FL: The Footlocker Wish List

Foot Locker remains one of our top ‘bench’ ideas headed into 2010. No, the timing still is not right, but the fundamental story should begin to align – for the first time in a long while. There’s still a wall of silence from FL on its strategy. Here’s our initial wish list.


On our 4Q theme conference call (if you missed it, let us know and we’ll get you the slides/replay), we mentioned that we were warming up to Footlocker.  We still are. And while we definitely don’t have all the answers on this one, we continue to dig deeper in an attempt to figure out the potential for a turnaround.  Importantly, there seems to be a fair level of interest (and intrigue) with our focus here.  Not because Foot Locker is a screaming buy at this very moment, but because it has fallen off of so many people’s radar screens over the past couple of years.


In absence of answers, we do have plenty of questions.  And based on the FL-related inquiries hitting my inbox, so do you.  I’m get the same simple question from anyone who is even remotely interested in understanding what’s going on at Footlocker.  What can they possibly do to fix this business?  Not having done a ‘double secret one-on-one’ we have no special “insight” into recently hired Ken Hicks’ game plan, but here’s an initial wish list for what should be key to improving the future of the chain:


  • Right-size the store base and optimize the portfolio by brand.  With 8 sub-brands (Footlocker, Footlocker International, Lady Footlocker, Kids Footlocker, Footaction, Champs, CCS, and Eastbay) there is ample opportunity to put the right stores in the right place.  Historically, the focus has been overly centered on the total portfolio and a modest amount of store closings in any given year.  Recall that past management was very much in favor of “addition by subtraction”, which resulted in a 3-4% per annum reduction in square footage over the 2007-2008 period.  Many conference calls of yesteryear touted the 50bps annual benefit the company could achieve by simply closing stores. Closing a large amount of stores may or may not be the right answer. After all, one might argue that mass store closures would take away some of the leverage FL has with vendors and landlords as an 800lb gorilla.  But with a 30+ point margin spread between the least profitable and most profitable stores, doing the analysis is a start.


FL: The Footlocker Wish List - fl store growth


  • Focus on the product.  Sounds simple, but it’s not.  When 60+% of your merchandise comes from one vendor (Nike ranges from 44% to 78% of total sales depending on the nameplate), it seems to me that this is a “buy” and not a “sell” mentality.  Ken Hicks brings a substantial amount of experience to the table in areas of sourcing, branded apparel and footwear, large chain store operations (Payless), and private label/exclusive brand development.  All of these areas are key to the future of Footlocker in my view.  Better brand balance (less Nike, more of everything/anything else), improved product mix utilizing apparel to drive higher gross profits, and increased use of exclusive product offerings to drive pricing power and differentiation should all be considered.  The days of trying to cross sell 5 for $20 tees with marquee Nike’s must come to an end.


FL: The Footlocker Wish List - nike footlocker


  • Europe probably doesn’t need as much fixing.  The non-US operations are in a different state at this point.  The brand is better positioned overseas, with product more skewed towards the premium level. Competition is more confined to local and regional players and the business exists outside the “mall”.  Quite simply, if it ain’t broke don’t fix it.  The US needs the most attention and at this point shareholders should recognize where the low hanging fruit exists.


  • This is not a financial engineering/restructuring.  With $438 million in cash and $138 million in long-term debt, there isn’t much to worry about here when it comes to liquidity.  Yes, the company has over $4 billion in operating lease commitments (that Wall Street loves to forget about) but that’s the price of admission when you operate in a mall.  An important consideration is that Foot Locker has among the shortest implied lease duration of most mall retailers. Not a bad place to be when the commercial real estate market is crashing and setting up for rate resets. The real focus here is on productivity and on profitability.  Both of which are achievable with the current balance sheet.  Are the stores tired? Yes, and maybe refreshing the in-store experience is part of the plan.  If it is, I don’t see it being at the top of the list or requiring substantial amounts of capital.


  • Seeds planted for limited, but some growth.  In the near to intermediate term I would be surprised to hear much about growth.  This is clearly a margin recovery story.  EBIT margins are likely to end the year below 3%, but were in the low 7% range from ’03-’06.   With a strong and well capitalized e-commerce platform, a growing International business, and the seeds planted for a new concept in CCS there will at some point be an opportunity for Footlocker to use its cash flow for new projects.  It just won’t be anytime soon.


So what’s next?  Hicks is expected to unveil his plan in the Spring, with the reporting of 4Q results.  We won’t be surprised when some combination of the abovementioned strategies will be employed to begin the turnaround.  Neither should you.  The question here is not what ideas will be communicated but rather if and how well they can be executed.  For us, the change in leadership alone is likely to be biggest single factor in the process.  At least to start.  No one needs to be buddies with Ken Hicks or get that exclusive early access to recognize that this company needs a new strategy, implemented by a new leader.  The old rules of bigger is better no longer apply.  Collaboration with Nike and Under Armour and Adidas and others will be key to this new focus.  Bullying suppliers and being overly reliant on one brand is no longer an option. 


It’s time to start paying attention to Footlocker as it remains one of the few retailers with a sizeable revenue base and a reason to exist, that has not benefitted from cost cutting and inventory cuts like the rest of retail. 


You’ll be hearing a lot more from us on this name headed into ’10.


Eric Levine


The End Of History

“What we may be witnessing is not just the end of the Cold War, or the passing of a particular period of postwar history, but the end of history as such…”
-Francis Fukuyama

It is impossible to separate a strong Macro process from having Edge on the state of the US Healthcare System. Here’s a look from Tom Tobin (Research Edge Healthcare Sector Head) as to how the two come together.

The disconnect between the politics of Washington D.C. and the economics of Wall St. are well known.  It is like a bad marriage of two co-dependent and borderline personalities.  On the one hand the banker identifies with the hand of God, He-eth who enables the creation of capital and the attending prosperity it brings to “the people.” Meanwhile politicians call bankers names like fat cats, and slander them with accusations of ripping tax payers off with free money government bailouts.  Politicians for themselves invoke the spirit of Jimmy Stewart’s Mr. Smith when they speak of their own role in the History of Man.  The banker remains silent in the argument at this point, at least publicly, and just tries to figure out who he has to pay to get favorable language in the next round of regulation.  All the while, the kids in the back seat are the American Public who rightly assumes they are getting taken for a ride by both.  Over the long term, the noise and bluster is just that, noise and bluster.

Politics is a process of seeking the advantage on the margin, the P&L consisting largely of intangibles, such as political capital and favors to call in.  But it leaves an outsider constantly grasping at their real motivation.  Personally, I hope the answer to the parlor game on the Left of “what Joe Lieberman got paid to kill the Public Plan” is more than a junket to play golf in Scotland.  At least on Wall St., your P&L is measured in dollars, the ultimate truth serum.  That is of course, you didn’t cheat to get there. 

For a time, President Obama held the mantle of renewal and rebirth for American politics.  Unfortunately, at least for the 45% of Americans currently registering their disapproval, that is no longer true.  There was a time when 80% of Americans approved of their newly elected President, so that must have included at least a few Republicans, and maybe a few who did not understand the question, or both.  When Americans loved him we were in a state of crisis, the next great Depression was upon us, and they were scared. 

Like Fukuyama’s End of History, President Obama promised an end of history in Washington D.C.  Transparency and Accountability would reign over the lobbyists, fat cat bankers, unjust wars, no-bid contracts, and tax cuts for the rich, putting the reins of power in the hands of the commoner.  But the bitter truth is Transparency and Accountability has been noticeably absent as the rhetoric has soared above the fray on high minded clouds, while the politics of the possible on the ground ended in school yard taunts.

Whether it is the Burning Buck and crisis-level Fed Fund rates, Swine Flu, Afghanistan, or Health Reform I, the speeches, while inspiring, have found their targets to be elusive.  The problems facing Healthcare are well known; Medicare will go broke in 2017 despite, or more likely because of, private market subsidization of the government who chronically underpays providers, uses a political process to set prices, and gets robbed daily.  The predictable outcome, which has been evolving over decades, has been spiraling healthcare inflation, and a swelling population of the uninsured.  With or without the subsidies outlined in Health Reform I, insurance premiums will be $20,000 per year for a family of four by the time Health Reform hits in 2014.   Either it was because nobody could ask the question, or wanted to hear the answer, but the most obvious question was never asked, which is “why is healthcare is so expensive?” The answer, of course, can be found where the costs are, at the hospital (31% of spending) and in physician offices (21% of spending).   

Now that the process is near complete, it seems the American taxpayer doesn’t have the right guy on speed-dial. The Obama team cut deals with the American Medical Association, who represent doctors and whose membership is dominated by high cost specialists (70%), and the American Hospital Association, even before the question of cost and quality were even discussed. This was an early sign that President Obama’s view of Transparency and Accountability were open to interpretation.

But things evolve and that is the key variable that Fukuyama forgot to contemplate in his end of history thesis.  Maybe if he had reviewed Darwin, or the modern updates of evolutionary theory, he would have found that evolution is a process that happens on the margin.  The end of communism was a triumph of western liberal democracy, but it did not happen the day the Berlin Wall came down, nor was the aftermath completely written.  Young men and women dying today in Afghanistan is our sad inheritance of that victory. 

Complex systems (markets and politics) and the organisms that populate them (bankers and politicians) have the power to passively and stably self organize.  This stability requires more than just one isolated event to define a new trend.  Joe Lieberman is not a lone gunman.  In this or any era, I don’t think “the people” particularly care about politics day to day.  Whether President Obama likes or not, a continuous state of crisis is unsustainable.  Even crisis can become commonplace.  The Marxist-Leninists saw themselves as “liberators” of the proletariat, and we know how that disconnect ended.

Tom Tobin
Managing Director
Healthcare Sector Head

VXX – iPath S&P500 Volatility For a TRADE we bought some protection at the market's YTD highs by buying volatility on 12/14.

EWZ – iShares Brazil As Greece and Dubai were blowing up, we took our Asset Allocation on International Equities to zero.  On 12/8 we started buying back exposure via our favorite country, Brazil, with the etf trading down on the day. We remain bullish on Brazil’s commodity complex and believe the country’s management of its interest rate policy has promoted stimulus.

XLK – SPDR Technology We bought back our position in Tech on 11/20. Rebecca Runkle has an innovation story in Mobility and Team Macro has an M&A story in our Q4 Theme, the “Banker Bonanza”. We’re bullish on XLK on TREND (3 Months or more).

GLD – SPDR Gold We bought back our long standing bullish position on gold on a down day on 9/14 with the threat of US centric stagflation heightening.   

CYB – WisdomTree Dreyfus Chinese Yuan
The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP – iShares TIPS The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

EWJ – iShares Japan While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

XLI – SPDR Industrials We shorted Industrials again on 11/9 on the up move as the US market made a lower-high.  This is the best way for us to be short the hope of a V-shaped recovery.   

XLY – SPDR Consumer Discretionary We shorted Howard Penney’s view on Consumer Discretionary stocks on 10/30 and 12/2.

SHY – iShares 1-3 Year Treasury Bonds  If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.


The Macau Metro Monitor.  December 17th 2009.



Trade between Macau and the Chinese interior has risen more than three-fold in the last ten years, totaling US$2.91 billion, according to the Chinese trade ministry.  A Xinhua-published report also noted that since 2006, all products manufactured in Macau have been exempt from taxes, which “made industrial restructuring easier” for the territory.


Most of Macau’s banks now operate with yuan and, last October, deposits in the currency of the People’s Republic of China totaled US$258 million, according to the trade ministry.




The parent company of Macau casino operator Melco Crown Entertainment is seeking to extend the maturity date of a HK$1.175 billion convertible loan due next September.  The extension is being sought in order to ease its funding needs, according to the company.

Early Look

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We are waking up today to the U.S. Dollar Index trading at a 3-month high on the strength of the U.S. recovery.  On the MACRO calendar today we have initial jobless claims and the Index of leading indicators; both data points will signal continued economic improvement.     


Despite all the signs of an economic recovery and inflation returning in the US, yesterday’s statement from the FOMC meeting proved to be a carbon copy of the last.  While the Fed clearly referenced signs of a pickup in economic activity, it failed to acknowledge that the cost of living in the US is accelerating.  The FED is way behind the curve.  


Yesterday the DOW finished down 0.1% and the S&P 500 finished higher by 0.1%.  Although a late-afternoon pullback left the indexes closer to the lows by the end of the day.  The year is winding down and the Research Edge quantative models have the sector study breaking down. 


Yesterday the MACRO calendar was supportive of the global RECOVERY trade.  The MACRO data included better-than-expected economic data out of the US and Europe – US housing starts, UK unemployment, German and French flash PMIs.  This led to the outperformance of the sectors most leveraged to the RECOVERY theme, such as Materials (XLB) and Energy (XLE). 


The move into riskier assets was evidenced by the Russell 2000 rising by 0.8% and the VIX declining 4.4%.  Over the past week the VIX is down by 9.4%.


The second best performing sector was Energy (XLE).  The XLE benefited as Oil rose the most in a month yesterday after the Energy Department said U.S. crude inventories declined to the lowest since the week ended Jan 9th.


In November housing starts increased 8.9% month-to-month to a 574,000 annual rate.   The overall number benefited from multi-family starts surging 67.3; the biggest gain since 1992. Single-family starts rose 2.1% to 482K following a 7.1% decline in October.   Permits (a key leading indicator) were also looking positive - multi-family permits rose 8.8% and single-family permits were up 5.3%.   On the back of this news housing-related stocks were among the best performers in the Consumer Discretionary (XLY) and the XHB was up 1.4%.


The Financials (XLF) slightly outperformed the S&P 500 despite the headwinds facing the banks.  Within the XLF the Life insurance names were a bright spot with LNC and PRU leading the way.


The worst performing sector yesterday was Healthcare (XLV).  The XLV underperformed by 0.4%, despite the continued upbeat sentiment surrounding managed care stocks on watered-down reform expectations.  The PBMs were among the biggest headwinds for the XLV yesterday. 


The range for the S&P 500 is 1.0% upside and 1.0% downside.  At the time of writing the major market futures are trading lower.


In early trading today, crude snapped two days of positive performance as the dollar index is up 1%. 


In London Gold is trading lower as the dollar is higher.  Gold is now 8.1% below the record $1,226.56 reached on Dec 3rd.


Copper fell the most in a week, declining 1% to 3.17.


Howard Penney

Managing Director


Bernanke's Burden Of Proof - Vol. II

As expected the FED ignored the recent CPI and PPI data…..  I will not change from what I said earlier today - today’s CPI data solidifies Bernanke changing the language at the next meeting.  He needs to remove his unsustainable and unreasonable policy that remains “exceptional and extended.”


We have used the term “pandering” to reflect the fact that the Federal Reserve is subjected to short-term political pressures to keep rates low.  FYI--the time to raise rates is now! 


The consensus expectations are convinced that there is no inflation worries building in the economy  and that rates will stay "exceptionally low" to keep the economic recovery on track.  However, it’s my belief that the CPI continues to run counter to what REAL people and business are experiencing.


Tomorrow Ben will be in front of congress.  A cynic would suggest that today’s FED statement did not contain anything inflammatory ahead of the confirmation process, and that he is just trying to get to the January meeting. 


Howard W. Penney

Managing Director


CityCenter may or may not generate the buzz MGM hopes for, but if it does it probably won't come from Vdara.



We've been in Vegas, staying at the Vdara, since Sunday night, and below are some of our impressions of City Center and small tidbits that we've learned during the last few days


City Center mechanics

  • City Center may not have 5,900 rooms after all, or at least not for a long time
    • Vdara currently has 400 rooms open and will likely remain at this level until at least end of 1Q2010.  Until MGM can figure out which buyers are going to close on the reserved condos, and which will back out, they can't really touch most of the rooms at this property
    • Harmon, which (until recently) management recently assured investors would open in 2010, is now indefinitely postponed until at least 2011 or until demand comes back, whenever that may be
  • Whatever condos don't close in early 2010 will not likely get sold off for another 12-24 months (ie whenever the market recovers)
    • The Mandarin residential product, which is 93% reserved, should have the best closing rate.  We would guess in the neighborhood of 70-75%
    • For Vdara and Veer, a 60% closing rate would be optimistic.  The issue for Veer is that they need to sell at least 50% of the inventory in order for their JV lender to offload the mortgages to Fannie/Freddie.  Otherwise Veer is basically impossible to finance and will likely sit dark.  We think that MGM will do whatever they can to push buyers from Vdara to Veer in order to reach that hurdle rate and just run Vdara like a regular hotel
  • It's unlikely that MGM gets any distributions from condo sales
    • Below is a quick outline of how condo proceeds will be distributed...if you do the math you will arrive at the same conclusion as us
    • First in line: up to $250MM of the condo proceeds to go towards construction costs
    • Second in line: the next $250MM of condo proceeds goes towards permanently reducing the City Center credit facility from $1.8BN to $1.55BN
    • Third in line: Dubai World gets priority on the next $491MM of condo proceeds
    • Last in line: After the $991MM of condo proceeds get distributed MGM can now get its distribution of what's left... our guess is that distribution doesn't come until the cows come home or the market recovers in 2011/2012
  • At some point MGM will need to re-start Harmon, which should cost around $300MM, any proceeds from condo sales will like be largely offset by construction spend on Harmon which MGM will need to fund


Our CityCenter experience (actually Vdara):


Vdara is a newer but unfortunately, less cool, version of The Hotel.  Given the ease of access, it appears to be more of a Bellagio adjunct than part of the CityCenter metropolis.


City Center feels like a cluster of separate properties rather than a cohesive resort.  If you are staying at Vdara and want to see the rest of the resort its not very easy.  To get to Aria you have to cross the "City Center highway" which is basically a 2 block walk across a maze of "highway" with no sidewalk or walking path.  There is however, a convenient covered walkway connected to Bellagio (no accident, we surmise).  To get to Mandarin you can take the covered walkway through Bellagio to the "City Center Tram" to Crystals, walk through Crystals and across the sky bridge to Mandarin.  Alternatively, you can walk across City Center highway to Aria and risk getting run over, walk through Aria, and then walk two blocks to Mandarin. You get the point. 


Vdara also only has one restaurant, Silk Road, which is quite tasty (all three meals) and a lobby bar & coffee station.  The gym is nice and there is a convenient $15 resort fee added to your room rate which covers the cost of the gym.  However, unless you are getting a treatment at the spa, you still have to pay $25 to access the tiny spa facilities containing only a locker room with showers, hot tub, steam room, and sauna.  This is no Encore Spa so the likelihood of a $25 splurge is probably low.


The room is fairly nice - a la "The Hotel" at Mandalay Bay - but smaller with a useless kitchenette and no separate living room. The observant traveler will be able to tell MGM didn't spend big bucks on the fixtures here.  Toilet paper holders seem to be having trouble staying on the wall and who needs a nightstand drawer that closes?  It's the little things, folks.

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