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RTA Live: April 8, 2015

Hedgeye CEO Keith McCullough will answer your questions about Real-Time Alerts live today at 10:00AM ET. 

 

 
 

 

There are three ways you can ask Keith questions:

  • Tweet us your questions via @Hedgeye with the #RTALive hashtag 
  • Call in and speak to him live toll-free on  
  • Ask questions in the chat box below the video player

 

If you are unable to watch this live, the replay will be available at the same link immediately following the completion of the show.


P: Losing the Critical Debate? (Web IV)

Takeaway: All the noise in the CRB filings is clouding the key debate, which is not the royalty rates, but the royalty structure...

KEY POINTS

  1. THE CRITICAL DEBATE: the royalty structure.  The key difference between the P and SoundExchange (SX) rate proposals is that SX is not distinguishing between ad-supported and subscription royalty rates.  It’s that potential step-up in ad-supported rates that could cripple P’s model.  So the question is whether the CRB believes there should be a distinction between the two.
  2. P MAY BE LOSING THIS DEBATE: We believe there are three main considerations regarding the varying royalty rate structure.  In short, we suspect P doesn’t have much of a leg to stand on in this specific debate because the premise/support behind its arguments have limited legal bearing on the Web IV proceeding.   
  3. WEB IV=POWDER KEG: What we mean is that the viability of P's model is highly sensitive to very small variations in final Web IV rates.  To expound further: If P cannot convince the CRB to distinguish royalty rates by revenue source, then P would likely have to blow up its own business model.  See the below scenario analysis and links to prior notes for supporting detail.

 

THE CRITICAL DEBATE

Both P and SX have provided a series of dense divergent arguments to the CRB; each discussing seemingly entirely different topics, which makes hard to tell who is really “winning the argument”.  With all the noise in the CRB filings, we believe the street is losing sight of the key debate, which is the royalty structure.

 

The key difference between P’s and SX’s rate proposals comes down to the distinction between royalty rates for ad-supported vs. subscription tracks; SX is not distinguishing between the two in its proposal.  It would be that step-up in ad-supported rates that could crush P’s business model.  So the question is whether the CRB believes there should be a distinction between the two.

 

P: Losing the Critical Debate? (Web IV) - P   Web IV proposals 2

 

P MAY BE LOSING this debate

We believe there are three main considerations regarding the varying royalty rate structure.  In short, we suspect P doesn’t have much of a leg to stand on in this specific debate because the premise/support behind its arguments have limited legal bearing on the Web IV proceeding.   

  1. Pureplay Settlement is Irrelevant: It’s important to note that the distinction between royalty rates by revenue source (ad-supported vs. subscription) was not the result of any CRB decision through any Webcaster proceeding.  It came from the Pureplay settlement agreement; the terms of which prohibited the associated rates from ever being included as a benchmark in any rate-setting procedure.  P’s current proposal is structured under the same framework as the Pureplay agreement, and potentially existing agreements in the market (see below).
  2. Existing Benchmarks May Not be Relevant: The center of the debate on royalty rates is what willing buyers/sellers would agree to in a competitive market outside the shadow of statutory rates.  Both parties are using different benchmarks as precedent to argue their cases: P is using existing webcasting agreements, while SX is using existing on-demand/interactive agreements.   P’s benchmark appears more logical, but those agreement only cover a small subset of the market (28 of 29 agreements with independent labels).  Further, it would be tough to argue that these rates were determined outside of the shadow of statutory rates (or worse the Pureplay agreement), especially since SX provided witness testimony from involved parties suggesting otherwise.
  3. P’s Financial Positioning is Irrelevant: P has taken the position that it can’t afford a rate increase, let alone current rates.  Sx has taken the position that P’s wounds are self-inflicted because it has focused on gaining market share vs. profitability.  But Sx concludes with a more important point.  P’s financial positioning has no bearing on what the appropriate rate should be, quoting the CRB judges in the Web III Remand final ruling.  “The Act instructs the Judges to use the willing buyer/willing seller construct, assuming no statutory license. The Judges are not to identify the buyers' reasonable other (non- royalty) costs and decide upon a level of return (normal profit) sufficient to attract capital to the buyers.” In short, P's monetization strategy (advertising vs. subscription) has no bearing the statutory royalty rate.  

 

WEB IV=POWDER KEG

What we mean is that the viability of P's model is highly sensitive to very small variations in final Web IV rates.  To expound further: If P cannot convince the CRB to distinguish royalty rates by revenue source, P would likely have to blow up its own business model.  

 

We had previously run a series of scenario analyses projecting P's EBITDA under various potential Web IV outcomes (see first link below).  Below is an additional scenario: P's proposed subscription rates applied to ALL of its listener hours.  For context, P has only $355 million in cash.  

 

P: Losing the Critical Debate? (Web IV) - P   Web IV Scen P Sub rates 2

 

We're highlighting this scenario because this might be P's best case scenario for Web IV if the CRB judges do not distinguish between ad-supported and subscription rates.  That is unless the webcasters can convince the CRB that statutory royalty rates should be reset below those rates established in Web III, which seems like a stretch.

 

For more detail on the impact of Web IV on P's business model, see the two notes below.  Let us know if you have any questions, or would like to discuss in more detail.  

 

P: Worst-Case Scenario? (Web IV)

03/23/15 09:30 AM EDT

[click here]

 

P: Webcaster IV = Powder Keg

01/13/15 02:49 PM EST

[click here]

 

 

Hesham Shaaban, CFA

@HedgeyeInternet 


Euro, Oil, Rates

Client Talking Points

Euro

Down -1% vs USD yes, +0.5% this morning to $1.08 with a tighter risk range of $1.07-1.09 (vs. 1.04-1.10 two weeks ago) and plenty of bearish intermediate-term TREND resistance overhead.

Oil

After another hopeful headline ramp yesterday is met with a -2.5% this morning for WTI, taking it right back into the red for the YTD with an immediate-term risk range of $46.48-53.39 – lots of short selling opportunities again in everything Energy from the top-end of respective risk ranges.

Rates

Lower-For-Longer? Yep. German and Dutch 10YR yields falling to 0.17 and 0.34%, respectively, as UST 10YR yield falls back to 1.88% with Fed Fund Futures pushed to DEC 2015 – those shorting these sovereign bonds on “valuation” have no catalyst unless global growth and inflation accelerate.

Asset Allocation

CASH 35% US EQUITIES 12%
INTL EQUITIES 15% COMMODITIES 0%
FIXED INCOME 30% INTL CURRENCIES 8%

Top Long Ideas

Company Ticker Sector Duration
MTW

Manitowoc (MTW) is splitting the business into two companies. Given the valuation differential between the sum-of-the-parts and the current enterprise value of the company, the break-up should be a substantial positive. Recent nonresidential and nonbuilding construction data remains firm for 2015, which suggests that MTW’s crane sales should see a pickup in the first half of the year. The Architecture Billings Index (a survey of architects) typically leads nonresidential and residential construction spending by approximately 9-12 months. More importantly, the ABI Index leads MTW Crane Orders by 2 quarters.

ITB

iShares U.S. Home Construction ETF (ITB) is a great way to play our long housing call, U.S. #HousingAccelerating remains 1 of the Top 3 Global Macro Themes in the Hedgeye Institutional Themes deck right now. Builder Confidence retreated for a 3rd consecutive month in March and New Home Starts in February saw their biggest month-over-month decline since January 2007.  We think the underlying reality is more sanguine with the preponderance of the weakness in the reported February data largely attributable to weather.  

 

                                           While labor supply constraints may serve as a drag to builder confidence, presumably it is rising demand trends that are driving tighter conditions in the resi employment market.  All else equal, we’d view improving demand as a net positive.  On the New Construction side, while the sharp drop in Housing Starts captured most of the headlines, we believe the real story was in the 3% gain in permits. We'd expect to see a big rebound in the next two months in housing starts as the data plays catch-up to the thaw.

TLT

Low-volatility Long Bonds (TLT) have plenty of room to run. Late-Cycle Economic Indicators are still deteriorating on a TRENDING Basis (Manufacturing, CapEX, inflation) while consumption driven numbers have improved. 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.

Three for the Road

TWEET OF THE DAY

SPECIAL EVENT: Calling all RIAs!!! ***Cinco De Macro*** Margaritas, Macro & More Ping Matt (mmoran@hedgeye.com) pic.twitter.com/tbjFYNhENw

@Hedgeye

QUOTE OF THE DAY

“Expect problems and eat them for breakfast.”

-Alfred A. Montapert

STAT OF THE DAY

Purchase Applications re-captured the 200-level on the index, rising +6.8% week-over-week  following +5.7% and +4.9% sequential gains in the prior two weeks, respectively.  On a year-over-basis growth in purchase demand was up +11.9%, marking a 3rd consecutive week of acceleration and the fastest rate of growth in 22 months.  


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MACAU WEEKLY ANALYSIS (APRIL 1-7)

Daily table revenues for the 1st week of April came in only at HK$569m, down 34% YoY. This is worse than the low HK$600s we had been seeing in March. The Chingming festival (April 5) may have played a role in the lower numbers.

 

Last year, revenues fell 21% in the Chingming festival week versus the previous week. For 2013, the difference between the weeks was 2%. So there could be some impact but it varies. 

 

However, if the current run rate persists, we could be seeing a monthly decline closer to -40% for April, which would be another disappointment.

 

We will have more details in our Macau monthly presentation/conference call this Friday at 11am.

 

MACAU WEEKLY ANALYSIS (APRIL 1-7) - 1

 

MACAU WEEKLY ANALYSIS (APRIL 1-7) - 2


CHART OF THE DAY: Lower #Oil For Longer

CHART OF THE DAY: Lower #Oil For Longer  - 04.08.15 chart

 

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

 

Then I got lucky as the lead supply story on Oil for the last 3-6 months (rising Oil production) hit the tape:

 

    1. The API reported domestic crude inventories increase another 12.2MM barrels week-over-week
    2. That was basically the biggest sequential increase we’ve seen through this whole downturn
    3. A DOE number in that area code (10:30AM EST today) would be the biggest sequential ramp since DEC 5th, 2014

 


Stimuli and Effects

“Learning involves assessing relationships between stimuli and their effects.”

-Ed Hess

 

If that isn’t the truth about risk managing Global Macro markets, I don’t know what is. It’s Ed Hess’ opening volley in an excellent chapter from Learn or Die titled “Learning: How Our Mind Works.”

 

As our catalogs of stimuli and their effects grow, we develop stories that link them together so that we don’t have to remember them all individually… When we gain confidence with our stories, they become our reflexive, more automatic shorthand for interpreting the world. That is, they become our internal operating system…” (page 9)

 

Again, I think that is bang on. It’s all about the storytelling. And while we all know people who live, profitably, through plenty of lies, the fabrication of the truth eventually catches up to you in our profession. Long-term repeatable alpha is non-fiction.

 

Stimuli and Effects - 345

 

Back to the Global Macro Grind

 

The thing about the stimuli and their effects in markets is that they are constantly changing. For now, for example, you have to believe that A) Chinese growth and inflation are slowing in order to believe that B) the government is going to provide massive stimuli as a result. Then, by respecting market expectations, you are both bearish on Chinese growth/inflation and long its stock market!

 

I didn’t always think this way. I used to think that I was smarter than the market and that things like the aforementioned Chinese example couldn’t happen because the fundamental truth was that if growth was slowing, I could be short that market and eventually kill it (then I tried that more than a few times, shorted those types of markets … and got killed).

 

If you truly understand the fundamentals, the most important thing for you to solve for next is how that stimuli will be priced from a market expectations perspective. You don’t need a Ph.D. to master either expectations or your emotions. You need to check both your intellect and ego at the door, and risk manage the market you have, as opposed to the one you want.

 

Let’s apply some multi-duration, multi-factor stimuli and effect analysis to the oil market:

 

  1. Oil (WTI) is down over 47% year-over-year on #StrongDollar, Rising Supply, and Slowing Demand
  2. Oil was up +3.3% yesterday, taking it to +13% for the month-to-date on Saudi headlines  (with USD +1% on the day)

 

Ok. If my story about that isn’t 100% accurate, please email me and we’ll see if you have a better testament of what you believe is the truth (I’ll publish it on our site). I’m open to being edited! Internally, our commodities analyst, Ben Ryan, edits me all of the time.

 

Here’s the story Ryan told me about the head-fake stimuli (i.e. what the Saudi Oil Minister actually said vs. what mainstream media thought he said) yesterday:

 

  1. “I think this is very similar to what he's said all year”
  2. “He said it's not in their interest to cut production, but he'll work with other OPEC members”
  3. “They aren't in competition with shale producers and Oil prices will go up and down, adjusting for market forces”

 

One other thing Ryan noted is that the Saudi's are really the only OPEC member that has a significant amount of spare production capacity (more than half of all of OPEC). Their take is "we're already doing our part."

 

Again, to me that sounds as reasonable as any other story I read (from a credible independent research source) on the matter. So I rolled with that and sent out a SELL signal in Oil at 3:32PM EST in Real-Time Alerts. #timestamped

 

Then I got lucky as the lead supply story on Oil for the last 3-6 months (rising Oil production) hit the tape:

 

  1. The API reported domestic crude inventories increase another 12.2MM barrels week-over-week
  2. That was basically the biggest sequential increase we’ve seen through this whole downturn
  3. A DOE number in that area code (10:30AM EST today) would be the biggest sequential ramp since DEC 5th, 2014

 

But you make your own luck in this business by being able to:

 

A)     Contextualize a price/volume/volatility move within what we call our immediate-term TRADE risk range and

B)      Overlay that quantitative signal with an intermediate-term TREND research view

 

I went through this in our Q2 Global Macro Themes Call yesterday in what we’ve coined as Oil’s #DeflationDeck, which is effectively a bearish intermediate-term view of West Texas Crude Oil with an intermediate-term range of $36.11-57.54/barrel.

 

No, that’s not the “price deck” your Canadian Investment Banker is going to give you from his latest confab in Alberta. Neither is it the price your favorite “buy your own oil well” radio advertiser is going to tell your stories about from Midland, Texas.

 

It’s our story (born out of our process) on why our call on Global #GrowthSlowing and #Deflation will perpetuate lower-Oil-for-longer and why all of the #DeflationDomino risks associated with that to both levered Energy debts and equities remain firmly intact.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.84-1.93%

SPX 2060-2089
RUT 1
DAX 114
VIX 14.06-15.93
USD 96.65-98.98
WTI Oil 46.48-53.39

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Stimuli and Effects - 04.08.15 chart


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