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LEISURE LETTER (02/27/2015)

TICKERS: IGT


 

 EVENTS

  • Mar 5: The 3rd Session of the 12th National People’s Congress (NPC), China’s top legislature will convene in Beijing

headline news

  • IGT -
    • Received all gaming regulatory approvals required under the Agreement and Plan of Merger, dated as of July 15, 2014. The transactions contemplated by the Merger Agreement remain subject to U.K. court approval and other customary closing conditions set forth in the Merger Agreement, and are currently expected to close in early April 2015. The combined company will be named IGT.
    • Headquarters will be in UK; stock listed under NYSE- ticker IGT
    • 3 business units: North America, International, Italy
      • North America gaming segment (IGT gaming, Doubledown, sports betting) and lottery segment
      • International:  all business conducted outside of North America and Italy 
      • The Italy business unit will operate as it does today. All product development, marketing, manufacturing, and servicing will be supported by North America Lottery and North America Gaming as appropriate.
  • The Corporate Leadership team will be comprised of the following:
    Marco Sala – Chief Executive Officer, International Game Technology PLC
    Renato Ascoli – Chief Executive Officer, North America Gaming/Interactive (DoubleDown Casino)
    Walter Bugno – Chief Executive Officer, International
    Fabio Cairoli – Chief Executive Officer, Italy
    Michael Chambrello – Chief Executive Officer, North America Lottery
    Alberto Fornaro – Executive Vice President and Chief Financial Officer
    Donald R. Sweitzer – Chairman, IGT Corporation (North America) and Senior Public Affairs Advisor
    Robert Vincent – Senior Vice President, Human Resources and Corporate Communications
  • IGT chairman Phil Satre will serve as the new company’s chairman and IGT chief executive Patti Hart will become vice chairman.

Takeaway: Not a lot of senior management from the IGT side. 

COMPANY NEWS

Aristocrat -  Video Gaming Technologies (VGT) acquisition has been “highly accretive” to Aristocrat’s U.S. operations, more than tripling U.S. recurring revenue, said Aristocrat’s CEO Jamie Odell.  He added that the group expected increased debt levels associated with the VGT acquisition, as well as “a significant increase in interest costs” over the 2015 fiscal year.

ARTICLE HERE

INDUSTRY NEWS

Inbound visa policy - Macau’s Secretary for Social Affairs and Culture Alexis Tam Chon Weng says the Macau government does not wish to reduce the number of mainland visitors coming to Macau. It wishes instead to “improve” the issuance of visas to independent travelers from mainland China under the mainland’s Individual Visit Scheme (IVS), according to a statement from Macau’s Government Information Bureau.

 

‪Tam on Thursday said the local government would approach the central government in Beijing to discuss how to control the issuance of visas under the IVS policy. Tam admitted that the tourism industry has shown some concern over the government’s plans, but said that the 31 million-plus visitors that came to Macau in 2014 are more than enough.

 

The Portuguese-language channel of Radio Macau quoted Mr Tam saying that the new policy would have to be introduced “gradually”. He added that in his view a limit around the current 31 million visitors a year “wouldn’t be bad,” Radio Macau reported.

ARTICLE HERE

Takeaway:  Tam seems to be backtracking a little bit on his previous comments. However, the casino industry needs growth not a freeze at 31 million visitors.

 

Russia - The parliament of South Ossetia, which broke away from Georgia in 1990, has passed a law banning all gambling activities on its territory.
The region, which has close ties with Moscow, has ruled all slot machines, sports betting shops and bookmakers’ offices should be closed.

 

There are all indications now that the first hotel in the Primorye gambling zone will be opened in March, as initially planned. Work on its interior finish began earlier this week. But levels of investment across the zones varies widely.

Primorye officials in January said the region had received pledges of investment for about $2.2 billion.

ARTICLE HERE

 

Gongbei Tunnel - slated for completion in 2016. The construction of one of the main segments of the ‘super project’ Hong Kong-Zhuhai-Macau Bridge – the Gongbei Tunnel – is slated for completion by the end of 2016, according to Xinhua News Agency.

ARTICLE HERE

Takeaway:  Build more transportation infrastructure but limit tourists.  Makes sense.  Most of the infrastructure projects have been delayed. Will this one complete on time?

 

Indiana land bill -  The Indiana House voted (House Bill 1540) in favor to let riverboat casinos move onto land and to allow live dealers at Indiana’s two racinos. However, Gov. Mike Pence has stated that he opposes any expansion of gambling.  Pence added another wrinkle this week when he worked behind-the-scenes to oppose a provision of the bill that would allow live dealers for games like blackjack and poker at racinos in Anderson and Shelbyville.

 

The state’s current gambling laws allow live table games at riverboat casinos, but only slot machines and electronic games at racinos.

Takeaway: Indiana is facing tremendous competitive pressures and any part of this bill would help.

 

Olympic betting - Nevada gambling regulators voted Thursday to allow the state’s sports books to offer bets on the Olympics for the first time in years.

It was a move unopposed by anyone in the industry and cheered by the regulators themselves. International sports books in Great Britain, Ireland and Australia and offshore Internet sites already allow such bets.

ARTICLE HERE

 

Hotel developer interest in CBD - Interest has swelled for properties in densely populated urban corridors, whose demand drivers are pushing performance to historic heights. Hotels located in central business districts ended 2014 with higher occupancies (71.8% versus 63.7%), average daily rates ($157.82 versus $110.83) and revenue per available rooms ($113.35 versus $70.62) than their counterparts throughout the rest of the country, according to STR.    

 

“From an investor perspective, the (real estate investment trusts) and some of the other public companies are generally focused on buying assets in some of those locations. If I’m a developer and I’m going to build a hotel, my universe of potential buyers might be a little bit higher and a little broader if I were to build in an urban location,” said Joel Eisemann, chief development officer of the Americas for InterContinental Hotels Group.

ARTICLE HERE

 

River cruise lines cancel Russia in 2016 -  River cruise lines operating in Russia have announced cancellations and cutbacks for the 2016 river cruise season. AmaWaterways and APT Tours will both suspend operations in Russia in 2016, and APT Tours also has postponed the refurbishment of ms Anastasia -- a new addition to the line's fleet that was set to begin operations in Russia in May 2015.

ARTICLE HERE

Takeaway: Will ocean liners follow suit?

MACRO 

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.


WTW: Chapter 11? (4Q14)

Takeaway: Disaster guidance release + premature debt service talk = deteriorating setup in a name that will struggle to tread water moving forward.

KEY POINTS

  1. ANOTHER DISASTER RELEASE: WTW's 2015 guidance came in $0.40-$0.70, well below consensus of $1.43 and our bear-bull case EPS range of $0.71-$1.09.  Management guided to 2015 revenues of $1.2B (down -14% y/y), with the majority of that pressure coming from its core North America segment, which is expected to decline in the low-20% range.  The more important note is that the 2015 may wind up being WTW's worst winter selling season in its history.
  2. AIRING ITS DIRTY LAUNDRY: We're not sure why management chose to highlight its cash preservation priorities, and upcoming 2016 debt maturity, to a sleepy sell-side audience with a 3-yr track record of grossly overestimating its prospects.  The metrics that management provided were somewhat unsettling.   What were once whispers of a potential bankruptcy are now front in center on the street.  
  3. SILENT ON THE HEALTHCARE OPPORTUNITY: Not too much to add here since management didn't provide any incremental color on either the HUM deal or its Healthcare opportunity, which is central to its recovery plans.  Our thoughts here haven't changed.  We don't believe the actual opportunity is anywhere near its $300M estimate, but even if it is, it's small change relative to the $1.4B generated by its core business, which may be in secular decline.  
  4. CHAPTER 11? Still way too early to say, but it doesn’t seem like there is much management can do to avoid it.  Aside from all the anecdotal chatter on how WTW can’t keep up with a rapidly evolving industry, its financials tell a more tangible story.  WTW needs to aggressively invest in its business to return to top-line growth, but its massive debt load ultimately limits most of its options (see charts below).

 

ANOTHER DISASTER RELEASE

WTW's 2015 guidance came in $0.40-$0.70, well below consensus of $1.43 and our bear-bull case EPS range of $0.71-$1.09.  Management guided to 2015 revenues of $1.2B (down -14% y/y), with the majority of that pressure coming from its core North America segment, which is expected to decline in the low-20% range.  The more important note is that 2015 may wind up being WTW's worst winter selling season in its history.

 

WTW: Chapter 11? (4Q14) - WTW   1Q Selling Season 2015 3

 

2015 guidance is inclusive of its plan to cut $100M, but doesn’t include the associated $10M restructuring charge in 1Q.  Management didn’t provide specific 1Q15 EPS guidance, but suggested that it expects to produce “marginally profitable” operating income, but expects to produce negative EPS.  Management is essentially saying that it can’t cover its interest expense in 1Q15.

 

AIRING ITS DIRTY LAUNDRY

We're not sure why management chose to highlight its cash preservation priorities, and upcoming 2016 debt maturity, to a sleepy sell-side audience with a 3-yr track record of grossly overestimating WTW’s prospects (Note the disclosure came before Q&A started).  

 

Management provided the following detail, which are hard to draw any confidence from.  The basic math suggest that WTW is expecting to generate ~$90M in CFO in 2015, vs. the $232M it achieved in 2014.  Further, management painted a picture that retiring its 2016 debt may be a challenge.  

  • 2014 Ending Cash: $301M
  • 2015 CapEx: <$40M
  • 2015 Year-End Cash Target: >$350M
  • 2016 Debt Maturity: $314M (due in April) 
  • 2020 Debt Maturity: $2.4B

Now it’s all on the table; what were once whispers of a potential bankruptcy are now front in center on the street.  

 

SILENT ON THE HEALTHCARE OPPORTUNITY

Not too much to add here since management didn't provide any incremental color on either the HUM deal or its Healthcare opportunity, which is central to its recovery plans.  Our thoughts here haven't changed.  We don't believe the actual opportunity is anywhere near its $300M estimate, but even if it is, it's small change relative to the $1.4B in 2014 revenues generated by its core business, which may be in secular decline.  

 

CHAPTER 11?

2020 is still a whiles away, so way too early to say.  But right now, it doesn’t seem that there is much management can do to avoid it.  Aside from all the anecdotal chatter on how WTW can’t keep up with a rapidly evolving industry, its financials tells a more tangible story.  WTW needs to aggressively invest in its business to get out of its hole; particularly marketing (ad campaigns)

 

WTW: Chapter 11? (4Q14) - WTW   Revenue vs. Marketing 

 

However, increasing advertising spend may not be enough moving forward.  Member acquisition costs (marketing expense/new member) have skyrocketed since 2011.  WTW is now approaching the point where it is barely generating enough gross margin to cover its member acquisition costs.  

 

WTW: Chapter 11? (4Q14) - WTW   Chapter 11 v2

 

Right now, WTW's 2015 guidance is essentially calling for Interest coverage ratio of ~2.0x, which means it doesn't have a  ton of wiggle room, especially given its high fixed cost structure.  Any gamble on investments and/or promotions (e.g. price cuts) could come back to bite them.  

 

WTW: Chapter 11? (4Q14) - WTW   Interest Coverage

 

In summary, WTW needs to aggressively invest in its business to return to top-line growth, but its massive debt load ultimately limits most of its options.

 

 

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

 

Hesham Shaaban, CFA

@HedgeyeInternet

 

Thomas Tobin

@HedgeyeHC 

 


Keith's Daily Trading Ranges, Unlocked

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Keith's Daily Trading Ranges, Unlocked - HE DTR 2 27 15

BULLISH TRENDS

Keith's Daily Trading Ranges, Unlocked - Slide2

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Keith's Daily Trading Ranges, Unlocked - Slide5

Keith's Daily Trading Ranges, Unlocked - Slide6

 

BEARISH TRENDS

Keith's Daily Trading Ranges, Unlocked - Slide7

Keith's Daily Trading Ranges, Unlocked - Slide8

Keith's Daily Trading Ranges, Unlocked - Slide9

Keith's Daily Trading Ranges, Unlocked - Slide10

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February 27, 2015

February 27, 2015 - HE DTR 2 27 15

 

BULLISH TRENDS

February 27, 2015 - Slide2

February 27, 2015 - Slide3

February 27, 2015 - Slide4

February 27, 2015 - Slide5

February 27, 2015 - Slide6

 

BEARISH TRENDS

February 27, 2015 - Slide7

February 27, 2015 - Slide8

February 27, 2015 - Slide9

February 27, 2015 - Slide10

February 27, 2015 - Slide11
February 27, 2015 - Slide12

February 27, 2015 - Slide13

 


CHART OF THE DAY: Dr. House-ing (2nd Derivative HPI Matters!)

CHART OF THE DAY: Dr. House-ing (2nd Derivative HPI Matters!) - CoD2

 

This is an excerpt from today's Morning Newsletter written by Hedgeye U.S. Macro Analyst Christian Drake.

 

Anyway, after being on the right side of the acute housing demand infarction in 2014, we reversed our diagnosis for 2015 in November of last year alongside our expectation for a recession and reversal in many of the industries underlying maladies.  

 

Since much of what we like about 2015 is what we didn’t like about 2014, juxtaposing the two years across a selection of key factors should sufficiently capture the core of our call.

 

HPI | 2nd Derivative Trends Matter:  Housing demand leads home price growth and housing stocks follow the slope of price growth.  Since 2008 the correlation between housing equities and the year-over-year rate of change in HPI has been 0.90. 

  • 2014:   Home price growth decelerated sharply in 2014, slowing from ~12% YoY in February to ~5% in October according to CoreLogic data.  The housing complex (XHB/ITB) underperformed the market by ~15% alongside that expedited deceleration in HPI.
  • 2015:  Home price growth stabilized in Oct/Nov across all three of the primary price series (CoreLogic, Case-Shiller, FHFA) and have, in fact, shown modest re-acceleration in December.   Performance has again followed suit with the XHB and ITB outperforming the SPX by +12% and +10%, respectively, since the 2nd derivative HPI stabilization began in November.  Ongoing inventory tightness, with months of supply on the existing market holding below 5 months, remains supportive of stable to improving price growth trends over the immediate/intermediate term.  

Net: In the Chart of the Day we show the inflection in housing equity performance following the 2nd derivative inflection in HPI. 

 


Dr. House-ing

“There’s no ‘I’ in team. There’s a ‘me’ though, if you jumble it up.”

-Dr. Gregory House 

 

Sometimes pretending you’re a cynical, misanthropic drug-addict doctor with deific deductive dexterity is what it takes to stay excited about staring at your screen for 14 hours a day. 

 

The Dr. House metaphor is both apt and easy as it relates to the Hedgeye Housing teams (@HedgeyeFIG & me) inquisition for industry research alpha. 

 

Distilling the convoluted milieu of domestic housing data in the attempt to diagnose and front-run positive and negative dispersions from industry homeostasis holds obvious parallels to the challenges inherent to diagnosing physiological pathology in the attempt to front-run … death.   

 

Plus..you know..it illustrates our marginal cleverness with the whole “House” reference.

Dr. House-ing - CoD

Anyway, after being on the right side of the acute housing demand infarction in 2014, we reversed our diagnosis for 2015 in November of last year alongside our expectation for a recession and reversal in many of the industries underlying maladies.  

 

Since much of what we like about 2015 is what we didn’t like about 2014, juxtaposing the two years across a selection of key factors should sufficiently capture the core of our call.

 

HPI | 2nd Derivative Trends Matter:  Housing demand leads home price growth and housing stocks follow the slope of price growth.  Since 2008 the correlation between housing equities and the year-over-year rate of change in HPI has been 0.90. 

  • 2014:   Home price growth decelerated sharply in 2014, slowing from ~12% YoY in February to ~5% in October according to CoreLogic data.  The housing complex (XHB/ITB) underperformed the market by ~15% alongside that expedited deceleration in HPI.
  • 2015:  Home price growth stabilized in Oct/Nov across all three of the primary price series (CoreLogic, Case-Shiller, FHFA) and have, in fact, shown modest re-acceleration in December.   Performance has again followed suit with the XHB and ITB outperforming the SPX by +12% and +10%, respectively, since the 2nd derivative HPI stabilization began in November.  Ongoing inventory tightness, with months of supply on the existing market holding below 5 months, remains supportive of stable to improving price growth trends over the immediate/intermediate term.  

Net: In the Chart of the Day below we show the inflection in housing equity performance following the 2nd derivative inflection in HPI. 

 

 

Credit:  Discrete tightening in 2014 gives way to marginal easing in 2015

  • 2014 Contraction:  The implementation of QM regulations, FHA loan limit reductions and the expiration of the Mortgage Forgiveness Debt Relief Act collectively served to constrict the credit box and capsize housing demand in 2014. 
  • 2015 Credit Box Re-Expansion:  Recognizing the discrete drag on the housing recovery, regulatory policy momentum is shifting away from the over-pricing risk for the current wave of would-be borrowers and towards policy adjustments aimed at improving affordability and modest credit box expansion. 
    • FHA & Fannie/Freddie:  FHA premium cost reductions (from 1.35% to 0.85%) implemented in January along with the re-introduction of 3% down payment loan options from the GSEs for 1st time buyers could boost purchase demand by ~3% over the intermediate term. 
    • Vantage Scoring:  The FHFA is currently considering adoption of Vantage Scoring – a credit scoring system which provides a more comprehensive risk scoring framework than conventional FICO models and is capable of scoring thin file consumers previously locked out by FICO and other conventional models.  Vantage Score 3.0 is estimated to score approximately 30-35mm more consumers than conventional models and could bring ~500K more borrowers into the fold in the coming years under conservative assumptions. 

Net: Growth by the stacking of marginal easings in 2015, while likely to be modest-to-moderate, stands in sharp contrast to the restrictive QM/Loan limit reductions that headlined the regulatory environment in 2014. 

 

Ball Under Water:  The Illusion and the Inflection  

  • 2012-2014 | False Perceptions:  Since the start of 2011 there have been ~5.3mn net, new households formed which, using a historically consistent scalar, require 7.2mn new housing units.  However, there have been just 2.97mn housing units started, resulting in a cumulative supply-demand gap of approx 4.2mn units.  This math has underpinned the bullish ball-under-water housing demand/construction thesis for the better part of last two years.  The misunderstanding has been rooted in the reality that the imbalance has been largely illusory as the number of shared households have increased by over 3.4mn over the same period.
  • 2015:  Bear Market in Basement Dwelling:  The increase in shared households slowed markedly in 2014 and the bottom in “basement dwelling” and headship rates now appears to be in.    The implication of an inflection in shared household growth is that what has here-to been a perceived ball underwater becomes, in fact, a real ball underwater and a true support to new housing unit construction.    

 

Rates:  Rates are currently running ~40bps below their 2014 average, providing an approximate 4% boost to affordability.  With global growth slowing, disinflation/deflation predominating and DM yields anchoring the long-end, we don’t see acute upside risks to bond yields in the immediate/intermediate term.

 

Elsewhere Across Housing Macro:  Residential Construction Employment in January saw its largest sequential gain since November of 2005, employment growth across the key 20-35 YOA demographic continues to accelerate and  Consumer Sentiment around housing – as measured by the University of Michigan’s “Good Time to Buy a Home” index – continues to advance alongside the broader rise in Consumer Confidence and ongoing improvement in the domestic labor market.  Further, the latest CPS/HVS survey estimated that the total number of households grew by 2.0MM in December vs a year earlier, the largest yearly change since July 2005 and the first material acceleration in year-over-year growth in 8 years. 

 

The 2015 Score | RoC Solid:  Mortgage Purchase Applications were up +9.8% in the latest week marking the fastest rate of growth since June of 2013, Pending Home Sales accelerated to their fastest rate of growth in 18 months in December (we’ll get the January data this morning), New Home Sales in January held at 7 year highs, single-family housing starts were up 16% YoY in the latest January data and home price growth is reflecting a fledgling re-acceleration. 

 

In short, our expectation for improving rates of change across the preponderance of housing metrics in 2015 is finding positive confirmation in the early year data.  Of course, cheerleading a call that’s already worked is generally a great way to top tick yourself, but we still like the intermediate term fundamental outlook.  We’ll continue to let Keith risk manage the exposure in RTA. 

 

Was any of the above analytically ingenious?  Probably not, but having a process for effectively capturing, curating and contextualizing the monthly torrent of shifting housing dynamics in real-time is more than trivial for resource and time-constrained investors.   

 

As Sherlock Holmes (the figure on which Dr. House was based) characterized his investigatory process: 

 

“You know my method. It is founded upon the observation of trifles.” ….”It’s quite exciting, he said with a yawn”

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.84-2.08%

SPX 2091-2120
RUT 1

VIX 13.08-16.65

USD 94.01-95.45

Oil (WTI) 47.61-50.97 

 

The risk of heart attack rises by 20% on Mondays, Enjoy the weekend. 

 

Christian B. Drake   

U.S. Macro Analyst

 

Dr. House-ing - CoD2


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