WTW: Covering Short

Takeaway: No fundamental change to thesis. WTW just isn't interesting anymore.

We shorted WTW back in January 2014 when the jury was still out on its questionable prospects within a rapidly evolving industry.  That debate is over.  Now it's just a question of whether the company will go bankrupt.  


As a reminder, WTW is dangerously approaching the point where it costs more to acquire its members than the gross margin it earns from them.  If that ever happens, it’s basically game over.  WTW’s 2015 target of $290M in cash can only go so far with an annual debt service of roughly $120M.  For more detail, see the note below.


WTW: Chapter 11?

02/27/15 08:46 AM EST

[click here]



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


Hesham Shaaban, CFA



Thomas Tobin



EVENT: Internet FOCUS LIST Quarterly Update

Takeaway: Please join us for our call Thursday, July 23rd at 1:00pm EDT. Dialing instructions will be published Thursday morning.

We will be hosting our quarterly INTERNET FOCUS LIST Update Call this Thursday.  We will be reviewing the major themes and incremental developments to our Best Idea Short theses (YELP, P), our Short thesis on TWTR, and our Bearish thesis on BABA (covered).  The emphasis of this call will be to highlight our view over various durations as well as the upcoming catalyst calendar; identifying the major risks and catalysts to each position over the near-to-intermediate term.  In addition, we will preview our new Best Idea Long thesis on LNKD ahead of our upcoming Blackbook.


Please join us for our call Thursday, July 23rd at 1:00pm EDT.  Dialing Instructions will be published Thursday morning.



  • Review of major themes and incremental developments to our thesis on YELP, P, TWTR, and BABA.
  • Highlighting our view over various durations as well as the upcoming catalyst calendar: Risks & Catalysts to each position over the NTM.
  • We will also provide an overview of our new Best Idea Long thesis on LNKD


Hesham Shaaban, CFA


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.47%
  • SHORT SIGNALS 78.68%

Dangerous New Highs for the Market?

After nearly two months under water, the benchmark S&P 500 has finally made a new all-time high. While optically impressive, there are a myriad of quantitative signals underneath the hood that do not support chasing the market here.


Immediate-term TRADE Duration Risk: The SPX is at the top end of its immediate-term risk range of 2,091-2,130.


With nearly 2% downside, 0% upside and the VIX nearing the low end of our 11.29-14.59 immediate-term risk range, investors would do well to book gains in U.S. equities here (i.e. reduce gross and/or tighten net exposures). As Keith highlighted on today’s Macro Show, if 2,091 breaks, there’s no support to 2,035.


Dangerous New Highs for the Market? - SPX


Intermediate-term TREND Duration Risk: Our Tactical Asset Class Rotation Model (TACRM) is now generating a “DECREASE Exposure” signal for U.S. equities. Currently, TACRM is generating a commensurate bearish signal for each of the six primary asset classes tracked by the model (slide 6).


Sell everything? As predicted in our previous refresh, the recent bullish-to-bearish reversals in Emerging Market Equities, Foreign Exchange and Commodities were, in fact, a harbinger for similar breakdowns across the Domestic and International Equities asset classes. Our recent decision to add SPY to the short side of our thematic investment conclusions confirm how we are thinking about this risk in real time. At the bare minimum, it implies investors would do well to reduce their gross exposure and/or tighten up their net exposure to global asset markets.  


CLICK HERE to learn more about TACRM, what these signals imply and how best to incorporate them into your investment process.


Long-term TAIL Duration Risk: Market breadth is broadly deteriorating and in dangerous territory.


One of the conventional “isms” of stock market analysis is that benchmark indices tend to peak very late into the economic cycle – well after broad-based signs of deterioration have emerged at the single-stock level.


In the face of a #LateCycle slowdown, benchmark indices are able to continue higher due to the fact that investors increasingly crowd into large-caps and/or stocks that have idiosyncratic growth opportunities that are less tethered to the [deteriorating] economic cycle, at the margins. Ultimately the cycle always prevails (see: 2000-2002 or 2007-2009), but positive absolute returns can be sourced from an increasingly narrow group of stocks and/or style factors well into the start of any given bear market.


Dangerous New Highs for the Market? - SPX 2000 02

Source: Bloomberg L.P.


Dangerous New Highs for the Market? - SPX 2007 09

Source: Bloomberg L.P.


There’s a number of ways to measure market breadth on a trending basis (e.g. % of stocks making new highs, % of stocks correcting, % of stocks crashing, etc.), but for the sake of simplicity we track the percentage of stocks below their respective 50-day and 200-day moving averages in the Russell 3000 Index – which, at covering about 98% of the investable public equity market, makes it the broadest measure of the U.S. stock market.


On this measure, broad U.S. equity market breadth is as poor as it has been at any local peak since 10/9/07 – the previous cycle’s all-time high closing price for the SPX – surpassing the deterioration we saw at the 5/21/15 high, which was very much on par with the 7/19/07 local peak.



Dangerous New Highs for the Market? - BMBI 7 20 15


October 9th, 2007:

Dangerous New Highs for the Market? - BMBI 10 9 07


May 21st, 2015:

Dangerous New Highs for the Market? - BMBI 5 21 15


July 19th, 2007:

Dangerous New Highs for the Market? - BMBI 7 19 07


While not useful as a timing indicator, the aforementioned deterioration does imply the duration and scope for prospective returns are substantially worse than many investors may assume given consensus expectations for the length and strength of the current economic cycle, which we can loosely infer from consensus expectations for U.S. monetary policy.


Checking back in with TACRM, we are seeing market leadership increasingly concentrated amongst the exact style factors we’d expect to outperform in the latter innings of an economic and market cycle: large-caps (defensive safety and dividends), healthcare (increased consumption and the ability to maintain pricing power during economic downturns) and growth (many biotech and new tech companies don’t have earnings to speak of, therefore investors don’t have to worry about earnings misses derailing the momentum of the respective charts).


Dangerous New Highs for the Market? - 8


All told, we hope you find these quantitative signals helpful with respect to your individual investment mandate. As always, feel free to email us with questions.


Best of luck out there,




Darius Dale


The SEC Tweets – Relentless Pursuit

By Moshe Silver


The SEC trumpets its latest investor protection enforcement actions (Litigation Release 23303 / July 14) charging 34 individuals and entities with manipulating microcap stocks. Among the alleged perpetrations, the activities of one Harold Bailey “B.J.” Gallison II caught our eye. 


Call us cynical, but we’ve been around this industry a long time.  In fact, we were already seasoned professionals back in 2000 when the SEC brought fraud charges that resulted in said B.J. Gallison being sentenced to five years in prison. 


The SEC Tweets – Relentless Pursuit - z eye


This week’s SEC 67-page complaint describes Gallison as “a repeat securities law violator,” citing his “extensive regulatory history” back to 1996.  Gallison, now 57, is charged with running a brokerage operation out of Costa Rica that facilitated fraud by providing “anonymity to customers who sought to manipulate the market for microcap stocks in the US,” including shares in a company with the imposing name of Warrior Girl.


Details of the alleged fraud include such Hollywoodesque monkeyshines as having US-based fraudsters posting fake background photos on their Skype accounts to give the impression they were located in Costa Rica – rather than sitting in an apartment in Spokane, WA, where they were not registered and therefore not eligible to run stock orders for US customers.  The press release alleges some $5 million in purported illicit gains from only two of these activities; the full extent of customer losses may never be determined.


The bottom line is that every dollar fraudulently obtained by such activities is an after-tax dollar taken right out of the pocket of a private investor.  And, given that these frauds have been around for decades, it continues to be the least sophisticated investors who get caught in them – read: the least well educated and the least affluent.  The $5 million or so referenced in today’s press release likely represents serious pain for families who can ill afford the losses.

Once there were two people who decided to go into business together: one of them had money, the other had experience.  A year later, the positions were reversed.  Welcome to our world.


For all the Commission’s turning up the heat, we find it not so comforting to know that a convicted stock fraudster continues to ply his trade over a decade after his last case came to light.  The prosecutor in the 2000 case told news media at the time that Gallison showed open contempt for regulatory efforts to block his activities, and he predicted that Gallison would continue to run his illicit activities from his prison cell (Take that, El Chapo!)  It is not clear whether any measures were put in place to hinder or even surveil Gallison’s activities subsequent to his being released from prison.  We’d guess not.


It is worth quoting verbatim from the SEC release:


“ ‘This case demonstrates the Commission’s resolve to relentlessly pursue the villains behind these microcap fraud schemes wherever in the world they may be hiding,’ said Andrew M. Calamari, Director of the SEC’s New York Regional Office.  Michael Paley, Co-Chair of the SEC Enforcement Division’s Microcap Fraud Task Force, added: ‘This case presents an excellent example of the capacity the Microcap Fraud Task Force has developed to pierce the layers of sham entities and nominee accounts that predators employ to harm investors and evade detection by law enforcement.’ ”


We are not aware of any serious effort either by law enforcement or by academics to calculate how much money is lost by small investors who get caught up in these scams, but our best estimate is: lots and lots.  It may be a cheap shot to go after the Commission for cases such as this, but with Gallison on their radar as far back as 1996 – and with him having done jail time for essentially the same activities – we wonder where the Justice Department is on such cases – not to mention apparent lack of international coordination, though it is well known that such frauds are routinely perpetrated from offshore – and we wonder equally what yardstick the SEC is using to measure their “relentless resolve.”


The SEC is asking for the usual: disgorgement and restitution.  We’re not sure where that money is supposed to come from, nor how far the law will punish Gallison and his cronies if they are convicted.  If you had the opportunity to buy shares in Warrior Girl and didn’t, this would be a good moment to wipe your brow and praise Divine Providence.  If you did buy shares in Warrior Girl, we suggest you seek solace in the relentless resolve of the federal agency.


And don’t do it again.


Moshe Silver is a Managing Director at Hedgeye Risk Management and author of Fixing a Broken Wall Street.


MCD is on the Hedgeye Restaurants Best Ideas list as a LONG.

A widely popular McDonald’s survey released last week, articulated how dissatisfied McDonald’s franchisees are with the current environment in which they operate.  We don’t disagree with the conclusions of that survey; in fact, the survey sheds light on some alarming concerns that we highlighted in our recent Black Book.


Our thesis on McDonald’s is that the company is broken and is in the process of being fixed and there are other issues to consider when analyzing the health of the McDonald’s franchise system.  In addition, most of the broader opinions in that survey are backward looking.


Taking the other side of this debate and looking at it from a different perspective, there are two critical metrics to consider: 

  1. Franchisee profitability
  2. Franchisee EBITDA valuations

MCD is far from fixed and there are problems within the franchise system that still need to be addressed, but the company and franchisees are healthy.  From the franchisee perspective, the MCD concept is one of the best quick service restaurants to own and we remain confident McDonald’s management is taking the right steps towards returning the business to prosperity.


In fact, the same survey that says the company is broken makes the same point we are.  As one operator in the survey said:


“…We have the best cash flow in the industry driven by our higher sales and guest counts…Operators will need to evaluate the lifestyle they currently live and determine if five or less stores will generate enough cash to support their habits and complete investments necessary to keep the brand strong.”


Below is a chart that looks at McDonald’s Franchise system sales and margin performance.  This chart makes the point above that the McDonald’s concept has the best cash flow in the industry. 




According to our data, Franchisee EBITDAR margins peaked in 2010 at 25.3%.  We would note that this is the same year MCD made its big push into beverages and launched the “cold” side of its McCafe strategy.  With the big push into beverages and expanding the afternoon day-part, average unit volumes peaked two years later in 2012 at $2.6 million. 


Since their respective peaks, by 2014 margins had fallen 260bps and average unit volumes had fallen by $62K.  It’s also important to note that in 2014 MCD EBITDAR margins although down remained strong at 22.7%.


After 3-4 years of declining margins its only normal for franchisee anxiety to be at peak levels and it also makes for great press as MCD is an easy target.

What is even more challenging is taking the other side (being LONG) and convincing people that there are plans in place that are going to help franchisees and shareholders be better off.


Clearly, some of the concerns and negativity from franchisees are warranted, but management is working hard on improving the business and alleviating these concerns.  Change will not happen overnight. 


Another issue the company faces is that there are a significant number of McDonald’s franchisees, and management is not going to make everyone happy.  The largest MCD franchisee owns 60 stores, with the top ten largest franchisees owning a total of 409 stores in the U.S., representing 2.9% of the system. The implications are that there are thousands of franchisees that all have an opinion on how things should be run!


Another important metric to consider is franchisee valuation trends.  Looking at the data from Restaurant Research, the data on valuation trends also point to a very healthy system.


The chart below displays the unit level EBITDA multiple valuation trend for MCD, which peaked in 2014 at 5.75x, +16% higher than the segment average. 




The demand for MCD restaurants among new and existing franchisees remains very healthy, despite the issues the company faces. 


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