When I undertook the bankruptcy analysis for our recent conference call, I figured I would be loading the ball in the musket for the shorts. High leverage, big spending, declining returns all should’ve given me some ammo. On the contrary, my analysis uncovered a surprising level of liquidity which blew a hole in my initial bankruptcy thesis and may turn the shorts into duds. After trashing casino management teams over the years I have come away with a new respect for the CFOs at a lot of these companies and even less respect for this country’s big financial institutions. While levering up in the boom years could’ve been disastrous during this downturn, these guys negotiated credit facilities that provided their companies with very low borrowing costs and tremendous liquidity. They’ll be some serious sticker shock when these facilities are renegotiated beginning generally in 2010 but we’ll save that discussion for a later post.

  • The first chart shows the average trailing leverage ratio over the past 10 years. We are at a 10 year high which on the surface is troubling and looks like the end of the classic boom and bust cycle. However, liquidity profiles for most of the casino companies are in great shape and borrowing costs are low. Contrast this with the private gaming companies. This is where we’ve seen the recent bankruptcies and will likely see the next few bankruptcies.

  • The next chart is busy I know but drills down into the specific metrics for the casino operators. On the surface ISLE appears to be a bankruptcy candidate but Dale Black, CFO, has done an outstanding job with this once dire financial situation. Despite a ton of leverage and a low coverage ratio, near term liquidity is significant, the company is free cash flow positive on a net basis, and there are no significant debt maturities until 2012. BYD, PNK, and LVS maintain aggressive development pipelines but for the most part, projects can be cancelled or delayed. MGM is probably at most risk due to its high exposure to Las Vegas where I see the most downside. Moreover, MGM has high leverage and significant maturities in 2010. Kerkorian and Dubai World are, of course, potential backstops.

  • As the shorts continue to press the regional casino companies along with other highly leveraged companies, an advantageous liquidity situation seems to have been overlooked. The industry capitalized on the financing fat years by negotiating significant liquidity and low borrowing costs. Sure there are issues but significant liquidity will keep these guys out of the red zone until at least 2010.

Significant liquidity offsets historically high industry leverage
Low borrowing costs keep coverage ratios reasonable despite high leverage


If it’s going to be different this time - Food and Labor inflation are going to be the driver of this bankruptcy cycle. Clearly, the trend in these costs is disconcerting, and there does not appear to be any relief in sight for the foreseeable future. In my mind, food or labor costs, alone, are not going to bankrupt any single company, but rather the risk lies in how a management team manages these inflation pressures. To date, inflation pressures have been partially sidestepped by raising prices. However, as I have seen over and over again, excessive pricing can kill a concept.
  • As a result, I believe that restaurant analysts are going to increase their scrutiny of traffic trends as traffic is the primary indication of the health of a concept.


Research Edge recently held a consumer bankruptcy conference call. One of my slides covered the impact of a hypothetical smoking ban across the regional gaming markets, a distinct possibility over time. Following sharp declines in revenues in Illinois and Colorado, some short sellers have focused on the smoking ban to press the regionals. I estimate a worst case scenario of a 20% decline in EBITDA. The impact on the credit ratios is not as severe as I would've thought. Leverage obviously increases but with only ISLE in the danger zone. With the exception of ISLE, coverage ratios remain in good shape even after the EBITDA reduction. ISLE will still cover interest and should have liquidity until 2012. ASCA and PNK have large credit facility maturities in late 2010 which could present a liquidity problem for both companies should the credit environment remain unfavorable.

Even after 20% decline from a potential smoking ban, most regional operators maintain decent credit ratios

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 80.52%
  • SHORT SIGNALS 78.67%


The other side of the washout that is going to occur in the hedge fund community is the squeezing of their consensus shorts.

Fannie had a +30% squeeze move today on huge volume to close at $9.20.

My model has this stock with the potential to run-up to $13.02, and nothing changing in terms of its bearish formation. If it does, how many short selling geniuses out there can manage that risk?


  • Fannie (FNM)
chart courtesy of

The Bankruptcy Cycle Chart

The spike in the 2008 part of the chart is Indy Mac. Don't forget this was the largest US Bank failure since Continental Illinois in 1984. The people lined up at the 33 branches they closed over the weekend don't foget.

  • From the Research Edge Conference Call 7/16/08


When you think about the bankruptcy cycle, chain restaurant companies are not the first thing that comes to mind. Most restaurant companies don't need working capital to survive, as a result this is the primary differentiator between restaurants and other consumer companies.

  • Three themes to take away from companies that have gone bankrupt:

    (1) Family dining and Casual Dining make up the bulk of companies that have gone bankrupt.

    (2) Inefficient consumer proposition

    (3) Executive suite revolving door

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.