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American Hope

“Creativity comes from trust. Trust your instincts. And never hope more than you work.”

-Rita Mae Brown


Some of the best American quotes come from the hardest working American people. Rita Mae Brown is known in some circles for being tennis star Martina Navratilova’s ex-girlfriend, and in others for being a bestselling author about American fox hunting. She was born in Pennsylvania, but was raised in Florida. She’s lived a typically anonymous, yet public American life.


Despite the politically inspired fear-mongering of this being a “Great Depression”, many Americans still wake up every morning with hope in their hearts and hard work on their sleeves. As another University of Florida grad who is becoming popular in conservative political circles recently quibbled about Washington: “They think Americans need a guardian class of really smart people who went to the right schools to tell us what to do.”


That was Cuban-American politician Marco Rubio, who was quoted in this weekend’s edition of The Economist in an article titled “The anti-Crist” (that’s not a spelling error; it’s in reference to the 38 year old Rubio crushing the sitting Governor of Florida, Charlie Crist, for the open US Senate seat in FL). Ironically enough, that same issue of The Economist has a cover titled “Hope At Last”, with a nice blue sky, an American flag, and a rainbow…


Ah… with the weather this nice on the East Coast, how romantic a hope that is… Unfortunately, hope is not an investment process.


The Economist opened its hopeful missive with something that resembled a story line from Little House on the Prairie suggesting that “great storms and floods have a way of altering landscapes”…  “the financial deluge has passed and the recession it caused, the worst since the 1930’s, is ebbing”…


Little House, of course, was a series of children’s books by Laura Ingalls Wilder that were published during the real Great Depression (1). When I see shoppers hurling toward the counter at an Apple store for an iPad, I still can’t find it in me to accept prefacing every analytical point I hear with this narrative fallacy of how bad the lives of America’s upper-class have become.


But that doesn’t mean that a levered up American economy is going to get better from here. It certainly doesn’t mean that we are sitting on the edge of a rainbow that is going to lead us to another inflated pot of gold either. It could mean we just stay the same – politically conflicted, compromised, and confused.


With all of the debts we have created, we are most certainly going to inflate a lot of things in our lives – not the least of which is hope that this US stock market’s +75.6% gain from the March 9th low is going to sustain itself.


I shorted the SP500 on Thursday. So far that position has not worked. It has gone 0.64% against me. It doesn’t make me happy. It doesn’t make me sad. I understand where my risks are, and I will deal with them accordingly. If I see any SP500 price north of 1192 in the coming days, I will short it again. If it holds 1072, I’ll probably cover the position. If it doesn’t hold, and starts to break down like the US Treasury market has, well… that’s not a risk I’ll be bearing.


After you see market melt-ups like this, the most difficult thing to reconcile is that immediate term tops are processes, not points. The more hope you see in the Manic Media, the more careful you need to tread on the high-wire of making sales. Not unlike buying in April of 2009, selling here in April of 2010 is not for the faint of heart.


Wall Street is all about selling stories, not risk management. In early February, after the SP500 dropped -8% in a virtual straight line from its January 19th high, we acknowledged the selloff for what it was – Wall Street and Washington “Selling Fear” – and we got longer. Now, after a +12.3% monster rally from the February 8th low, the only fears that remain are those of either getting squeezed on the short side or missing the next bull market in hope.


Selling high is never easy, and I certainly don’t always get it right. From an intermediate term TREND perspective, the SP500 is undoubtedly in a bullish position. In fact, its in what we call a Bullish Formation, where all 3 of our core investment durations underpin one another. That said, Bullish Formations always get immediate term overbought. Nevertheless, our TRADE, TREND and TAIL lines of support are as follows:

  1. TRADE (3 weeks or less) = 1172
  2. TREND (3 months or more) = 1124
  3. TAIL (3 years or less) = 1039

At this stage of the rally, hopes and fears are the same thing. You can hope you aren’t chasing another immediate term top, and at the same time fear that you are selling something that will never go down again. That, of course, isn’t born out of anything other than what’s inside your brain.


My friend, Dr. Richard Peterson, who wrote the book on this (Inside The Investors Brain, 2007), would chalk this up to your stress hormones and how they behave when you are faced with something that isn’t working. Whether that be your short positions in the SP500 or your view that this “recovery can’t be real”, they are one and the same.


The art of this game is sometimes simply turning everything, including your iPhone, off. After all, corrections always come. Timing the when is more about math than hope.


My immediate term lines of support and resistance in the SP500 are now 1172 and 1192, respectively.


Best of luck out there today.



American Hope - Marco Rubio



The Macau Metro Monitor, April 6th, 2010

HOLIDAYS NOT GAMBLING macaubusiness.com

According to the 2009 Visitor Expenditure Survey, only 8% of visitors said they came to Macau mainly for gaming. 69% of Macau visitors said they were there mainly for a vacation. However, 50% of the interviewed visitors said they had participated in gaming activities during their stay in Macau. 



BYI lowering of guidance wasn’t a complete surprise and smart move in light of the Rainbow sale announcement. This doesn’t really change our long term outlook but does highlight the near term risk we were concerned about.



BYI lowered its EPS range for FY2010 to $2.15 to $2.25 ($0.15 to $0.25 below original guidance) due to:


“1) slower than expected deployment of capital by customers thus far in calendar 2010; 2) the interruption of gaming in Alabama (discussed below); and 3) lower-than-anticipated win per unit in Gaming Operations in the third quarter. Despite lower revenues than previously anticipated, gross-margin percents are expected to be within the normal ranges. The Company now anticipates the range of systems revenues to be $217-$223 million for fiscal year 2010 versus the previous $220-$230 million.”

So basically the guide down of $0.15-$0.25 cents breaks down as follows:

  • Alabama:  $0.04-$0.05 cents for 2H2010
  • Systems:  $0.03 to $0.06 cents from systems.  $3MM-7MM of revenues which is most likely higher margin upgrade product since new systems openings are more or less known and the slippage of Marina Bay Sands will still fall into 2010. 
  • The two items above explain $0.07 to $0.11 cents of the guide down leaving the balance to lower unit sales and lower win per day results in gaming operations.  Our guess is that the vast majority is from lower unit sales.

While no one likes to see lower guidance, the reality is this doesn’t change the outlook for the future but rather highlights the near term risk we’ve written about.  Not surprisingly, BYI was very positive about their outlook as well:


“While we are disappointed with the pace of customer capital deployment so far in calendar year 2010, we remain confident in our longer-term prospects. We have just begun delivering our new wheel-based recurring revenue product including Cash Spin, which won “Best Slot Product” at last year’s Global Gaming Expo (G2E).  Pre-orders for Cash Spin have been the strongest of any product in the Company’s history.   And, this summer, we will be releasing our new ALPHA 2 platform and Pro Series™ Upright gaming cabinet, which have received very positive feedback.” 


Other positives mentioned on the call included:

  • Color on Italy:  BYI revealed that they would be receiving several systems contracts and placing over 3,000 gaming devices on some sort of participation basis
  • New participation product looks strong
    • 900 Fireballs installed in just over 10 months
    • Expect to have over 500 Cash Spin games shipped by June 30, 2010 and have commitments for over 1,300 new wheel products (including Cash Spin)

In addition to pre-announcing the EPS miss, BYI also announced several other material events:

  • Sale of Rainbow Casino: BYI announced they signed a definitive agreement for the sale of its Rainbow Casino in Vicksburg, MS to Isle of Capri Casinos for approximately $80MM.  Rainbow will be classified as an asset held for sale, and its results will be classified as discontinued operations in the March 31, 2010 financial statements.  The sale is expected to close in by June 30, 2010. 
    • We estimate that Rainbow did about $12MM of EBITDA in FY2009 and about $19.5MM in FY08.  Rainbow did $39.6MM of revenues in FY09 and $17.7MM for the 1H2010.  We came up with the same EPS impact from the sale of Rainbow as  BYI’s mentioned on the call ($0.10-$0.11)
    • BYI thinks that it will clear approximately $60MM of net cash proceeds from the sale, and if all those proceeds were used to buyback stock then the transaction will be EPS neutral to slightly accretive.
  • Enterprise-wide contract with ISLE for a new system:  BYI announced that it entered into a enterprise-wide contract to replace a competitor’s system with a full suite of Bally systems and server-based gaming solutions in 10 of its properties over the next few years.  Isle’s remaining properties already use Bally systems.
    • We estimate that this contract could be worth approx. $0.30 share for the installation and up to $0.07 a year in recurring EPS several years down the line once the conversion is complete.  To come up with our numbers we estimated that 10-11,000 of ISLE's machines are not already connected to a BYI's system (we need to confirm this assumption).
  • Credit agreement amendment:  BYI’s is working to amend its credit agreement to increase the Company’s allowable leverage ratio and remove the current limitations on restricted payments, including share repurchases, as long as the Company remains below certain leverage ratios.  At BYI’s current leverage ratio (less than 1x), there would be no restrictions under the proposed amendment.  The amendment is expected to be completed by mid-April. 
    • As a reminder, BYI’s completed their current facility on October 1, 2009, in the midst of the financial crisis.  Therefore, the terms weren’t exactly “favorable”.  BYI Maximum Consolidated Leverage is currently 2.25x dropping to 2.0x in the quarter ending June 30, 2010.
  • Accelerated share buyback and new $150MM share repurchase plan:  "Combined with approximately $80 million of cash on the Company’s balance sheet at March 31, 2010, net cash expected from the Rainbow sale, availability under the Company’s $75 million revolving credit facility, and the free cash flow generated from operations, the Company expects that this amendment will allow it to accelerate purchases under its current share repurchase program and have increased liquidity for other corporate purposes.”
    • Again we are not sure how fast the buyback will occur, but given how under leveraged BYI is, this would certainly be accretive.
  • Alabama:  “As of March 31, 2010, the Company had approximately $5 million in development financing advanced; 1,750 recurring-revenue games in four locations with a net book value of approximately $7 million; and $1 million in uncollected receivables.  Depending on the evolving circumstances in Alabama, all or a portion of these assets may be considered impaired possibly as early as the finalization of the Company’s March 31, 2010 financial statements.” 
    • No real surprise here… potential write-downs here are much more of an issue for IGT.

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Below are our notes from the business update.  We will follow up with a more detailed note shortly.



  • Agreement to sell Rainbow will allow them to concentrate on their core business – no surprise since this has been rumored in a while
  • Reluctance of customers
  • Low win per day in gaming operations seems to be bouncing back – claim it was weather related
  • Alabama negatively impacting them by 2-3 cents per quarter
  • Italy placements will begin in latter half of 2010.  BYI expects to play a meaningful role on both the games and systems side. Expects to place over 3,000 games and get several systems contracts
  • Releasing Alpha 2 with a 10 times improvement in processing power over Alpha 1. 
  • Digital Towers – great – 900 Powerballs and have commitments for 1300 slot products for their wheel products. 
  • Continue to take share on the systems business.
  • Canada RFP’s represent a big opportunity for them as do other new markets


  • No difference between big operators and small ones on the replacement side
  • G2E meetings were very positive, but the orders just didn’t come – which was surprising based on the feedback from G2E.  Thinks part of this is due to weather and weak performance in Jan & Feb.  Their numbers in game operations bounced back in March and hopes that implies an uptick in operators results
  • Write-offs in Alabama? Not yet, hoping that they will have more clarity in the next few days there.
  • Rainbow – in discontinued operations? 10-11 cents a share from loss of Rainbow. But if they use the proceeds then it’s neutral from an accretion/ dilution standpoint.  Tax basis on Rainbow? Estimate net proceeds of around $60MM (+/- $5MM)
  • Credit Facility Amendment?  Gives them more market pricing and more flexibility to use their balance sheet – old deal was done in the a rough time in the market
  • Still think that their market share is still in their 20% range +/- several percent
  • Think that they can get about 500 cash spins out until the end of June. Alpha 2 platform not out until Sept 2010.  Those 500 are included in the 1,300 wheel number.
  • Fireballs are replacing their products, while Cash Spin is helping them gain incremental floor share (50% or less cannibalization). 
  • Systems business lead time – is that getting shorter or longer?
    • Well shorter since it has shifted more to maintenance products from new openings
    • But its taking customers longer to make decisions
    • Guidance they are giving for the balance of this year is mostly for business in the bag – but there could be some slippage for openings.  However for next year – when they give guidance, a lot of it will be based on upgrade assumptions.

Oil Prices Rule

Over the course of the past week, our quantitative models on commodities have gone from a bearish formation for oil to a bullish formation.  Fundamentally, there are a number of factors that have been driving this change in quantitative set up.


First, geopolitical tensions seem to be picking up on the margin.  In recent weeks, Vladmir Putin has visited with Hugo Chavez and President Karzai of Afghanistan has made a number of anti-Western comments, in addition to reaching out to Iran and China.  This morning, as well, the river card was shown in the way of increased terrorist activities in Pakistan.  A U.S. consulate was attacked in Pakistan and another related bombing killed 25 people in Pakistan.


Second, there is increasing evidence that slack in the global economy will tighten for more than just the short term, which improved the global demand picture for oil.  As we highlighted in our oil Black Book last year, supply globally is tight despite massive investment over the last decade.  Therefore, when projecting for the tightness of supply and demand, the key factor to solve for is a pick up in demand.  In the short term, pundits will point to the most recent relevant data point from the United States - the better than expected jobs report which added 162,000 jobs.  More important though is the sustained growth from Asia, most notably China. 


One of our key themes for Q1 2010 was Chinese Ox in a Box, with which we accurately predicted a correction in Chinese equities.  While we did see a slow-down in various economic data points in Q1 for China, we also see continued demand for commodities, which most directly support sustained demand for oil. Specifically, on March 23rd, we wrote in the Early Look:


“Vale is the second largest mining company in the world, so when Vale speaks, our commodities team listens.  Last night Vale sent a document to its customers saying it was raising iron ore prices to $122.20 per tonne, versus $57 per tonne year last year.  That is a 114% increase.  I don’t need a degree from MIT to know that is inflation.”


In the chart below, we have highlighted the long term oil import trends for the Chinese, suffice it to say, they are up and to the right:


Oil Prices Rule - China Crude Oil Imports


Finally, days supply of oil in the United States continues to trend below year ago levels, as it did for much of February and March. While there are currently 25.2 days’ supply in the United States, it is below last year’s level from the same week by 0.2 days.  Including the Strategic Petroleum Reserve, however (this is above historical levels), the aggregate supply level in the United States continues to be at improved levels versus last year.


Predicting the direction of the price of oil globally is no easy task.  It requires a global supply and demand analysis, and also an incorporation of a varying number of factors, which change with time (as an example the inverse correlation to the U.S. dollar has become slightly less relevant versus last year).  Nonetheless, as with most markets, prices rule, and the prices, combined with the fundamentals on the margin, are suggesting a bullish set up for oil.  Our immediate term price levels are outlined below:


Oil Prices Rule - OIL


Daryl G. Jones

Managing Director

ROST: KM Stepping Up the Short -- Again

ROST: KM Stepping Up the Short -- Again


Keith dipped his toe back in the water again on ROST today, shorting a name that we’ve been on the cautious side on for a while. We remain convinced that the opportunities to meaningfully exceed both guidance and elevated Street expectations are gradually becoming harder and harder to achieve.  When you add in eight quarters in a row of inventory declines (while sales have accelerated) it remains hard to envision anything but a deceleration in momentum is on the horizon.  There is no question that this has been a great run, as it has been for other retailers benefitting from value pricing and the consumer trade-down effect.


Check out this historical perspective below, which takes a detailed but long look at the relationship between the industry’s inventory management (represented by the Sales/Inventory spread) vs. ROST historical same-store sales.  The Sales/Inventory spread for clothing and accessories retailers is currently at its widest margin since before 1996.  Tough to argue with that one…  We then line this up against Ross’ topline results and you will see that ROST’s same-store sales exceed the Sales/Inventory spread far more frequently than not, 139 months out of 169 or 82% of the time.  In fact, of the 30 times the sales/inventory spread outpaced comps over 13 years, 5 have been since September of last year alone.


The cleanliness of the inventory pipeline for retailers and manufacturers alike is about as good as we’ve ever seen and as a result, there are simply less “quality”  goods for ROST to procure.  Additionally, with fewer units floating around in the pipeline, we should begin to see ROST (and others) no longer being able to buy as close to need as we have seen over the past year.  This should have an adverse impact on inventory turns as well as the industry’s ability to flow fresh, unique good as frequently.  All this points to diminishing upside on margins and earnings. This is one of those names where we don’t need to see earnings collapse to be right, but rather simply stop going up.


ROST: KM Stepping Up the Short -- Again - ROST Comps


ROST: KM Stepping Up the Short -- Again - ROST Margins


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