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WMS AND INTERNET GAMING

This morning Fantini’s Gaming Report wrote about WMS’s foray into online gaming.  For those of you that missed it here’s what was written:

 

“WMS has set up shop in the United Kingdom to launch Internet gaming late next fiscal year, eGamingReview reported.  The company is hiring 25 employees in London in preparation for the launch of a UK-facing site, then will follow with sites aimed at France, Italy and Spain as those countries open their markets to competition beyond their state-granted monopolies. WMS will be the first major US slot machine company to go beyond licensing games to online operators. It also would give WMS experience to offer its games directly to Americans already familiar with them in slot machine form if I-gaming is legalized in the US. As such, it could start a trend of suppliers to brick-and-mortar casinos competing against them on the Internet, and opening whole new revenue streams.”

 

We spoke to the company and got some clarification on what’s really going on.  The online gaming effort in the UK is has been an ongoing part of WMS’s R&D efforts and is already reflected in the R&D budget – so the employees are not new hires.  The online strategy in the UK is an extension of what WMS showed in it vault at G2E this year, namely increasing customer loyalty to the casinos and WMS games by allowing them to continue their experience online on operator’s websites.  In the UK, regulation allows WMS to have a more direct strategy. The launch of their online gaming efforts in the UK will be a FY2011 event, and should not have any material impact on R&D or SG&A in the interim.  As far as the US is concerned, online gaming is not likely to get legalized in the foreseeable future, at least not until the federal government can figure out a way to tax online gaming.

 


AC, PA, MD, DE, MGM, BYD

Unfortunately, this party of acronyms may not be so happy.

 

 

With Delaware and now Maryland considering table games, the positive Atlantic City inflection point continues to move farther out on the horizon.  MGM may not have the patience to wait it out.  As reported in the Las Vegas Review-Journal yesterday, MGM may be looking at exiting the AC market through selling its 50% stake in Borgata.  It’s no secret that New Jersey gaming regulators have not been happy with MGM’s involvement with Pansy Ho given the alleged ties of her father Stanley Ho with the Chinese triads.

 

We cannot think of a worse time to sell an Atlantic City asset.  BYD, MGM’s 50% partner in Borgata, is sitting pretty in at least one respect.  Certainly, Borgata represents over 20% of the company’s property EBITDA so that’s not good.  However, BYD does hold the right of first refusal on any MGM agreement to sell.  So while it's a bad time to sell for MGM, it’s probably a good time to buy for a long-term investor such as BYD.

 

In the meantime, Borgata cash flow expectations probably need to be ratcheted down.  Pennsylvania slots have had a huge impact on AC and with table games just legalized, the market share shift will continue.  Maryland is not even built out yet but slots, and maybe table, are coming.  The Delaware House just passed table game legislation and the Senate is supposed to follow suit.  The Governor has indicated he will sign the legislation. 

 

The following chart shows that table games have outperformed slots in Atlantic City most of the last two years during which slots in Pennsylvania proliferated.  That is, up until recently as table game play fallen off the cliff, and that’s before the addition of tables in PA, DE, and MD.  The problem for Borgata is that it generates almost 40% of its gaming revenue from the tables, the second highest in the market.  Borgata's table dominance has partly attributed to its ability to outperform the market until recently.  Given the supply outlook, table revenue is probably more at risk over the next few years.

 

AC, PA, MD, DE, MGM, BYD - ac tables vs slots


HOUSING GONE WILD

I agree that the December existing home number is a statistical aberration, but that is not the point.  The issue remains that the current trend in joblessness is still a big drag on the economy and the government can’t prop up the housing market forever. 

 

Earlier today the NAR reported that sales of existing U.S. homes plunged almost 17% in December.  The decline was more than a Bloomberg survey and the biggest decline since records began in 1968.  The decline comes one month after a government tax credit was originally due to expire.  Congress extended the first-time buyer credit to cover deals signed by April 30, 2010 and closed by June 30 2010, and expanded it to include current homeowners.

 

What is clear from the December existing home number is that the original tax credit measure pulled sales forward.  The current program will have the same effect in 1H10, and sales will begin to fall off again in June 2010.

 

With Washington propping up the housing market it is nearly impossible to say with any certainty that the housing market is recovering.  As we said last week when the housing “starts” was reported, the government has put a floor under the housing market.  The “bottoming process” for housing will take time and future growth is dependent on job creation, not government stimulus measures. 

 

Howard Penney

Managing Director

 

HOUSING GONE WILD - ushomesales

 


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 80.64%
  • SHORT SIGNALS 78.57%

Chinese Bubbles? Some Context...

Understanding that it’s now fashionable for consensus pundits to fancy themselves as professional Crash Callers is what it is. After missing making the call on the 2008 crash, it’s called career risk to miss the next one.

 

In an environment where Professional Bubble Watchers are in increasing supply, beware of calling something a bubble that’s already popped. Even though we are currently bearish on China for the intermediate term TREND (see our Macro Theme titled Chinese Ox In a Box), we are not superimposing this view across all longer term durations, yet…

 

Duration mismatch is a classic mistake that I (and plenty other short sellers) sometimes run into. In an industry where most bosses ask the same investment question (“what’s your best idea?”), there is a structural pressure locked into investors brains to be early with “new ideas.” However, the repeatable edge in this business resides in neither being too early, or staying too late.

 

Let’s assume for a minute that the Chinese make up all the numbers. But let’s also agree that, if they have been making them up the entire time, that everything is relative. The chart below shows real estate prices in 70 Chinese cities going back to 2006. This price data comprises of both residential and commercial real estate, allegedly…

 

What are some takeaways and questions from this chart?

  1. If there was a bubble in 2007, it already popped once
  2. If the current pace of y/y price growth is another bubble forming, its potentially locking in a lower-high (see the red line)
  3. The latest reading is a December number, and the Chinese have started to tighten much more aggressively here in January

Altogether, this morning’s December report was for real estate price growth of +7.8% year-over-year.

 

Is less than double digit price growth a bubble? Or are we still so scarred by having missed living through our own real estate bubble, that everyone else must be in a bubble? And that we are the only ones who can see theirs?

 

Too many questions without answers for a Monday.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Chinese Bubbles? Some Context...  - chihaus

 

 


BERNANKE’S BUBBLE

Consistent with our views on China, the US is setting up to be in a difficult position in 2Q10, or what I’m calling BERNANKE’S BUBBLE.  Like our 1Q10 theme, “CHINESE OX IN A BOX”, Ben Bernanke is in a jam.

 

Right now China is tightening monetary policy as inflation accelerates and that is exactly what the US needs to do.  On January 13th, I outlined our “CHINESE OX IN A BOX” theme by saying, “Similar to our view that ‘HE WHO SEES NO BUBBLES’ (Bernanke) needs to remove his current unsustainable and unreasonable monetary policy of ‘extended and exceptional’, the People’s Bank of China has altered its policy verbiage from ‘appropriate increases’ in lending to ‘moderately loose’ monetary policy.” 

 

Slowing sequential growth, combined with accelerating sequential inflation, is now BERNANKE’S BUBBLE, and it is putting pressure on the S&P 500 for the intermediate term.

 

Slowing growth and accelerating inflation? Just look at the math:

 

1.       GDP growth will begin to decelerate in 1Q10 as the benefit of government stimulus begins to fade.  Current GDP growth estimates are 4.0% in 4Q09 and 2.7% in 1Q10.

 

2.       Consumer Price Inflation (CPI) and Producer Price Inflation (PPI) accelerated in December, up 2.7% and 4.4%, respectively, and both will continue to accelerate in 1H10.

 

As it stands now, the current 4Q09 GDP growth estimate of 4% reflects a range of estimates as high as 6.7% and as low as 1.5%.  Given that real, annualized quarterly GDP growth over the last 30 years has averaged 3.2%, the 4Q09 numbers are well above trend.   

 

If the consensus is right, then the 4Q09 GDP data point, which will be reported next Friday, will likely be bullish.  That being said, it is an indicator of trends in 4Q09 and is more likely reflective of a topping process as we are lapping a 5.4% decline from 4Q08 and significant government spending has allowed significant growth to the upside.  Going forward, GDP will likely moderate as implied by the 1Q10 GDP consensus estimate of 2.7%.

 

A number of sectors of the economy have bottomed out or are signaling a bottoming process (i.e. housing).  Adjusting for seasonal patterns, real retail sales are not improving and look more like housing.  Industrial production was up for the quarter, but without a subsequent increase in demand, this leads to increasing inventories.  The trade deficit and the contraction in employment are a small negative for GDP.  Regardless of how 4Q09 GPD comes in, it’s difficult to make the case that the U.S. economy is booming.  Instead, it looks like 4Q09 could be the peak.  Adjusting for “government stimulus measures,” GDP looks to be trend line flat.   

 

Therefore, the only factor that could conceivably support such strong growth in 4Q09 GDP is an extraordinary buildup in inventories, meaning that stronger production has not been matched by stronger consumption.  A sharp inventory buildup in 4Q09 would be consistent with a renewed slowdown in the first-quarter 2010, as inflation accelerates.

 

Growth decelerating at the same time inflation is accelerating suggest that BERNANKE’S BUBBLE needs to pop.

 

Howard Penney              

Managing Director

 

BERNANKE’S BUBBLE - GDPCPI

 


Repetitive Consequences

“We hope that the weight of evidence in this book will give future policy makers and investors a bit more pause before next they declare, “This time is different.” It almost never is.”

-          Reinhart and Rogoff

 

We recently finished reading “This Time Is Different”, by Carmen Reinhart and Kenneth Rogoff, which provides “a quantitative history of financial crises in their various guises.”  We obviously found the book interesting on a number of levels. 

 

Firstly, both Keith and I worked at major private equity firms when the world was purportedly “awash” with liquidity.  Many of the world’s “great” financiers theorized that things were different that go around and were modeling company cash flows with no business cycles imbedded therein.   If we need any more evidence of this, it comes from Tishman Speyer Properties handing over Peter Cooper Village and Stuyvesant Town to their lenders this morning.  After closing the most expensive real estate purchase in history at the top of the real estate market, Tishman walked away today with its equity investment marked-to-market at zero.

 

Secondly, the book is an incredible resource for studying financial crises, particularly related to sovereign debt defaults.  Sovereign debt is a particular focus of our macro analysis this year given the massive amount of sovereign debt issuance piling up globally.  This is both an issue in the domestic United States, but around the globe as nations continue to issue debt to offset the budgetary issues related to the “Second Great Contraction”, as Reinhart and Rogoff refer to the global recession of 2008 / 2009.

 

The premise of the book is to look at historical financial crises and to attempt to quantify both what a crises is and what exogenous factors led to the crises.  If there is any lesson from the historical studies from the book, it is that crises are more normal than most market operators believe.  In fact, while we have been in a period of low sovereign debt defaults, over history this has not been the norm.  Typically a period of limited debt defaults is followed by a resurgence of default.   As Rogoff and Reinhart note in the preface to the book:

 

“If there is common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom.  Infusions of cash can make a government look like it is providing greater growth to its economy than it is.”

 

Historical analysis is valuable because it can provide a range of outcomes for the future.   One of our Q1 Macro Themes is Chinese Ox in a Box, which refers to our belief that China will slow in Q1 of 2010.  Obviously, the most recent data from China already supports this thesis.  A key longer term question relates to the health of the Chinese banking system.  The bears are quite concerned, while the bulls continue to buy Chinese growth with little concern. 

 

The history of the Chinese banking system is less than stellar.  In fact, the last major crisis in Chinese banking occurred in the late 1990s.  As Reinhart and Rogoff write:

 

“China’s four large state owned banks, with 68% of banking system assets, were deemed insolvent.  Banking system nonperforming loans were estimated at 50%.” 

 

Another banking crisis of that magnitude may be solidly out on the TAIL in terms of probability, but we are pretty sure most China bulls aren’t even considering this in their scenario analysis for the Chinese stock market.  And certainly, this scenario is definitely not priced into Chinese stocks.  If Rogoff and Reinhart’s historical studies tell us anything, it is that history tends to repeat itself.  According to George Santayana:

 

“Those who cannot remember the past are condemned to repeat it.”

 

Indeed.

 

 

 

Daryl G. Jones
Managing Director


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