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Who Really Knows?

“Our greatest power is that we know that we don’t know.”

-Ray Dalio

 

Do you really know what the Federal Reserve is going to say today? I don’t. If you do, with 100% certainty, please don’t call and/or email me with that information. I don’t want to go to jail.

 

Having witnessed some characters in this business take on orange-jump-suit-risk to get what some of them call “edge” (i.e. inside information), I’ve spent my entire career trying to build a #process that doesn’t need short-cuts (i.e. cheating).

 

That puts me in a position of really not knowing what I’m not supposed to know. Instead of selling you certainty, it forces me to embrace uncertainty… and probability weight each and every decision I make based on the most recent data and market pricing.

Who Really Knows? - Fed doves cartoon 04.21.2015

 

Back to the Global Macro Grind

 

We had our company meeting yesterday. We do one every quarter. It’s usually lunch and 3-4 hours of thought leaders at Hedgeye thinking out loud about #process: what’s working; what’s not – what can we do next. #BestPractices

 

The best part about these meetings is the element of surprise. When you have 57 thoughtful people in a room who have decided to open their minds to learning, a lot can happen in an afternoon. Who can really make you challenge yourself and think?

 

Our veterans (Daryl Jones, Howard Penney, and Tom Tobin) stepped up and delivered the wood on that front yesterday. In fact, I don’t think I’ve ever seen objective and critical self-reflection like that – back to back to back.

 

You can call us a cult. But we call ourselves a team.

 

During yesterday’s meeting, circa 3:15PM, one of our analysts slammed his laptop and left the room in a frenzy. This had nothing to do with Penney telling Hesham Shaaban to “embrace meditation” – one of his Best Short Ideas, Twitter (TWTR) was blowing up!

 

Fat finger on the pre-market close release. Stock down 18% in a New York minute. Halted. #Boom!

 

And the Hedgeyes smiled.

 

There’s something about building an independent think tank that prides itself in SELL ideas that gets me up in the morning. As most of you know, building a repeatable #process on the short side is not an easy thing to do. That’s why we’re doing it.

 

At one point in the QA session of the meeting, I was asked what our “pipeline of prospective analyst hires” was looking like. And, for the first time, instead of rattling off names of people we’re interviewing, I said I just wanted to see more of our rookies play.

 

Not only do the “young” guys/gals at this firm get how to not be certain about anything, they know how to build a battle-tested #process that allows them to probability weight both the accuracy and timing of their research ideas.

 

While you can criticize Shaaban for literally never having presented a Best Long Idea (yet), he’s nailed the following names to the proverbial NHL playoff boards in the last 18 months (i.e. since we let him start publishing on his own names):

 

  1. Weight Watchers (WTW)
  2. eHealth (EHTH)
  3. Pandora (P)
  4. Yelp! (YELP)
  5. Alibaba (BABA)

 

In other words, what he really needs next is to get run-over in one of these things. Because no analyst I have ever worked with stays this good (on the short side) for this long, in an up market!

 

I obviously don’t want the man to get crushed. But reality is that everyone gets tagged in this business, eventually – and that’s how we all learn. But if you listen to Shaaban talk through his ideas, he’s constantly talking about not only what he doesn’t know… but what the management teams he follows don’t know either.

 

And that, my friends, is how you get really good at this game.

 

That’s how you beat the guys who take the short-cuts, cheat, and have no other process than asking “management” what the numbers are. When management doesn’t know what they don’t know – the fundamentally driven research analyst who thinks for himself wins.

 

As for what macro “management” (The Fed) really knows… Cyclically, do they get that the US is #LateCycle? Secularly, do they get global demand is slowing due to #DemographicYields? We’ll see.

 

Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:

 

UST 10yr Yield 1.85-2.02% (bearish)
SPX 2095-2126 (bullish)

RUT 1 (bullish)
DAX 118 (bullish)
VIX 11.89-14.82 (neutral)

USD 95.63-97.83 (bullish)
EUR/USD 1.06-1.10 (bearish)
YEN 118.55-120.81 (bearish)
Oil (WTI) 52.61-58.30 (bearish)
Natural Gas 2.44-2.62 (bearish)
Gold 1181-1215 (neutral)
Copper 2.65-2.83 (bearish)

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Who Really Knows? - z 04.29.15 chart


TWTR: Rock and a Hard Place (1Q15)

Takeaway: Comping the 2Q13 Supply Shock will remain its Achilles heel until it finds better way to monetize its model. That won't be easy

KEY POINTS

  1. WORSE THAN WE EXPECTED: While we were expecting light 2Q15 guidance, which missed consensus by $60.5M (11%) at the midpoint, TWTR also missed 1Q revenues, and cut full-year revenue guidance by $100M.  There was a lot of noise on the call, but the culprit was ad engagements (see point 2), and tougher comps from non-recurring 1H14 tailwinds. 
  2. THE ISSUE WITH THE MODEL: TWTR’s recent strength in monetization had been driven by a rampant increase in ad load starting in 2013 (what we call the 2Q13 Supply Shock).  Now that TWTR has fully comped that tailwind, it is struggling to drive the type of growth that the street is expecting since ad engagements are decelerating precipitously on a y/y basis.
  3. ROCK AND A HARD PLACE: While we were very encouraged by the surge in Ad Pricing (CPE), we don’t believe that can turn the tide on its own.  TWTR will need to beat both revenue and MAU expectations in perpetuity to appease the street, yet its reported metrics suggest those two factors are working against each other.  In short, limited options with even less breathing room.

 

WORSE THAN WE EXPECTED

While we were expecting a light 2Q15 guidance, which missed consensus by $61M (11%) at the midpoint, TWTR also missed 1Q revenues by $21M (4%), and cut full-year revenue guidance by $100M. Management highlighted pressure on its direct response ad products in 1Q15, citing more stringent ad engagement requirements and somewhat faltering demand from rising ad prices.  

 

But the real culprit was decelerating ad engagements across its entire business (see point 2), and consensus estimates that weren't adequately considering from non-recurring 1H14 tailwinds (Olympics/World Cup).  Collectively, we believe this was the source of the shortfall in 2Q15 guidance. 

 

TWTR: Rock and a Hard Place (1Q15) - TWTR   Ad Engagement vs. CPE y y 1Q15

TWTR: Rock and a Hard Place (1Q15) - TWTR   FC Adj Ad 2 4Q14

 

 

THE ISSUE WITH THE MODEL

TWTR’s monetization strength had been driven by a rampant increase in ad load starting in 2013 (what we call the 2Q13 Supply Shock), which we believe was a sudden and sustained surge in ad load that drove much of TWTR's revenue growth through 2014 (more detail in our note, and S-1 excerpt below). 

 

TWTR: What the Street is Missing

05/19/14 09:09 AM EDT

[click here]

 

TWTR S-1/A MD&A (11/4/2013): “The decreases in cost per ad engagement over these periods [3Q12-3Q13] were primarily due to an increase in supply of advertising inventory available in our auctions, which was partially offset by increased demand for our Promoted Products. Supply of advertising inventory increased as we expanded the distribution of our Promoted Products to our mobile applications and additional markets outside of the United States in 2012. The increase in advertising inventory provided us with additional opportunities to place ads on our platform.”

 

Now TWTR is seeing a precipitous slowdown in average ad engagements, which means it must find a way to drastically improve its ad targeting ability, or increase ad load at a disproportionately higher rate to achieve comparable ad engagements.  That leads to a bigger problem..

 

TWTR: Rock and a Hard Place (1Q15) - TWTR   Ad Engagement vs. CPE q q 1Q15

 

ROCK AND A HARD PLACE

We were highly encouraged by the surge in Ad Pricing (CPE) in 1Q15, which not only a budding growth driver, but a testament to advertiser demand and improving products mix.  However, we don’t believe that can turn the tide on its own.

 

TWTR will need to beat both revenue and MAU expectations in perpetuity to appease the street going forward; yet its reported metrics suggest those two factors are working against each other.  So while TWTR could gamble on a muted surge in ad load, with less potential risk of a material drawdown in CPE from the tailwinds mentioned above, there is a chance it would sacrifice MAU growth at the same.

 

In short, TWTR appears to have limited options, with even less breathing room from consensus.  

 

TWTR: Rock and a Hard Place (1Q15) - TWTR   Ad vs. MAU 1Q15

 

 

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

 

Hesham Shaaban, CFA

@HedgeyeInternet


The Tax Man Cometh

This note was originally published at 8am on April 15, 2015 for Hedgeye subscribers.

“The avoidance of taxes is the only intellectual pursuit that still carries any reward.”

-John Maynard Keynes

 

If any of you are like me, you hate paying taxes.  Admittedly, I’m just a lowly sell side Director of Research, so I don’t make nearly as much money as many of you Masters of the Universe. That said, paying taxes every year still feels punitive.

 

Sure, I get the patriotic component of paying your taxes (even though I’m technically Canadian), and certainly we all do have an obligation to help those who are less off in our society.  But the fact remains: our tax bill every year is astonishingly high.

 

In fact, in their most recent projections, the Congressional Budget Office projects that more than $2.6 trillion, or 80%, of the projected revenue for the federal government will come from the combination of individual income taxes and payroll taxes.  On the other hand, corporations will contribute a paltry $328 billion to the annual revenue of the Federal government.

 

The bigger question is how all of this hard earned money is being spent.  As a percentage of the projected 2015 Federal government outlays, the largest buckets are:

  • Medicare and Medicaid – 26%;
  • Social Security – 24%;
  • Discretionary defense – 16%; and
  • Interest – 6%

Incidentally, the deficit in 2015 is expected to be an additional -$468 billion and projected to grow to - $1.1 trillion by 2025.  So if you want a long term reason why interests will be somewhat capped in the United States, it’s simply that the U.S. government can’t afford to pay high rates on the $7.6 trillion in debt it is going to have to borrow over the next decade to fund the federal budget.

 

Of course there is an alternative. The government could just raise our taxes and not borrow so much . . .

 

Back to the Global Macro Grind...

 

Now, inasmuch as we all wish to pay lower taxes and had more discretionary income, not all alternatives are that compelling.  In fact, our system is pretty good.  If this were a communist system, the government could just take all of our money! Speaking of which, China reported GDP numbers last night for Q1.

 

The Tax Man Cometh - China cartoon 04.14.2014

 

In today's Chart of the Day, we highlight Chinese GDP growth going back five years by quarterly y-o-y growth.  As you can see, this is the slowest growth in that time period. The direction is very clearly that of a long term deceleration mode.

 

This point was reiterated in the post release press conference (yes, even Communists have pressers!) as a National Bureau of Statistics official made the following comments:

  • Important to keep property market steady;
  • Economy likely to remain under pressure in Q2 as destocking, clearing over capacity could take time; and
  • Prioritize stable growth, jobs and profitability.

Actually, it sounds like almost the perfect economy! Although there is no word on whether anyone asked at the press conference how rail traffic in China could be down 9% year-over-year in Q1 and GDP be up 7%. But far be it for us to focus too much on the details.

 

Over in Europe, there was also some not-so-shocking news... The ECB left rates, gasp, unchanged!  Draghi is set to have a presser of his own at 8:30am ET and while he may get tougher questions than the Chinese official did during their GDP press conference, we can be fairly certain his dovish tone is unlikely to change.  

 

If you don’t believe us on the likelihood of a continued dovish tone, then just look at the data. Germany’s March CPI came in at a final number of +0.3% and the EU came in at +0.1%.  Clearly, Draghi has a lot of data cover to continue incinerating the Euro and implement his QE program.

 

The more interesting pin action in Europe relates to the heightened and continued rhetoric over potential for a Greece default.   The Germans are leaking that they likely won’t approve an April transfer to Greece and the Greek Prime Minister is apparently headed to Washington where he will, among other things, meet with a sovereign debt / bankruptcy lawyer from Clearly Gottlieb.  This is starting to get interesting!  But don’t worry, a Greek default will be completely contained . . .

 

Finally, a recent survey from Bank of America highlighted the strongest case we’ve noticed in a while for the bond and equity bull markets to continue.  According to the survey, four in five managers think the bond market is overvalued, which is the highest proportion ever.  In addition, a quarter thought equities were overvalued, the highest since 2000.

 

It reminds of the quote from Sir John Templeton:

 

“Bull markets are born on pessimism, grown on scepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”

 

Indeed.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.85-1.96%

SPX 2080-2110
VIX 12.66-16.01
YEN 118.81-120.98
Oil (WTI) 48.65-54.28

Gold 1182-1219

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

The Tax Man Cometh - 04.15.15 chart


Early Look

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Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

WYNN: ESTIMATES AREN’T THE ONLY THING BEING CUT

Takeaway: DIVIDEND CUT COMPOUNDS A VERY BAD QUARTER

CALL TO ACTION

As if badly missing sharply (and recently) reduced estimates wasn’t bad enough, Wynn Resorts also cut its dividend.  WYNN traded down 10% after hours last night in response.  Contrast this stock action with LVS last week which held up (down only 2%) despite a quarter that revealed much more troubling trends (base mass) than anything in the WYNN release. The difference? LVS maintained the dividend. 

 

So where do we go from here? Beyond the initial reaction to the respective dividend policy decisions, let’s get back to earnings drivers. We wouldn’t be buyers of either stock but with WYNN down 10%, LVS looks like it has more downside. The biggest risk going forward, on the margin, is not VIP, it’s base mass. Yes, LVS has decided to do what it can to protect the dividend and that’s great.  WYNN, in typical fashion, is being more conservative. However, dividend cuts typically follow cash flow trends, albeit in a lumpy fashion. With with each passing day, the probability of an LVS dividend cut increases.  

 

Please see our detailed note:  

http://docs.hedgeye.com/HE_WYNN_Doom_4.29.15.pdf


April 29, 2015

April 29, 2015 - Slide1

 

BULLISH TRENDS

April 29, 2015 - Slide2

April 29, 2015 - Slide3

April 29, 2015 - Slide4

April 29, 2015 - Slide5

April 29, 2015 - Slide6 

BEARISH TRENDS

 

April 29, 2015 - Slide7

April 29, 2015 - Slide8

April 29, 2015 - Slide9

April 29, 2015 - Slide10

April 29, 2015 - Slide11


WYNN Q1 2015 CONFERENCE CALL NOTES

Takeaway: WYNN missed lowered estimates badly and cut the dividend. Negative implications for LVS and MGM.

WYNN Q1 2015 CONFERENCE CALL NOTES - WYNN

 

CONF CALL

  • Hope for improvement from CNY turned out to be incorrect 
  • Degradation in VIP volumes have continued even into April
  • Q1 trends have continued into April
  • Las Vegas softness: Asian impact on baccarat
  • Dividend lowered based on soft results.  Board of Directors would not hesitate to change dividend policy again going forward.
  • Wynn Palace on track to open on March 2016
  • Allocation of new tables depend on non-casino/casino % (Wynn Palace has most attractive non-gaming option).
  • Wynn Everett:  Start construction in the fall; almost completely financed with non-recourse debt 
  • "Don't want to div out borrowed money"
  • New junket rooms did well.  Other junket operators 'weren't as powerful'.
  • LV Occupancy/room night fell YoY: because of ConAgg comps in March.  Lot of convention business but not much room inventory in January.  
  • LV:  May convention strong mix; 
  • LV: Summer trends in 2015 not pick up as in previous years due to stronger $ and weak Chinese play
  • LV: EBITDA decline continued in April
  • LV: Non-casino rev was flat in 1Q and will be flat in 2Q
  • Macau Labor allocation: got less than what they wanted and appealed the process
  • Macau:  smaller inventory of rooms than their competitors so less of an occupancy drop
  • Grew mid-segment of their mass segment quite nicely
  • 2014 employee turnover was 11% (less than market average of 20-25%) but will not protect them in the new changes in the marketplace
  • Uncertainty is the word of the day in Macau
  • Social harmony affected by Cotai expansions
  • Beijing policies have been unpredictable
  • Dividend policy:  quarterly reviewed. Want to avoid another deduction. 
  • Reallocated rooms from VIP to mid-tier mass.  Over half of rooms are now allocated to mass.
  • Slow down project in Cotai and/or Boston?  Can't slow it down. 
  • Chinese President Xi Jinping unequivocally supports Macau
  • Japan Diet: study bill appeared today. Good news.
  • Macau:  decline in VIP has opened a window to attract more premium mass customers. 
  • Wynn Palace: primarily a non-casino attraction
  • Wynn has smoking lounges in the terraces, some competitors don't have some advantage
  • Macau LRT bridge:  should be done in 2017 or as late as 2020.  Need to take care of reclaimed land issue from HK.
  • Boston: making forward with permit progress. Have performed drilling on site.  Hopefully get it open at end of 2017. Have spent $200m to date. Still need to spend $100m more on remediation and other fees before groundbreaking this year.

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