IGT's declining slot ship share has been a major topic of discussion for some time. Less talked about is participation revenue share, and how much more room there is for IGT to fall.



A frequently asked question in this space is whether IGT can maintain its severely depleted ship share, now hovering around 35%.  A more important question may be how IGT is going to maintain its participation revenue share of 65% among the Big Three (it's probably around 60% in total)?  The answer is probably the same as it was for ship share 6 years ago when it was 60%:  it won’t.  What is amazing is that it was actually 90% six years ago.  Certainly, IGT's new participation games seem to be getting warm reception.  However, holding participation share significantly above its ship share may be difficult to maintain over the long-term.  See the chart below and note IGT’s steady decline that doesn’t look like it will abate. 


PARTICIPATION SHARE UP FOR GRABS? - Participation Games  revenue 6


Due to its superior content, WMS is the most likely thief of IGT's participation share.  Moreover, up until now, WMS hasn't participated in the Class II market which will boost their market share going forward.  BYI could also be in a solid position since IGT is overly reliant on the Wheel games (See our 11/27/09 post, HOW LONG WILL THE WHEEL KEEP TURNING?) and BYI has developed a whole new wheel product line since the IGT's wheel patent was ruled invalid.  However, our long-term bet would remain with WMS.

HIBB: It’s Just Different

HIBB: It’s Just Different


We stirred the pot a little this morning with our detail on Sports Authority, and evidence that we’re starting to see that they’re dressing up the pig to take it public. It led to a nice little validation on HIBB’s competitive positioning.


We peeled back the onion on management’s comment about giving the Texas market ‘special attention’ due to a share battle with DICK’s and Academy. In looking at a map, however, check out how well positioned Hibbett is relative to the others that are literally sitting on top of one another. HIBB stores are so evenly spread across major AND minor MSAs. This is not to say there’s anything incrementally positive about owning HIBB today (though we are more inclined on the long side), but serves as a good nugget to delineate HIBB from its big-box big-market competition.


HIBB: It’s Just Different - HIBB map




Two weeks ago we highlighted three incremental positive datapoints for the housing market: (1) California's $10k homebuyer tax credit, (2) Bank of America's plan to roll out principal forgiveness on a limited basis, and (3) the White House's renewed plan to combat foreclosures under new HAMP initiatives. Today, we are highlighting a few additional positive datapoints, combined with a word of caution in looking ahead.


First, yesterday's February pending home sales report was decidedly positive. Remember, pending home sales are a better leading indicator than existing home sales. While both measures are released with roughly a one month lag, existing home sales reflect contract closings, which reflect activity from 1-2 months prior. In other words, February existing home sales reflect buying activity from December/January. In contrast, February pending home sales, which was released yesterday, reflect contracts being signed, which will close in one to two months. In this respect, pending home sales lead existing home sales by approximately 1.5 months, which is why this is where the focus should be. The February pending home sales index rose to 97.6 from 90.2 in January, a month-over-month increase of 8.2% and an increase of 17.3% from the prior year. The following chart demonstrates.




Some context is necessary here. When the original homebuyer tax credit was set to expire on November 30, 2009 it pulled forward significant pending home sales volume into September and October. As the following chart shows, September volume rose 18.6% yoy while October was up 29.8% yoy. November then dropped to a yoy rate of 16.7% (down 13.7% mom) and went on to drop further in the months of December and January. Remember, all this data is seasonally adjusted, so winter vs summer should be irrelevant. From a timing standpoint, we think February corresponds with September (i.e. both 2 months prior to the tax credit expiration, and March will correspond with October (one month prior). We expect to see a significant uptick in March sales once the data comes out a month from now. Between now and then we wouldn't be surprised, and in fact would expect,  to see the broad-based housing-related credit tailwinds persist.




Second, HUD announced that it is changing its definition of foreclosure to now include loans that are 60 days delinquent. This will enable HUD to more aggressively deploy funds under its Neighborhood Stabilization Program, which require that homebuyers seeking grants use that grant money only for "foreclosed" homes. The program has disbursed some ~$6 billion to date, and it is expected that this number could increase materially with the new definitional change that will allow buyers to step in earlier than they otherwise would be able to. The White House has been using the housing-related government agencies (HUD, FHA, Ginnie Mae) and quasi-government agencies (Fannie Mae, Freddie Mac) to shoulder much of the heavy lifting in repairing the housing market, separately, and in addition to, Congressionally legislated initiatives such as HAMP and HAFA. We think the move by HUD represents yet another step in this direction.



While these datapoints are undeniably positive for the housing market, we remain skeptical of investors' exuberance around the recovery in the housing market for three reasons.


First, after the March pull-forward of activity ahead of the tax credit expiration on April 30, 2010 has passed, we expect to see a significant fall-off in buying activity just as we saw in the late Fall following the November 30 expiration.


Second, mortgage rates are rising. 30-year conventional rates are up 25 bps in the last few weeks. This is principally due to the 40 bps backup in 10-year treasury rate, and we expect the 10-year to continue to rise over the next year, and mortgage rates to rise with it. We expect additional pressure on mortgage rates to come from the Fed's exit from the Agency MBS purchase program last week. While it's unclear whether this will pressure mortgage rates directly through reduced Agency MBS purchasing, or indirectly through reduced Treasury purchasing (which drives Treasury rates higher in turn pushing mortgage rates higher), we think its clear that the end of the Fed's program will adversely effect mortgage rates. Further, once Fannie and Freddie complete their $200 billion repurchase program in a few months, we think that could add further pressure to the market, pushing rates higher. We've published in the past the significant sensitivities of buyer's purchasing power to even small changes in mortgage rates. We think this will be an overhang as we move further into 2010.


The third risk we're highlighting this morning is the official rollout of the HAFA program yesterday. The HAFA program is the Home Affordable Foreclosure Alternative program. For those borrowers who don't qualify for a HAMP loan modification, they may qualify for assistance under the HAFA program, which provides incentives to servicers to allow short sales and deeds-in-lieu (DIL) of foreclosure. While this may ultimately be preferential to the alternative of foreclosure for both the lender (or asset-backed investor), the reality is that foreclosure volume has been held back from hitting the market for some time now through a combination of HAMP, lender modification programs, state moratoriums around foreclosure and various other incentives lenders have to kick the foreclosure can down the road. HAFA may provide a significant boost to an already bloated unsold inventory of housing stock. Remember, HAFA has been in place for several months, but hadn't yet gone effective until yesterday meaning that servicers have already built up pipelines of eligible HAFA borrowers - many of whom are in the system already, paperwork complete, because they applied, but didn't qualify for HAMP. This inventory should hit the market in the next few months as HAFA ramps up, right at the time when we envision both natural demand diminishing because of the pull-forward and mortgage rates rising.


The key to this call is understanding the duration differences. To reiterate, we expect that in the near-to-intermediate term (1-3 months) the data will get better before it then gets worse over the intermediate-to-long term. Along these lines, we would expect the trends and the rally to continue as long as housing is improving. However, once we move beyond the near-to-intermediate term, we see the headwinds starting to pile up.


We have been working for the last several weeks on a robust housing industry model to try and make more quantifiable sense of these moving pieces, and until the model is complete we consider our conclusions preliminary. That said, we do see a number of potential cross currents, if not outright headwinds, converging around housing in the not too distant future. The question is whether they will be more or less powerful than the onslaught of new government and private sector initiatives to combat the housing crisis.


Joshua Steiner, CFA

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Hedgeye Book Club: The Genius in All of Us by David Shenk

Talent is not a thing; it's a process.

-David Shenk, 2010


On Wednesday, March 31st, Keith interviewed Richard Peterson as a guest host for Bloomberg's taking stock. Peterson, the author of Keith's favorite book on investing - Inside the Investor's Brain - went back and forth with Keith in a rigorous and lively discussion about behavioral finance. In that discussion, Keith explained to Peterson how he likes to work key takeaways from various readings into his own investment process  -  always open to new information and evolving intellectually.


Such has become the culture here at Hedgeye. A few weeks back (Mar. 10th), my colleague Daryl Jones wrote one of our most popular notes YTD. The note titled, What Are You Reading, highlighted the current favorite book recommendations of various members of the Hedgeye team. In taking that one step further, we've decided to open our library and share with you any new and old required reading with the intent to deliver keen reviews and detailed synopses of the content. We hope you will find these valuable in your quest to evolve your own investment process.


So without further a due, here's our first shot:


In one of the most comprehensive books I've read in my young life, David Shenk's The Genius in All of Us : Why Everything You've Been Told About Genetics, Talent, and IQ Is Wrong completely hammers home the fundamental notion that greatness, superior talent, high achievement, and sheer excellence are not at all the result of natural gifts bestowed upon us by our genetic code. Rather, it is the sum of hard work, perseverance, and a confluence of genetic and environmental interaction - which Shenk aptly titles "GxE" (genes multiplied by environmental factors). Using one of the most voracious research processes I've seen (sorry Keith), he masterfully pores thorough just about all the required reading on the subject in order to dispel the old, tired way of thinking about cognitive, social, and athletic development: "G+E" (genes plus environmental factors). Not only does he accomplish this, he takes it a step further in using more cutting edge research to suggest the best methods for "cultivating greatness" - as he puts it. It is our pleasure to walk you though some of the key takeaways from the book an how you can use them to cultivate greatness within your own investment process.


In the first part of the book titled, "The Myth of Gifts", Shenk explains how groupthink within the scientific community and the media has successfully kept alive the "simpler and more alluring idea of giftedness", one where individual characteristics and achievement levels are more likely the product of genetic inputs, rather than the result of a confluence of factors - many of which we (and our parents) have control over (Shenk 49). In the introduction, Shenk does a great job of using anecdotal evidence about Ted William's masterful skill at baseball to introduce us to one of his main conclusions - "talent is not a thing: it's a process" (Shenk 8). Shenk remarks, "[Ted Williams] sought out the great hitters of the game - Hornsby, Cobb, and others - and grilled them about their techniques" (Shenk 7). In this business, no one is right 100% of the time. Heck, you can make a killing even if you're right less than half of the time. At Hedgeye, we've been right on our trading calls within our virtual portfolio roughly 85% of the time. Rather than rest on our laurels, we're up grinding well before the crack of dawn each day in order to try to capture that remaining 15% - and were not afraid to consult some of the best to do so (see Keith's Feb. 3rd exchange with David Einhorn of Greenlight Capital or any of his recent appearances as host of Bloomberg's Taking Stock).


That brings me to Shenk's next major point: "high… achievers are not necessarily born 'smarter' than others, but [rather they] work harder and develop more self-discipline" (Shenk 42). If you've ready any of our work, by now you're familiar with our love affair with processes over here at Hedgeye Risk Management. Every morning, every member of our team has their feet on the floor, flushing though hordes of macro and industry-specific data to deliver the best research we can possibly put out. My high school offensive line coach used to say, "talent doesn't win when talent doesn't work hard". Shenk goes one step further in suggesting that talent doesn't even become talented without many thousands of hours of deliberate practice.  Furthermore, Shenk uses the latest scientific advancements to debunk similar "born with it" myths about Kenyan runners:


"These are not super humans with rare super genes. They are participants in a culture of the extreme, willing to devote more, to ache more, and to risk more in order to do better. Most of us will understandably want nothing to do with that culture..." (Shenk 89)


Our processes don't change day-to-day, no matter how much attention the manic media can sometimes pour into one story (see: iPad). We gather it all the relevant data, analyze it with dozens of years of industry experience, and crank out the content. Then we rinse and repeat. There is no secret Hedgeye sauce. The secret sauce might be that we don't really have a secret sauce. We just grind. Shenk aptly suggests that becoming great "requires enormous, life-altering amounts of time - a daily grinding commitment to become better" (Shenk 55). At Hedgeye, we substitute "become great" for "managing risk and delivering absolute returns for our subscribers".


The second part of Shenk's book walks the reader though a multitude of scientific discoveries and how these findings can be used to form successful ways to "Cultivate Greatness". Shenk flat out says to the reader:


"The only way to [become great] is to go farther, harder, longer than almost everyone else, to push well past the point of login or reason. If it looked easy or even attainable to most, then many more would get there." (Shenk 100)


Plain and simple: there are no shortcuts on the path to remarkable achievement, according to Shenk. Those that are willing to make the long journey must have already developed the understanding that "the big prize is appreciated as a far off goal… not lusted after… [and] small accomplishments along the way provide more than enough satisfaction to continue (Shenk 101). In investing, particularly risk management, the best players are those that relish in the small accomplishments along the way. Too often investors get run over chasing tops, shorting lows, and constantly looking for the next big idea. Unfortunately, the next big idea is the next big idea for a reason. Big, career-making calls are not always around the corner. Most of the time, this job requires that you have to be satisfied with not losing your clients money and capturing the most alpha by strategically managing risk around all of your positions.


As Shenk puts it, "an emphasis on instant gratification makes for bad habits and no effective long-term plan" (113). Ask any baseball player if swinging for the fences is the best approach to driving in runs. Even the littlest of little-leaguers will tell you that "just getting on base" is how teams win ballgames. Moreover, Shenk uses additional scientific justification to suggest that building a winning culture requires that teams "set high expectations, but also show compassion, creativity, and patience" (Shenk 123). Patience, sometimes can sometimes be the most important factor in delivering absolute returns to your clients. Too often investors suffer from duration mismatch because they are too early on their trading calls. As Keith learned form trial in error throughout his years managing hedge funds (and I from him in a few weeks), being early equals being wrong. Furthermore, managing risk requires you know when and at what price to get into each of your positions - no matter how sweet the fundamentals look on the long or short side.


In short (note the irony - sorry for the lengthy note), we hope you'll find this piece as additive to your investment process as it has been and will continue to be for us. Be on the lookout for more notes of this nature, as we are planning to open up to you our process for intellectual fulfillment and investment evolution. As stated before, the best performers in any arena are the ones who willing to adapt and evolve. Scientific study has proven that true for animals, humans, athletes, investors, and everything in between.


As the facts change, so do we. Wash. Rinse. Repeat. That's risk management.


Darius Dale


The Hope Chart: SP500 Levels, Refreshed

Hope, when combined with fear, can be amazing to watch – particularly when it’s being priced on a market tick.


I walked through the following TRADE, TREND and TAIL lines of support in this morning’s EL:

  1. TRADE (3 weeks or less) = 1174
  2. TREND (3 months or more) = 1124
  3. TAIL (3 years or less) = 1039

From a risk management perspective, protecting against immediate term hope and fear is really not that complicated. We have made these overbought/oversold calls on the SP500 since we started the firm. They are tactical in nature and more about realizing where your risk/reward is from a time and price than anything else.


From our updated immediate term sell line (as of 11AM EST) we have outlined below at 1189, downside to our most immediate term level of TRADE line support is -1.3%.  Downside to the TREND and TAIL lines are -5.5% and -12.6% respectively.


While we haven’t had many down days in the SP500 that are more than 1% since the February Freakout, this chart outlines the hope that that day isn’t closer today than it was yesterday.


Hope is not an investment process.



Keith R. McCullough
Chief Executive Officer


The Hope Chart: SP500 Levels, Refreshed - S P

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