $1 million (US $130,000) per night, while its jewelry shops won’t sell a single bauble worth less than $1 million. In September, Hung made headlines by placing a $20 million order for a fleet of 30 Rolls Royce Phantoms to ferry his VIPs, the single largest order the luxury car manufacturer has ever received.

Article HERE

Takeaway: Louis XIII facing the headwinds of the enforcement and crackdown activities.  It could be difficult for a Louis XIII gambler to be seen driving around Macau in a red Rolls Royce in the current environment.


880.HK – SJM was invited by a venture of South Korea’s Paradise Co. and Japan’s Sega Sammy Holdings Inc. (6460) to jointly manage the resort at the Incheon International Airport. It would be SJM’s first foray into the country. The foreigners-only integrated casino project, called Paradise City, is due to open in the first half of 2017 at the airport’s International Business Center and cost about 1.3 trillion won ($1.2 billion) to build, according to a Nov. 21 press statement from Sega Sammy.  

Article HERE

Takeaway: SJM wants a piece of the action in South Korea


MAR – announced the launch of CANVAS, a global incubator for food and drink concepts. Mariott is inviting entrepreneurs, chefs, bartenders and artisans to visit and pitch a food or drink concept for a select group of Marriott hotels, beginning with the JW Marriott Shenzhen (China) and Renaissance Phoenix Downtown. During the next six months, the number of locations will grow to approximately a dozen hotels across the globe.

Article HERE

Takeaway: MAR looking to jump start its F&B offerings.


HOT– completed the sale of the Philadelphia Airport Complex to The Lightstone Group and its affiliates. Located on Island Avenue one mile from Philadelphia International Airport (PHL), the Philadelphia Airport Complex consists of three Starwood properties including the 252-room Sheraton Suites Philadelphia Airport, the 177-room Four Points by Sheraton Philadelphia Airport and the 136-room Aloft Philadelphia Airport. All three properties will be operated by Island Hospitality, undergo renovations and continue to fly the three brand flags.


Starwood purchased the Philadelphia Airport Complex in 1998 and converted the two existing hotels to its Sheraton and Four Points by Sheraton brands. The company then built and added Aloft Philadelphia to the complex in 2008.

Takeaway: While not a material transaction in terms of price or EBITDA, HOT continues its asset-light strategy.


RCL – Royal Caribbean announced the last few Freedom of the Seas itineraries were changed and while the ports the ship was planning on visiting remains unchanged, the amount of time in port is being reduced.  As with other altered cruises due to this propulsion problem, Royal Caribbean will give passengers onboard credit as an apology for the change.  A letter with the credit amount will be delivered to each stateroom. There is no word on what caused the propulsion problems. Royal Caribbean maintains the ship is perfectly safe.  Freedom of the Seas is scheduled for a dry dock session in January 2015.

Article HERE

Takeaway: RCL doing damage control on Freedom of the Seas


Southern China Crackdown on Porn and Gambling – Police  in Guangdong Province said Sunday they captured more than 30,000 suspects in a two-month crackdown on porn and gambling. As of Dec. 15, the province arrested 3,014 people and more than 5,000 others were put under criminal detention in the campaign, said the Guangdong Provincial Public Security Department.

Article HERE

Takeaway: Porn, gambling and all illicit activities continue to be the focus of enforcement and crackdown efforts.


Japan may pass gambling bill by June – Dynam Japan Holdings Co. Ltd. (06889.HK), the largest operator of pachinko (pinball slot machine) halls, believes there is a '99%' chance the Japanese parliament to pass a bill legalizing casinos by June 2015.  Dynam chairman Yoji Sato He said part of the reasons why Prime Minister Shinzo Abe dissolved the parliament in November was to ensure enough support for the gambling bill.

Article HERE

Takeaway: It's good to be optimistic but Dynam is definitely in the minority here.


November Macau Inflation – The Statistics and Census Service said the annual rate of consumer price inflation was 6.12% during November due to higher rents for housing, pricier meals in restaurants and costlier health care were the main causes. The annual rate of housing and fuel price inflation was 11.75%, the annual rate of food and non-alcoholic drink price inflation was 6.3% and the annual rate of health cost inflation was 5.42%.

Article HERE

Takeaway: With housing inflation in the low-double digits, the labor unions may continue to pressure the gaming operators for higher wages despite the drop in GGR.


New Jersey Officials Discuss New Casinos – As lawmakers in Trenton hash out the details of a referendum that could allow casino gambling to expand beyond Atlantic City, local politicians, businessmen and others are touting the benefits of their locations. The Meadowlands and Jersey City have a clear head start, but locations in Essex, Monmouth and Sussex counties also have been raised as possibilities in various quarters. The referendum under discussion, which would go before the voters in November, is expected to focus on two key points: ending Atlantic City’s statewide monopoly on casinos, and explaining that a portion of revenues from North Jersey casinos would go to support the struggling seaside resort and its casino industry. 

Article HERE

Takeaway: New Jersey fighting to keep its citizens gaming at home, while also trying to capture the metro New York gaming spend.  Recall the State of New York could open metro New York to table gaming in seven years.


New York Native American Gaming Expansion – The Oneida Nation announced plans Sunday to open a Class II casino this spring with 436 slots and a 500-seat bingo hall off Route 5 in the unused portion of the Chittenango Tops plaza. It will be open 24 hours a day. The Oneidas received approval for the casino, which is on Oneida Nation land, through the New York State gaming compact in 1993, which was negotiated with the state and approved by the U.S. Secretary of Interior. The Chittenango casino announcement came just days after a state panel recommended licensing three non-Indian casinos in Upstate New York. Rochester developer Thomas Wilmot plans to build one of those - a $425 million casino and hotel - 42 miles west of Syracuse in Seneca County. The 67,000-square-foot Chittenango casino, to be called the Yellow Brick Road casino in honor of author L. Frank Baum's "The Wizard of Oz," will employ 250 people.

Article HERE

Takeaway: Following the State of New York up-state casino expansions, the Oneida Nation announces their effort to short trip Syracuse visitors to the Wilmot/Tyre casino. 


Hedgeye Macro Team remains negative Europe, their bottom-up, qualitative analysis (Growth/Inflation/Policy framework) indicates that the Eurozone is setting up to enter the ugly Quad4 in Q4 (equating to growth decelerates and inflation decelerates) = Europe Slowing.

Takeaway:  European pricing has been a tailwind for CCL and RCL but a negative pivot here looks increasingly likely in 2015.  

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