Sober and realistic have typically been good words to describe PENN management commentary. We’d say they apply to CFO Bill Clifford’s recent thoughts on MGM.



PENN CFO recently spoke at a conference and the commentary turned to Las Vegas and MGM.  Bill Clifford’s comments were enlightening and not just because we agree with them.  Here are a few:


Bill Clifford on Las Vegas and CityCenter

“I mean 63% occupancy for a CityCenter is a good thing? I don’t know, I mean. And I’m not trying to be – I mean obviously, it’s a new property and they’re going to grow into it and it’s a property that’s very focused on group business or it’s a property designed significantly for group business. And obviously that market’s got to come back, et cetera, et cetera. But – so I don’t want to downplay the CityCenter results as necessarily bad. I think that’s just a natural process and it’s an enormous facility. I mean it’s – I mean thousands and thousands of rooms that are – that they’ve got to fill. You’ve got Cosmopolitan coming. But all of a sudden the stock market’s basically saying, well, everything is great in Las Vegas. So valuations are up. I saw somebody’s report this morning. It wasn’t this guy. But 14 times is a good number. Okay, 12 times for next year, great. We can’t buy a facility at 14 times and make it work. We just can’t”


Basically, 12x is a ridiculous multiple for Las Vegas assets; unworkable from a buyout perspective.  The public equity multiple is higher than a private multiple, so what gives?  Investors must really be expecting a v-shaped recovery.  Our view is that there are too many structural issues with the consumer and the economy. The LV of 2005-2007 was housing fueled more than anything else.  We are not getting back to those levels anytime soon.  We think PENN management probably agrees.


Clifford was being fair when it came to CityCenter.  The property will get better but there are still a lot of hurdles including new capacity.  As of now, it is pretty much a disaster.


Bill Clifford on Borgata

“We’ve got 95 million for Perryville, I don’t how much Borgata can I get for [that much]...I don’t think it’s very much either. I mean buying Borgata, I just can’t imagine a situation where given that Boyd has a right for first refusal, I just can’t imagine there’s a price we would pay that Boyd wouldn’t match. So – and I don’t know anything about Boyd’s strategic objectives. But just given that they’re a controlling partner and our views on Atlantic City, the price that we’d offer is just not going to be something that I think Boyd would sit there… I actually very much expect Boyd would be 100% owner of Borgata”


Clifford’s Borgata comments followed a trashing of Atlantic City’s prospects.  The question really is how much would you pay for half of a good asset in a horrible market with no operating control from a forced seller.  The answer is not much which pretty much guarantees BYD will end up with 100% ownership at a very good price.  This is not good for MGM.


Of course, Clifford’s comments must be taken with a grain of salt.  It’s no secret that PENN maintains some dry powder and has expressed an interest in acquiring a Strip property.  From this perspective, management is probably not happy that Las Vegas valuations have gotten so high.  However, I’ve always known this management team to be straight shooters and Clifford’s assessment makes a lot of sense.


Our sense is that people want to own this group. BYI already let the cat out of the bag for the March and June quarters. Numbers would have to be awful for IGT to disappoint.



IGT is reporting its FQ2 this Thursday and we are expecting a miss.  In fact, we’ve been at $0.17 since IGT reported its FQ1.  Despite the Street’s current $0.20 estimate, real expectations are lower and therein lies the problem for any would be shorts.  Anyone who’s been listening to the company’s commentary and extrapolated from BYI’s pre-announcement knows that the near term earnings picture is cloudy at best.  Replacement demand is still sluggish, weak casino results negatively impacted gaming operations, and Alabama units have been offline for almost a whole quarter and will likely to remain so for the next few quarters. 


Not only is IGT probably not a great short into Thursday, it may actually see a relief rally.  Investors seem to want to own the slot guys.  The bad news for the group is short term and well known.  Judging from the muted reaction to a pretty nasty earnings revision by BYI, IGT will probably get another pass.  Forward commentary – beyond the June quarter – may be positive and discussion of a new Server Based Gaming contract with Cosmopolitan (See “IGT BAGS THE ELEPHANT?” from 4/14/10) could actually provide a positive catalyst.


Don’t get us wrong, we still think there are lots of booby traps with this name - primarily as it relates to share loss on the participation side, but that doesn’t mean that the name may not work for a trade – given the exuberance and momentum that is prevalent in this space.


We’re at $0.17 cents vs. the Street at $0.20 and are projecting FY2010 EPS of $0.84 vs. consensus of $0.91 (despite company guidance of $0.77-$0.87). Below are some details behind our estimates.



We are forecasting product revenue of $205.7MM and 52% gross margins

  • $124MM of NA product sales producing a gross profit of $67MM 
    • We are projecting 4.6k of units sales, with 3,250 replacements, 1,250 new units (including recognition of deferred units) at an ASP of $15.3k  
    • We estimate that NA non-box sales of $53MM, but don’t have any ‘edge’ on forecasting this number since it includes systems, conversions kits, used parts and ‘other stuff’ 
  • $82MM of international product sales producing a gross profit of $39.5MM 
    • International units of 6.2k –with 3k of those shipments from lower priced Barcrest units, thereby lowering the sequential ASP to $9.7k since Barcrest machines sell for roughly $4k. 
    • Non-box sales of $22MM- again – no real ‘edge’ here

Gaming operations revenue of $277.5MM with a 61% gross margin

  • We estimate 350 incremental installs, sequentially
  • Yield decline of 7% y-o-y


Other Stuff:

  • SG&A of $93.5MM, including $3.5MM of provision for bad debts – we’re below the company’s guidance of $95-100MM ‘run rate’
  • R&D of $51MM in-line with guidance of “low $50MM range”
  • D&A flat sequentially
  • Net interest expense of $30MM
  • Tax rate of 38%
  • While we don’t model these, we do expect charges related to the closure of IGT’s Japan operations.  The company guided up to $20MM of charges for the 2nd and 3rd quarters of FY2010.  


Here are just some of the comments about YUM’s quarter that have been printed in the past 24 hours:


  • China sales appear to be rebounding, muting concerns
  • YUM China turns the corner
  • Better trends out of China
  • Concerns about China business abating
  • China - strong start to FY10


Yet the company says this….


“We are particularly pleased with our business in China, which reported robust profit growth of 37% driven by both strong unit development and same-store sales growth.”


“Same-store sales grew by 4% and units expanded 14%, while restaurant margins were at a record level of nearly 27%. All combined to generate robust profit growth of 37%.”


“As we review a few of our highlights, let’s start with China. We had a very strong Chinese New Year holiday. This led the first quarter system sales growth of 15% including same-store sales growth of 4%. Sales were solid across the country including the high export regions.”


“We expect moderate same-store sales growth in China in the second quarter.”


 “We do not expect China’s exceptional margin performance in the first quarter to continue”


Granted, the numbers from China were very strong and provided an upside to the quarter despite the lackluster performance in the U.S. business.  Other than printing a 4% same-store sales figure, what leads you to believe that Yum issues in China are behind them?


  • Margins seen in China in 1Q are unsustainable
  • YUM needs to see a 10% 2Q same store sales number from China to maintain 2-year trends.  Anything less than 2% will produce a lower low from the -1% 2-yr trend Yum China saw in 4Q09. 
  • Average unit volumes declined 3% in 1Q10 - we know what that means


As I wrote yesterday, we have been short YUM, which has been the wrong call, particularly into first quarter numbers, which came in better than both sales and earnings expectations.  That being said, I continue to have my concerns, largely related to what I recognize as overly aggressive unit growth in China and profitability issues in the U.S. 



                                                                              YUM - THE STREET IS GLOWING ABOUT CHINA - YUM China 2Q trends


Howard Penney

Managing Director

Early Look

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Position: Short the S&P 500 via the etf SPY; Long Volatility via the etf VXX.


Tops are processes, not points….  This is how we see the risk management setup for the S&P 500 in 2Q10.


As we move through the balance of April and head into May, we expect stocks to lock in intermediate term highs as bonds break down to lower-highs.  As such, we will be managing risk around the potential for bonds to break down more severely and for the S&P 500 to correct by about 7% in the back half of 2Q10.


Currently, the S&P 500 is in a bullish formation.  A bullish formation occurs when the TRADE, TREND, and TAIL lines of support for a security's price sit below the current price and the longest term duration underpins our intermediate and immediate term durations of price momentum.


Right now we think the best idea is to be long high grade bonds and equities and short high yield!


We have a very healthy degree of skepticism of Government, Politicians and the market’s current levels and we are managing risk accordingly.  As we think about the setup for the S&P 500 over the next three months we observe all the following as headwinds for the market: 


  • Market Sentiment:
    • Volatility is broken on all three durations – TRADE, TREND, and TAIL
    • Institutional Investor survey (weekly) shows one of the widest spreads between “bulls” and “bears” since 2007
    • By early May the “easy compare” of 1Q10 earnings season will be in the rear view  
  • The Economy:
    • Headline CPI accelerated sequentially (month over month) from +2.1% last month to +2.3%
    • The balance sheet of the US is no different than the other P.I.I.G.S.
    • Sovereign debt issues are here to stay
  •  Interest Rates:
    • The April Fed meeting…. “extended and exceptional” is unsustainable and unreasonable; should be removed
    • The high yield market is at levels not seen since 2007; junk and muni issuance are making new highs
    • Treasury yields are scaring the horses out of the barn; the big rate moves (UP) across US history start in the spring and end in the fall
  • Commodities:
    • Oil prices are at levels not seen since Q408 (bullish TREND) and inflationary
    • Copper prices continue to be in a Bullish Formation (bullish TRADE, TREND, and TAIL).
    • Gold has very recently signaled being back to a bullish intermediate term TREND; is the Fed debasing the Dollar again?
  • The Consumer:
    • Consumer and Business confidence is stuck at very low levels
    • Job creation is anemic
    • Mortgage rates are headed higher - mortgage applications were down last week led by a sixth-straight decline in refinancing

Howard Penney
Managing Director



NKE/FL: 'Irrational Magnification'

We want to prep you for what could be some perceived 'irrational magnification' of actual facts unfolding today.



(1)    At least three factories in China have burned down during recent earthquake. These are apparel factories, and should not impact footwear directly. Athletic apparel, however, could be impacted. 

(2)    Athletic Footwear appears fine from a factory standpoint, but timely shipments are being jeopardized by volcano ash and shaky transportation infrastructure.


When I think back over the years of port strikes, earthquakes, and simple product gaffes, I find it amusing how these nuggets race around the market and the stocks move (down) without any real consideration as to what the real impact is. I'm not overly worried about this. Why?


(1)  The factories were apparel. This will impact athletic apparel, but lets remember that there are over 10,000 apparel factories globally.

(2)  I'd be concerned if this was footwear. Those factories are more like cities that self-sustain the global industry. unlike apparel, there are only about 30 factory groups in the world that make footwear. Furthermore, 86% of our footwear is made in China. 

(3) Keep in mind that Nike and Adidas source less than a third of their respective product in China. They're far less exposed than the other brands to any hiccup in China.


Ultimately, the demand is there and the product cycle is there. Could this tweak things by a week here or there, or give an underperforming retailer an excuse to point to? Yeah...I guess. 


But overall, our confidence in our athletic call for 2010 remains quite strong.  We issued a note in conjunction with Keith about FL yesterday and it being near-term overbought. If these anecdotes push the stock lower, it might be a shot to re-engage for those that have watched from the sidelines.


NKE/FL: 'Irrational Magnification' - 4 16 2010 3 16 57 PM



In the Early look on Thursday, we highlighted a glaring disconnect in today’s HIGH-LOW society.  The most obvious example of this is the dichotomy between Wall Street and Main Street. 


Yesterday the S&P 500 hit 1,211 (up 8.7% YTD and 14.6% from the February low) and today the Reuters/University of Michigan Consumer Sentiment Index is at a 5 month low and 6% below where it was in February. 


The Reuters/University of Michigan preliminary April Consumer Sentiment Index fell to 69.5 from a 73.6 in March.  A Bloomberg survey projected the sentiment index would be 75.0. The estimates ranged from 73 to 80, so nobody got it right!


The index of consumer expectations for six months from now, which more closely projects the direction of consumer spending, slumped to 62.3, the weakest reading since March 2009, from 67.9.  As a point of reference, the Consumer Discretionary (XLY) was index was 40% lower in March 2009.


No one can accuse of us on being shy about our views on inflation, but we are not the only observers seeing inflation.  In today consumer confidence report, the survey said they expect an inflation rate of 2.9% over the next 12 months, up from 2.7% last month. 


While the FED and other compromised groups want to look at the “core” inflation rate, the consumer cannot escape the reality they face at the pump and elsewhere. 


We remain confident in our Q2 theme - Inflations V-Bottom!


Howard Penney

Managing Director



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