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Extremely Improbable Events

“We can't solve problems by using the same kind of thinking we used when we created them.”

-Albert Einstein


We have been in a recession since December 2007 and what has changed?  Ok, George Bush is no longer in office, but Barack Obama has not been able to solve anything, largely due to a screwed up political system and corrupt politicians.  That’s the obvious answer…. 


The financial crisis was born out of a pattern of accumulating hidden risks in the system, coupled with an increasing complexity of the financial system around the world.  Never before have we had so much complexity and so much ignorance as to what is going on.  After more than two years of trying to fix the system, some corporations are slightly better off, but the reality is that nothing has changed.


For the last two days I have found myself writing about structural problems which are hard to ignore, and some are worse than others. 


First, consumers account for more than 70% of GDP, yet growth in personal consumption cannot be sustained without growth in inflation-adjusted income.  Short-term benefits can be gained through debt expansion, but consumer credit continues to contract, and disposable consumer income is not keeping up with inflation.  This is a long-term structural problem, and until it is addressed, there can be no sustained economic recovery. 


Second, the most recently revised GDP report revealed another structural problem as current trends are not sustainable.  Private inventory growth accounted for 4%, or 67%, of the revised 5.9% annualized growth in 4Q GDP.  


Third, Washington has dug a very big hole and there is no real insight on how to deal with the issues, and now the politicians and Washington’s “Groupthink” is begetting speculation that is potentially unhealthy.   More importantly, the federal government or “the system” appears to be accumulating more hidden risks which could end up leading to an “extreme improbable event.”  At Hedgeye Risk Management, we call that “TAIL” risk. 


As a financial analyst, I have learned that all of the real juicy stuff can be found in a company’s footnotes.  I’m not claiming to have read all of the 2009 Financial Report of the U.S. Government, but the footnotes and the statement of the comptroller general of the United States are alarming.  Anybody reading them would come to the conclusion that the US government is a short. 


Consider the report’s covering Statement of the Comptroller of the United States, the overseeing accounting authority, where "material" questions are raised in terms of the valuation of the bailout liabilities and assets.  According to, Gene L. Dodaro, Acting Comptroller General:


"The economic recession and the federal government’s unprecedented actions intended to stabilize the financial markets and to promote economic recovery have significantly affected the federal government’s financial condition. The resulting substantial investments and increases in liabilities, net operating cost, the unified budget deficit, and debt held by the public are reported in the U.S. government’s consolidated financial statements for fiscal year 2009. Because the valuation of these assets and liabilities is based on assumptions and estimates that are inherently subject to substantial uncertainty arising from the uniqueness of certain transactions and the likelihood of future changes in general economic, regulatory, and market conditions, actual results may be materially different from the reported amounts. Further, the ultimate cost of these actions and their impact on the federal government’s financial condition will not be known for some time."


Or how about this one….


“Certain material weaknesses in internal control over financial reporting and other limitations on the scope of our work resulted in conditions that prevented us from expressing an opinion on the fiscal year 2009 and 2008 financial statements other than the Statements of Social Insurance. “


The internal controls of the US Government are so bad the books can’t have an official opinion from the Comptroller of the United States. 


The US government is spending money it does not have, it can’t balance the books and the most read story on Bloomberg over the past eight hours is “Germany Snubs Greek Aid Plea as Protest Snarls Athens Traffic.”


How Germany and the EU end up dealing with Greece has broad implications for the other troubled countries in Europe.  I get that.  Europe has a real big problem and it’s called leverage and leverage is bad.  The US has a leverage problem too and we don’t have the internal controls to know where all the problems are.  The US fiscal issues don’t stop with the US government as there are many individual states (see Hedgeye.com for the details) that are nearly bankrupt and have funding issues too. 


Despite the current policies of the US government, the willingness of foreigners to fund our problems has been unwavering.  However, it’s worth note that yesterday the Dollar Index experienced its biggest one day drop since December 1, 2009 and has now fallen five of the last six days.  Unfortunately, it’s seems that the US could be headed toward one of those extreme improbable events.    


When a company can’t balance its books that is a real problem, but it’s ok for the US government to not have a handle on the numbers?  Something does not add up.


Wishing Keith and his family all the best today!


Function in disaster; finish in style!


Howard Penney
Managing Director




XLF – SPDR Financials — With sentiment negative and a Piggy Banker Spread hitting a record wide spread on 2/23/10, we bought red.


XLK – SPDR Technology — Technology is underperforming the SP500 YTD; a down day on 2/22/10 prompted us to buy more. We expect to see some positive mean reversion for Technology as M&A picks up.


UUP – PowerShares US Dollar Index Fund — We bought the USD Fund on 1/4/10 as an explicit way to represent our Q1 2010 Macro Theme that we have labeled Buck Breakout (we were bearish on the USD in ’09).

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 mispriced and that TIPS are a efficient way to own yield on an inflation protected basis.



EWP – iShares SpainThe etf bounced on 3/3/10 in part from a strong day from Banco Santander, the fund’s largest holding in the Financials-heavy (43.8%) etf. We shorted Spain for a TRADE, and have a bearish bias on the country. Massive unemployment, public and private debt leverage, and a failed housing market remain fundamental concerns.


IWM – iShares Russell 2000With the Russell 2000 finally overbought from an immediate term TRADE perspective on 3/1/10 and added to it on 3/2; we got the entry price that the risk manager makes a sale on strength.


GLD – SPDR Gold We re-shorted Gold on this dead cat bounce on 2/11/10. We remain bullish on a Buck Breakout and bearish on Gold for Q1 of 2010, as a result.


XLP – SPDR Consumer Staples Another capitulation squeeze is in full motion for the short sellers of everything "consumer". Shorting green as inflation starts to creep into the system again.


IEF – iShares 7-10 Year TreasuryOne of our Macro Themes for Q1 of 2010 is "Rate Run-up". Our bearish view on US Treasuries is implied.


The Macau Metro Monitor, March 4th, 2010



 During an interview with Bloomberg, MGM CEO Jim Murren said, "I'm confident we'll get the IPO done in the third quarter, probably in the August, September time frame." Murren also mentioned that the sale of $850 million in secured bonds between now and June would will give MGM a more flexible time frame on its debt in the near term. 


In advance of Great Canadian’s Q4 earnings release on Monday, we’ve summarized management’s forward looking statements from last quarter.



General Trends

  • The weakened economy continues to impact our markets”
  • “We believe that the cost structure that we have in place right now is appropriate for the revenues that we have but, you know, if revenues go up, certainly some of our costs will go up.  But the margin, margins will continue to grow as those revenues come back.”
  • “You know, unemployment in the Province of British Columbia has still been climbing – that’s where three quarters of our revenues are – and so we are continuing to prepare for the worst and it’s that conservative attitude that’s brought us into this position and that’s the way we’re going to continue to operate.”


Project updates & Outlook

  • Re: Georgian Downs “These new offerings have been well received so far.  We are confident that they will provide further evidence of the underserved nature of a good deal of the Ontario market.”
  • To date, results from the Canada Line have been promising.  Initial ridership has exceeded TransLink’s expectations and River Rock has witnessed increases, both in visitation and slot play.  While slot coin in for the third quarter still declined by 5 percent when compared to last year, it grew by 11 percent when compared to the second quarter of this year.  That sequential increase was not something we witnessed in 2008 and is an encouraging indicator of what River Rock may deliver going forward.”
  • On November 19th, we’ll complete the second phase of upgrades to the facility.  These include the renovated atrium, the elevated walkway that will connect the existing facility to the Canada Line station and a variety of enhanced amenities.  Furthermore, it will wrap up construction, ending the disruption that’s inconvenienced River Rock’s patrons for the past 18 months.”
  • “At Boulevard and River Rock, we will perform comprehensive overhauls of the layout of our gaming floors.  These modifications will both highlight the upgraded slot product at these facilities and increase their capacity.  Boulevard will feature 1,000 slot machines, while River Rock will feature slightly more than that.  Both casinos’ layout changes will be complete by the end of 2009 and will improve the alignment of their properties’ offerings with our patrons’ wishes.”
  • “For a historical note, River Rock hasn’t had any new product in there since we opened the doors….2004”
  • “At River Rock some of the slots that are going to be removed might produce as little as $50 a day and some of the ones that we might want to add more of produce well over $1,000 a day so that’s the kind of metric (unintelligible) slot machines (inaudible) and so the exercise is to get productivity up and get the non-producers out of there”

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FL: Turnaround Set In Motion

While it appears that FL’s $0.24 headline EPS is a miss relative to the $0.26 consensus, we view this is quarter as a solid start to the impending turnaround.  So how can a miss be construed as a positive?  There are a handful of details in the release that suggest the company is setting up well for an earnings recovery, beginning now.  



Earlier today on our conference call (if you missed it let us know and we’ll provide replay info) we walked through our thesis on why we like Foot Locker and the opportunities that lie ahead.  With 4Q earnings now officially out a mere 4 hours after our call, we’re still feeling confident in our view.  While it appears that FL’s $0.24 headline EPS is a miss relative to the $0.26 consensus, we view this is quarter as a solid start to the impending turnaround.  So how can a miss be construed as a positive?  There are a handful of details in the release that suggest the company is setting up well for an earnings recovery, beginning now.  The highlights:


  • Same store sales came in at down 2.3% for the quarter, essentially in line with Street expectations.  Importantly, the release notes that sales improvement has continued through February, with comps in positive territory since the new year.  Recall that expectations here had risen throughout the quarter, as footwear in general showed a strong trend as well as growing excitement for women’s fitness shoes.
  • Inventory management kicked in this quarter, with total sales up 0.6% and inventories down 7.4%.  A marked improvement  and something that bodes well for future margins and cash flow.
  • The skeptics have been fixated on the balance sheet and the possibility of a dividend cut.  With a year-end cash balance of $589 million (net cash of $451 million) and the board’s decision to extend its share repurchase facility, the data speaks for itself.  A dividend cut is highly, highly unlikely.
  • Finally, gross margins improved by 5 bps, even as inventories were taken down.  This comes on top of a strong margin performance last year.  For those fixated on tough compares, this offers a glimpse into the potential that lies ahead.


All in, this quarter sets a base for which CEO Ken Hicks and his team will work from.  4Q was largely out of his hands anyway, especially since plans were likely set before he arrived.  However, the areas that were in his control or under his watch appear to be moving in the right direction.  It certainly helps to see a glimpse of a positive comp trend as well, but this is really a bonus to the overall progress at this time.  Merchandising changes currently in the works should take the topline even further, but for now key components of the turnaround already appear to be set in motion.


FL: Turnaround Set In Motion - 1



Eric Levine



The details are in. In this post, we analyze the Macau properties' February performance.



As we already know from the press reports, total table revenues were HK$12.4 billion, up 73% y-o-y, higher than our estimate of HK$11.0-11.5 billion.  As can be seen from the data, some of the better than expected revenue related to higher VIP hold percentage since VIP revenues were up 90% but volume was up 67%.  Higher Direct VIP play could explain part of it as it gets included in revenues but not in the volume numbers.  The comparison was pretty easy as it will be through June.  Table revenues in February of 2009 declined 17% and did not contain the Chinese New Year celebration.


In terms of company specific insights, Wynn had a great VIP month but its Mass business lagged again, up only 7% yoy vs the Mass market up 38%.  LVS lost share sequentially in both VIP and Mass.  Possibly as a result of its aggressive junket pricing, SJM increased share considerably in both VIP volume and revenue.



Y-o-Y Table Revenue Observations:


LVS table revenues increased 38% with most of the growth coming from a 66% increase in VIP revenues and 16% growth in Mass

  • Sands was up 66%, driven by a 92% increase in VIP and 31% growth in Mass
    • VIP growth was almost entire driven by easy hold comparisons.  Junket rolling chip was only up 3%.  Sands suffered weak hold in Feb 2009 of around 2%, assuming 12% direct play.  If we assume 12% of total VIP play was direct in Feb '10, this implies hold of 3.65% 
  • Venetian was only up 16%, with VIP and Mass both up 16%
    • Junket VIP RC increased 21%
  • Four Seasons was up 172% y-o-y entirely driven by 444% VIP growth with Mass declining 25% 
    • Junket VIP RC more than doubled to to $531MM but was down sequentially from $857MM in January as well as below record results of $1.3BN in December. 
    • Over the last two quarters, FS has averaged $355MM of direct VIP play per month.  Assuming similar results in Feb, hold would be around 2.9%


Wynn table revenues were up 55%, almost entirely driven by a 69% increase in VIP, while Mass revenues were only up 7%

  • Junket RC increased by a massive 83%
  • Assuming 12% direct RC play in both months, Wynn's hold rate was declined from 3.3% lsat year to 3.0% in Feb 2010


Crown table revenues grew 172%, with most of the growth fueled by 584% growth in Mass and 139% growth in VIP

  • Altira was up 22%, with VIP up 26% while Mass declined 21%
    • VIP RC was down 1%, however, after quarters of bad luck, Altira finally held well, thus driving better VIP revenues.  We estimated that Feb 09 hold was 2.6% compared to 3.3% in Feb 2010.
  • CoD table revenue decreased 24% sequentially, due to a 34% decline in VIP win which was only partly offset by an increase in Mass
    • Mass ramped 17% m-o-m to $36MM
    • Junket VIP RC declined 9% sequentially
    • If we assume 20% direct play at CoD (in line with what MPEL said on their earnings call), then total VIP RC would be $3.2BN compared to $3.5BN in January, using the same assumption.  However, hold in January was high at 3.7%, while February hold was a little light at 2.6%


SJM continued its hot streak, with table revenues up 87%

  • Mass was up 42% and VIP was up 121%
  • As we wrote about on several occasions, we believe SJM is being very aggressive on junket pricing


Galaxy table revenue was up 35%, driven by a 42% increase in VIP win, while Mass declined 7% increase

  • Starworld's table revenue was up 65%, driven entirely by 73% growth in VIP revenues. Mass only increased 1% y-o-y


MGM table revenue was up 148%

  • Mass revenue growth was 38%, while VIP grew 221%
  • Before you get too excited about the growth in VIP revenues, we would caution that Junket VIP RC was up 27% y-o-y, but the hold in Feb 09 was an anemic 1.5% while Feb 2010 hold is high at around 3.3% (assuming 15% direct VIP play)


Market Share:


LVS share dropped 160bps sequentially to 19.6%, with most of the share loss coming from VIP

  • LVS's share of VIP revenues decreased to 17.2% from 19% in Jan, while Mass fell to 26.6% from 27.3% in Jan
  • Sands lost 30bps, dropping to 6.8% sequentially
  • Venetian lost 50bps to 10.9% sequentially while FS share dropped 80bps to 1.9%
  • After SJM, LVS commanded the second highest share of the Mass market with 26.6%, followed by Crown at 10%


WYNN's was a big share gainer this month, increasing market share to 14.5% from 12.9% in January

  • Wynn's share gain was driven by VIP growth, which increased Wynn's share of the VIP market to 16.5% from 14.3%
  • On a RC basis, WYNN's market share of 15.7% is second only to SJM which commanded 34% of RC share in Febraury.  This is very impressive since Wynn's market share at one property surpasses that of LVS's 3 properties combined and Crown's two properties.


Crown's market share fell by 2.3% to 13.6% in February

  • All of the share loss was in VIP market share which declined by 3.5% sequentially to 14.8%
  • Crown's Mass market share increased by 1.5% to 10% - with CoD garnering 8.8% market share, on par with Wynn


SJM's share increased to 32.3% from 30.9% in January

  • Most of the share gain came from a 2.2% sequential increase in VIP share to 28.8%
  • RC share also increased by 260 bps to 34%


Galaxy's share increased slightly to 11% from 10.4% last month

  • Starworld's market share was flat at 8.4%
  • Galaxy's share of Mass fell to 4.3% from 5.7% in January but was offset by a 1.1% gain in VIP share to 13.3%


MGM's share increased by 30bps to 9%


Slot market commentary:

  • Slot win grew 28.5% y-o-y to $81MM
  • LVS's slot win grew across all 3 properties by 29% y-o-y to $26MM
  • Wynn slot revenues declined by 12% y-o-y to $16MM. They were the only concessionaire to experience a decrease in slot win
  • Melco's slot win grew 48% y-o-y.
  • MGM's slot win grew 65.4% y-o-y to $8MM










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