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P: Worst-Case Scenario? (Web IV)

Takeaway: The worst case scenario isn’t effectively managing content costs to 55% of revenue; it’s the fallout if P can’t do so (insolvency)

KEY POINTS

  1. WORST CASE SCENARIO? We recently learned of a research report suggesting that P could weather SoundExchange (SX) proposed rates by managing content costs to the 55% revenue floor through a listener cap.  The analysis appears encouraging, but it's extremely sensitive to its rather optimistic underlying assumptions (e.g. revenues that are above street estimates).  Small variances in either revenue growth or listener hours would be the difference between treading water and insolvency.
  2. THERE’S NO SILVER BULLET: If SX proposed rates prevail, P would be in a precarious situation.  There wouldn't be much room to cut costs since the majority of its costs are tied to content & S&M, and any material cuts to the latter would put its revenues at risk.  The only real option is cutting hours, and while a listener cap seems like the natural option, it may not be enough, especially if revenues fall short.  We suspect management would take more drastic measures to proactively preserve its cash, potentially exiting unprofitable US markets altogether (both users and its local sales reps). 
  3. WEBCASTER IV = POWDER KEG: If Web IV settles somewhere in the middle, P remains in a precarious setup.  P’s prospects would still be tied to its ability to maximize revenue while limiting listener hours, which essentially means taking price and/or increasing per-user ad load (sell-through).  The latter may prove more challenging given a growing wave of competitive threats for listener hours.  We’re not sure how Web IV unfolds, but ultimately a compromise may not be good enough.  

 

WORST CASE SCENARIO?

We recently learned of a research report suggesting that P could weather SoundExchange (SX) proposed rates by managing content costs to the 55% revenue floor through a listener cap.  While the analysis appears encouraging, it’s extremely sensitive to its underlying assumptions, which are rather optimistic (particularly revenues, which are above street estimates). 

 

The key thing to consider is the trigger.  Under SX’s proposal, P will pay the greater of 55% of revenue or the per-track royalty rate. So if revenues are too light, or listener hours are too high, the higher per-track rate would apply.  Assuming P could seemingly manage those two dynamics to trigger the 55% floor is not the worst-case scenario under SX’s proposal, it’s the best case.

 

For example, if revenue growth is off by only 2-3 percentage points and/or the listener cap doesn’t curb usage to the magnitude expected, then the 55% floor wouldn't apply.  

 

Below are a two charts illustrating P’s cash burn under small changes in revenue and listener hour assumptions; the takeaway is that very small changes in either metric paint drastically different pictures, and the underlying assumptions in each are still fairly optimistic.  

 

P: Worst-Case Scenario? (Web IV) - P   Sx Scen 1

P: Worst-Case Scenario? (Web IV) - P   SX Scen 2

 

THERE’S NO SILVER BULLET

If SX rates prevail, P’s cash flows would become very sensitive to small variances in revenue growth or listener hours.  There won’t be much room to cut costs since the majority of which are tied to content, and any material cuts to its next largest line item (sales & marketing) would put its revenues at risk. 

 

The only real option is cutting hours.  While a listener cap would be the most likely option, it may not be enough if revenue growth falls short.  Below is an scenario analysis for total EBITDA through 2017.  We’re flexing revenue and listener hours (both on a 3-yr CAGR) under SX proposed rates.  Note consensus is calling for 23.5% revenue CAGR through 2017.

 

P: Worst-Case Scenario? (Web IV) - P   Web Scen SX

 

The takeaway from above analysis is that P could face an escalated level of cash burn over, which could ultimately lead to insolvency within 2-3 years.  Note that P still isn't generating positive FCF, has only $355 million in cash, with a $60M revolver.  

 

That said, we suspect management would take more drastic measures to proactively preserve its cash if SX rates prevail, regardless of its internal expectations for revenue growth or listener hours.  The risk of getting it wrong would be too severe.  We suspect that means exiting unprofitable US markets altogether (both users and its local sales reps). 

 

WEBCASTER IV = POWDER KEG

If SX gets there way, P will need to drastically alter its model (see point 2).  If P’s proposed rates prevail, P would see a massive reprieve in content costs over the next two years that would drive considerable ramp in cash flow growth.  

 

P: Worst-Case Scenario? (Web IV) - P   Web IV Scen P

 

If Web IV settles somewhere in the middle, P still remains in a precarious setup. Below are two additional scenario analyses.  The first is the midpoint between the two proposals, the next the midpoint between P's current rates and SX proposed rates.  We believe the variance between the two seemingly-similar situations illustrates how sensitive the situation is. 

 

P: Worst-Case Scenario? (Web IV) - P   Web IV Scen P SX

P: Worst-Case Scenario? (Web IV) - P   Web IV Scen P SX 4

 

Ultimately, P’s prospects would still be tied to its ability to maximize revenue while limiting listener hours, which essentially means taking price and/or increasing per-user ad load (sell-through). The latter may prove more challenging given a growing wave of competitive threats for listener hours. 

 

We’re not sure how Web IV will unfold, but ultimately a compromise may not be good enough.

 

 

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

 

Hesham Shaaban, CFA

@HedgeyeInternet

 


[UNLOCKED] ICI Fund Flow Survey | Drastic Year-over-Year Decline in Domestic Stock Funds

Takeaway: The first 10 weeks of 2015 have seen a drastic decline in U.S. stock fund flows which impacts several managers disproportionately

This note was originally published March 19, 2015 at 08:11 in Financials. Click here for more information on how you can become a subscriber to Hedgeye.

Investment Company Institute Mutual Fund Data and ETF Money Flow:

 

Domestic equity flows continue to be soft, coming in at a relatively low +$326 million this week and most importantly comping down a drastic 90% from trends in 2014. The first 10 weeks of 2015 have put up a marginal +$114 million weekly average inflow, this compares to the same two and a half month period in '14 which experienced a +$1.8 billion weekly subscription. This 93% decline year-over-year continues to relay the share losses for active funds to ETFs and also a rotation out of the U.S. stock market.

 

International equity fund flows are picking up some of the slack but are also comping down. In the most recent weekly survey, International stock funds put up a solid +$3.9 billion subscription, however even this week's decent number is only blending to a +$1.7 billion weekly average inflow year-to-date. The first 10 weeks in 2014 averaged a +$2.9 billion inflow, so while not as drastic a negative year-over-year comp, a -58% year-over-year decline for international equity funds is hard to get excited about. We continue to flag that shares of T. Rowe Price will bear the brunt of these weak equity trends and the stock continues on our Best Ideas list as a Short (or avoid - see our latest TROW research).

 

[UNLOCKED] ICI Fund Flow Survey | Drastic Year-over-Year Decline in Domestic Stock Funds - ICI 1

 

In the most recent 5 day period ending March 11th, total equity mutual funds put up net inflows of +$4.2 billion according to the Investment Company Institute, exceeding the year-to-date weekly average inflow of +$1.9 billion and the 2014 average inflow of +$620 million. The inflow was composed of international stock fund contributions of +$3.9 billion and domestic stock fund contributions of +$326 million.  International equity funds have had positive flows in 48 of the last 52 weeks while domestic equity funds have had only 15 weeks of positive flows over the same time period.

 

Fixed income mutual funds put up inflows of +$1.3 billion, trailing their year-to-date weekly average inflow of +$3.0 billion but outpacing their 2014 average inflow of +$929 million. The inflow was composed of +$1.0 billion of contributions to taxable funds and +$278 million of contributions to tax-free or municipal bond funds.  Munis have had a solid run with subscriptions in 51 of the last 52 weeks.

 

Equity ETFs lost -$190 million, trailing the year-to-date weekly average inflow of +$83 million and the 2014 weekly average inflow of +$3.2 billion. Fixed income ETFs gave up -$3.5 billion, trailing the year-to-date weekly average inflow of +$1.3 billion and the 2014 weekly average inflow of +$1.0 billion.

 

Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.   

 

Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the weekly average for 2014 and the weekly quarter-to-date average for 1Q 2015:

 

[UNLOCKED] ICI Fund Flow Survey | Drastic Year-over-Year Decline in Domestic Stock Funds - ICI 2

 

[UNLOCKED] ICI Fund Flow Survey | Drastic Year-over-Year Decline in Domestic Stock Funds - ICI 3

 

[UNLOCKED] ICI Fund Flow Survey | Drastic Year-over-Year Decline in Domestic Stock Funds - ICI 4

 

[UNLOCKED] ICI Fund Flow Survey | Drastic Year-over-Year Decline in Domestic Stock Funds - ICI 5

 

[UNLOCKED] ICI Fund Flow Survey | Drastic Year-over-Year Decline in Domestic Stock Funds - ICI 6

 

 

Most Recent 12 Week Flow Within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI), the weekly average for 2014, and the weekly quarter-to-date average for 1Q 2015. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:

 

[UNLOCKED] ICI Fund Flow Survey | Drastic Year-over-Year Decline in Domestic Stock Funds - ICI 7

 

[UNLOCKED] ICI Fund Flow Survey | Drastic Year-over-Year Decline in Domestic Stock Funds - ICI 8

 

Sector and Asset Class Weekly ETF and Year-to-Date Results: Sector SPDR call-outs are similar to last week.  The consumer discretionary XLY ETF experienced a +$579 million inflow (6% of its market cap) while the utilities XLU and long Treasury TLT saw outflows of -$438 (-6%) and -$664 (-9%) respectively.

 

[UNLOCKED] ICI Fund Flow Survey | Drastic Year-over-Year Decline in Domestic Stock Funds - ICI 9 2

 

 

Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a positive +$6.3 billion spread for the week (+$4.1 billion of total equity inflow net of the -$2.2 billion outflow from fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is +$1.1 billion (more positive money flow to equities), with a 52-week high of +$27.9 billion (more positive money flow to equities) and a 52-week low of -$15.5 billion (negative numbers imply more positive money flow to bonds for the week).

  

[UNLOCKED] ICI Fund Flow Survey | Drastic Year-over-Year Decline in Domestic Stock Funds - ICI 10 2

 

Exposures: The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:

 

[UNLOCKED] ICI Fund Flow Survey | Drastic Year-over-Year Decline in Domestic Stock Funds - ICI 11 

 

 

Jonathan Casteleyn, CFA, CMT 

203-562-6500 

jcasteleyn@hedgeye.com 

 

Joshua Steiner, CFA

203-562-6500

jsteiner@hedgeye.com

 


MACAU WEEKLY ANALYSIS (MAR 16-23)

Takeaway: Still trending about -40% for March GGR

CALL TO ACTION

Following the slight uptick the week prior, table revenues took another dive down. However, the downturn was anticipated in our model so no change to our -39-40% YoY growth forecast. Looking ahead, the last week of March is typically stronger but the comparison (+28%) is the most difficult of the month.

 

No change to our cautious investment thesis. Street GGR forecasts have come down and are not far from ours (HE estimate at -24% for 2015). However, we fear the Street is underestimating the Mass revenue deterioration which will adversely impact margins. Consensus EBITDA estimates remain well above Hedgeye.

 

Please see our detailed note: http://docs.hedgeye.com/HE_Macau_3.23.15.pdf


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Touchdown Deflation

This note was originally published at 8am on March 09, 2015 for Hedgeye subscribers.

“When Gronk scores, he spikes the ball and deflates the ball.”

-Tom Brady

 

That’s what Brady said about his tight-end, Ron Gronkowski, in a now infamous interview from 2011. He went on to explain that he loves that “because I like the deflated ball, but I feel bad for that football.”

 

That’s an appropriate metaphor for how the masters of the central planning universe must have felt after Friday’s strong US jobs report. Touchdown! Bloomberg/CNBC celebrated - and markets got smoked. I feel bad for anyone who was long anything.

 

It wasn’t just the US stock market that deflated. It was the FX market, Commodities market, and Bond Market. Oh, and Emerging markets got crushed too. An inverse-correlation spiking of the US Dollar it was, indeed.

Touchdown Deflation - Fed cartoon 01.28.2015

 

Back to the Global Macro Grind

 

Get the US Dollar right, you tend to get a lot of other things right. While I definitely didn’t get the long-end of the US Treasury bond market right last week, our #StrongDollar Global #Deflation Theme remains firmly intact.

 

With the US Dollar Index up another +2.5% on the week to +8.3% YTD, here’s what else happened across Global Macro:

 

  1. Burning Euros were devalued by another -3.1% to -10.4% YTD
  2. Canadian Loonies lost another -0.9% of their value to -7.9% YTD
  3. Commodities (CRB Index) deflated another -1.8% to -4.3% YTD
  4. Oil slid another -0.3% (WTI) to -8.6% YTD
  5. Gold got crushed -4.0% to now down for 2015 at -1.7% YTD
  6. Copper resumed its #deflation, -3.1% to -7.6% YTD
  7. Wheat #deflation of another -5.9% puts it at -18.8% YTD
  8. Oranje Juice got sacked for another -4.3% at -17.7% YTD

 

Wheat and OJ? Really? Yes, some of us Gen-X guys pound both for breakfast (every morning) and quite like the Gronk action in those prices. It’s kind of like a tax-cut (even though most companies aren’t get cutting those end market prices)!

 

And in terms of what most people care on (unless their asset allocator has Gold, Commodities, FX, etc. in their pie chart portfolio), which are stocks and bonds, the week-over-week wasn’t pretty either:

 

  1. Latin American Equities led losers, -7.2% on the week to -9.7% YTD
  2. Chinese stocks dropped -2.1% week-over-week to +0.2% YTD
  3. US stocks (SPY) were down for the 2nd straight week, -1.6% to +0.6% YTD
  4. US Energy stocks (XLE) deflated another -2.8% on the week to -3.0% YTD
  5. US REITS dropped -3.7% week-over-week to -1.2% YTD
  6. US 10yr Yield ramped +25bps on the week to close at 2.24%

 

Yep, it’s been a while since REITS (VNQ), the Long Bond (TLT), and the SP500 (SPY) were anywhere close to flat-to-down for the YTD… but no matter where you go this morning, there those returns are (the UST 10yr Yield started 2015 at 2.17%).

 

Clearly the market is a little freaked out that the Fed might make a policy mistake and go for what John, the Wild Thing, Williams in San Francisco calls “liftoff.” Forget spiking the ball, for some of these non-athlete central planners, this is as intense as it gets!

 

So now it’s game time for the Fed. At their March 18th meeting, they’ll need to either confirm or fade on the obvious market expectation of a June rate hike. But they’ll also have to outline the data “dependence” plan between now and June.

 

  1. What if the March or April jobs reports are as bad as February was good?
  2. What if February was literally as good as a late-cycle jobs report is going to get?
  3. What happens if the stock market does what it did Friday, every Friday?

 

Lots of questions. Lots of non-linear and interconnected risks. It’s not like the late-cycle recovery in the US employment data is either new or going parabolic like the US Dollar is.

 

To put the Non-Farm Payroll print in rate-of-change context, it was +2.39% year-over-year vs. +2.32% in the prior month. That was the 6th consecutive month of what we’ve called “acceleration”, but 6 months ago the rate-of-change was 2.04%. #nothingness

 

And, most importantly, as you can see in the Chart of The Day, the payroll numbers are the most lagging of late-cycle employment numbers there are. Most of the time they peak, AFTER the economic cycle does.

 

Sorry football fans, this makes for a macro market that I think will make for a lot of what hockey players call “read and react.” Other than risk managing levels and calendar catalysts, until the Fed clarifies, what else would you do other than stay flexible?

 

While I had some big immediate-term oversold signals in things I like right now (on Friday in Real-Time Alerts I signaled buys in IWM, XLV, and EDV – Russell, Healthcare, and Long-term strips), a hawked up Fed can #deflate my confidence in those positions, in a hurry.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.91-2.28%

SPX 2064-2105
RUT 1205-1234
VIX 13.81-16.21
USD 95.60-97.92
EUR/USD 1.07-1.10
Oil (WTI) 48.05-51.95
Gold 1165-1201

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Touchdown Deflation - drake1


CHART OF THE DAY: Lower Interest Rates for Longer

CHART OF THE DAY: Lower Interest Rates for Longer - 03.23.15 chart

 

Editor's Note: This is a brief excerpt from today's Morning Newsletter written by Hedgeye CEO Keith McCullough. Click here to become a subscriber.

 

"...[M]y fundamental research call for lower interest rates for longer (as the rate of change in both Global Growth and Inflation slow) remains intact. At the same time, I am not hoping for a devalued US Dollar. US companies who are reporting international revenues and earnings are. The only reason why US GDP growth isn’t falling below 2% is because real US consumption growth loves #StrongDollar."


Hope Remains Intact

“One would hope that the Fed will be very cautious about tightening.”

-Ray Dalio

 

That’s what Global Macro man, Ray Dalio, was hoping for in his Bridgewater’s Daily Observations note from March 11, 2015. He believes that it is “best for the Fed to err on the side of being later and more delicate than normal.”

 

While hope is not a risk management process, I was hoping for the same last week. And my fundamental research call for lower interest rates for longer (as the rate of change in both Global Growth and Inflation slow) remains intact.

 

At the same time, I am not hoping for a devalued US Dollar. US companies who are reporting international revenues and earnings are. The only reason why US GDP growth isn’t falling below 2% is because real US consumption growth loves #StrongDollar.

 

Hope Remains Intact - z doll 2

 

Back to the Global Macro Grind…

 

The problem, of course, is that when the Dollar is rising and Rates are falling (at the same time), you get #Deflationary forces in asset prices tied to inflation expectations. This is where Wall Street and Main Street are hoping for different things.

 

Last week, on the dovish Fed “news”, the US Dollar and Interest Rates dropped:

 

1. US Dollar Index (-2.4% for the week) had one of its biggest down weeks in the last 6 months

2. US Treasury Yields (10yr) dropped 18 basis points on the week to 1.93%

 

That was the very immediate-term move that Dalio and I were hoping for, as it took out the big bang risk of the Federal Reserve making a policy mistake at the end of multiple cycles.

 

On Down Dollar:

 

1. The Euro had one of its biggest up weeks in the last 6 months, +3.1% to -10.6% YTD

2. Gold had a big bounce (Gold loves Down Dollar, Down Rates) of +2.8% to 0.0% YTD

3. Commodities (CRB Index) finally stopped making new weekly lows, +1.6% at -6.9% YTD

4. Emerging Market Stocks (MSCI Index) bounced +3.2% to +1.4% YTD

5. Latin American Stocks (MSCI) had an even bigger bounce +5.4% to -9.6% YTD

 

Meanwhile, on Down Rates:

 

1. Biotech Stocks (IBB) ramped another +6.0% to +20.8% YTD

2. REITS (MSCI Index) ripped a +5.6% move to +6.8% YTD

3. NASDAQ tacked on another +3.2% to +6.1% YTD

4. Long Bond (TLT) had a great week, +3.8% to +4.6% YTD

5. SP500 had its 1st up week in the last 3, closing +2.7% putting it back in the black at +2.4% YTD

 

In other words, most of the #Deflation trades bounced to something less-than-terrible (both absolute and relative) for 2015, whereas the real alpha trending in macro markets continues to play to the lower-rates-for-longer camp’s advantage.

 

All the while, consensus was setup for a rate-hike. Here’s where futures and options net positioning (CFTC non-commercial positions) are:

 

1. SP500 (Index + Emini) net SHORT position rose to its highest of 2015 at -76,511 contracts

2. Long-term Treasuries (10yr) net SHORT position came off its YTD highs to -132,900 contracts

3. The Euro’s net SHORT position got pinned at YTD highs of -201,135 contracts

 

With the SP500, Long-term Treasuries, and Euros all straight up from within six minutes of the FOMC announcement, Consensus Macro getting squeezed provided for a cherry on top of what was an admittedly hoped-for reprieve in policy mistake expectations.

 

Hence my “buy everything” call on the news. But now what? Do you sell everything? I don’t think so – I’m definitely not selling Long-term bonds and/or anything that looks like a bond. Not if the market is expecting the Fed to deliver on “data dependence.”

 

While this week’s CPI data should get a small lift from Oil bouncing like it did in FEB, that #deflation data is going to look very dovish when it gets reported for MAR (in April). Friday’s final GDP report for Q414 will also look slower, sequentially.

 

Fortunately, our rate of change models are not built on hope.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.89-2.03%

SPX 2080-2119

RUT 1

USD 97.17-100.39

EUR/USD 1.04-1.08

Oil (WTI) 42.04-48.03

Gold 1159-1188

 

Best of luck out there today,

KM

 

Keith R. McCullough

Chief Executive Officer

 

Hope Remains Intact - 03.23.15 chart


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