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HOT: THE RIGHT WAY TO VALUE FEES

You can’t just slap a 14x multiple on managed and franchised fees.

 

 

Continuing our review of the valuation of HOT, we focus this post on valuing the Fee business and once again use JPM as a proxy for “consensus”.  At first glance, the “consensus” multiple of 14x times 2010 depressed Fees may look reasonable.  However, there are a few problems with this simple valuation of Starwood’s fee business.

  1. 2010 Fee estimates include about $80MM of amortization of deferred gains which are non-cash and have ZERO value.  They are remnants of the Host sale and will go away.  Take a look at Starwood’s cash flow statement; “amortization of deferred gains” are plain as day deductions on HOT’s cash flow statement.  That means zero cash.
  2. JPM’s Fee estimates also include roughly $40MM of termination fees and other one-time items.  While termination fees are certainly part of the fee business, by definition they are not “recurring.” Once someone terminates a contract you get the cash – that’s it.  We would value these fees as cash, perhaps even put a little multiple on them, but no one would pay 14x for them.
  3. JPM’s Fee number also includes $15-20MM of “miscellaneous other revenues” that used to be lumped in with Bliss before HOT sold that business.  As a reminder, Bliss revenues for Sept 09 TTM were $85MM - all included in “fee revenues” - which under the JPM method would have been valued at 14x.  Bliss Sept 09 TTM EBITDA was only $5.3MM, so the associated $80MM of expenses were captured in HOT’s SG&A, which gets a 50% reduction and a 12x multiple according to JPM… does that make sense to you?  Anyway, we don’t know exactly what's in the $15-20MM of other fee revenues line, but we’d bet that it’s low margin and doesn’t deserve more than 8x multiple.
  4. Another "small" issue with the above methodology is reducing total SG&A by 50% and classifying that reduced amount as "unallocated".  We know that roughly 75% or so of our estimated $325MM (ie $240MM) of SG&A in 2010 is related to the managed & franchised business.  Another $15MM or so is related to overhead of running the owned business.  The balance of roughly $70MM represents corporate overheard and unallocated expenses.  So again, I'm not sure how the 50% reduction makes sense, but this brings us to issue #4 relating specifically to the fee valuation – this isn’t a start up; EBITDA, not revenue, should be valued with multiples.  We don’t value Marriott or Choice by slapping a multiple on their revenue, so why would we value Starwood’s fee business this way? Management/ Franchise businesses have roughly 65-70% margins.  We would actually apply a higher multiple on the management and franchise base fee EBITDA since it's still depressed in 2010 and the highest quality piece of HOT’s fee business.  On a “revenue” basis, base fees are approximately 60% of HOT’s fee business.
  5. Incentive Fees – Sorry but this highly volatile revenue stream deserves a lower multiple than base fees since, as this cycle and every other cycle has illustrated, they are highly cyclical and cyclicals trade at lower multiples.

So where do we shake out on the value of HOT’s Fee business versus JPM and consensus.  With the all-encompassing 14x multiple, JPM values the Fee business at $9.7BN or $52/share versus our valuation of the fee business at $5.2BN or $28/share - only a $24 difference.  To make things a little more "apples to apples,"  we can apply all of JPM's Unallocated SG&A which they value at 12x as a reduction to the fee business valuation, and come up with a net value of HOT's fees at $7.8 billion, which still represents an $18 differential in value per share compared to where we shake out. 


US STRATEGY – FOLLOWING THROUGH

“The U.S. remains the proverbial elephant in the bathtub”

-John Williams

 

With S&P now down 11.9% from the peak on April 23rd on the fears of European financial instability, we are shifting our focus to when will the market shift and begin discount the fears of U.S. financial instability. The United States is not immune or separated from the current global crisis; Timmy Geither would be better served focusing on his own job rather than cheering Europe’s “capacity to manage through this”. Geithner said, “we just want to see them follow through”. In the interwoven web of global debt, there are many creditors hoping that their debtors follow through. China is indeed watching.

 

Yesterday, the S&P 500 index closed right around its worst levels for the day and postedthe biggest one-day decline for 2010. Once again, our “Sovereign Debt Dichotomy” theme is having a growing impact on the trajectory of the global economic recovery. On top of that, the issue is being exasperated by Germany's recent unilateral move to ban naked shorts on certain German banks, Eurozone government bonds and related CDS. Policy-related issues in China and the riots in Thailand also continued to weigh on sentiment.

 

At home, the economic calendar was a net negative, especially for consumer related names. Our Financials team has been harping on claims for a while now, pointing to the fact that they have been essentially flat for the last five months. Yesterday, they were actually up quite a bit. Initial claims unexpectedly rose 25,000 to 471,000 last week, the highest level in a month. The four-week moving average increased to 454,000 from 451,000. The reality is that without significant improvement in claims, a leading indicator, there will be little improvement in unemployment.

 

Leading indicators also disappointed, falling 0.1% month-to-month in April with negative contributions from six out of the ten components. The decline marked the end of a 12-month winning streak for leading indicators. The Philadelphia Fed Index rose for a fourth straight month in May, though the headline reading was only slightly better than consensus.

 

In early trading, the euro bounced big time from our intermediate term line of support of $1.21 and has now moved right to our target of $1.25. The euro is trading up versus all major currencies with the exception of the Swiss Franc. The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade (1.21) and Sell Trade (1.25). Despite this brief reprieve for the euro, the issues in Europe continued to be a drag on sentiment.

 

Over the short-term, elements of "flight to safety" in the U.S. dollar will help to contain short-term U.S. inflation.  We do, however, suspect that the U.S.'s day of reckoning is coming. The Hedgeye Risk Management models have the following levels for the USD – Buy Trade (85.62) and Sell Trade (89.97).

 

Currently, equity futures are trading below fair value as markets can’t escape the “Sovereign Debt Dichotomy”. As we look at today’s set up the range for the S&P 500, is 34 points or 0.1% (1,070) downside and 6.0% (1,136) upside. For the first time since early 2009, the Hedgeye Risk management models have moved to 0/9 sectors on TRADE and 0/9 sectors positive on TREND.

 

Commodities fell to an eight-month low. The CRB Index dropped 1% to 250.07. Intraday, the index was at 247.49, the lowest level since Sept. 8. Energy and precious metals led the decline. The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,182) and Sell Trade (1,255).

 

Crude oil was poised for a third weekly decline as European leaders struggled to contain the region’s debt crisis and reports cast doubts on the strength of the economic recovery in the U.S. The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (69.01) and Sell Trade (74.16).

 

Copper is headed for a sixth consecutive weekly loss as investors remains concerned that Europe’s debt crisis will spread and hurt a global economic recovery. The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.85) and Sell Trade (3.09).

 

In credit markets, the TED spread has widened further to 0.37 and LIBOR has ticked up to 0.49 from 0.48 yesterday. The inverse correlation between the TED spread and the euro tightened further to -0.96.

 

Howard Penney

Managing Director

 

US STRATEGY – FOLLOWING THROUGH  - S P

 

US STRATEGY – FOLLOWING THROUGH  - DOLLAR

 

US STRATEGY – FOLLOWING THROUGH  - VIX

 

US STRATEGY – FOLLOWING THROUGH  - OIL

 

US STRATEGY – FOLLOWING THROUGH  - GOLD

 

US STRATEGY – FOLLOWING THROUGH  - COPPER


Fiat Flashes

“They must often change who would be constant in happiness or wisdom.”

-Confucius

 

As prices and circumstances change; we do. We’ve learned this risk management lesson from many of this world’s great strategists. Unfortunately, most of them don’t have an opportunity to lead us out of this mess. Most of them are dead.

 

Fortunately, crises of government sponsored groupthink give birth to tremendous change. From the fall of the Roman Empire to the falling of the proverbial Berlin Wall of Wall Street conflicts of interest, opportunities come and go. Sell high and buy low. That’s my kind of capitalism.

 

I started this business during the crash of 2008 because I believed in one thing – doing my own work. Some of Connecticut’s finest hedgies called me names. Some of Nebraska’s hardest working said thank you. All the while, I took the good with the bad and kept doing that one thing…

 

In May of 2008, there were 4 of us here in New Haven, CT. Today there are almost 40. In May of 2008, Lloyd Blankfein said the crisis was in the late innings. Today, some of those who said the same about the sovereign debt crisis before the May Showers of 2010 wish they hadn’t too.

 

Today is a new day in modern finance. No matter where you were positioned yesterday, here you are. Today, there are new rules. Everything you say and do will be You Tubed and Twittered. Everything in finance is moving toward where most industries have already gone. In principle, transparency is winning. Opacity is losing.

 

Just like me, the professional forecasters on Wall Street and in Washington are storytellers. Barring any intra-game moving of the goal posts by Fiat Fools, our stories are all marked-to-market every day. Real-time accountability in all that we tell stories about is a tremendous progress born out of this crisis of leadership.

 

In the month of May, we have seen plenty of Fiat Flashes. These flashes of market selloffs were proactively predictable and we aren’t done with them yet. That said, every market has a time and a price. Our task as risk managers is to use the groupthinkers as our backboard to play against. The good news is that there are many more of them than there are us.

 

I covered our short position in the SP500 yesterday, then went long the SPY intraday. In doing so, I took our allocation to US Equities in the Hedgeye Asset Allocation Model up from zero percent to 3%. I am not levered up long. I still hold a 55% position in cash.

 

The freak-outs and Fiat Flashes that you’ll see this morning in pre-open futures trading is for reactive monkeys who weren’t proactively prepared for yesterday’s selloff. Some of them literally call risk management a 200-day moving average. Now that that their branch is broken, the 200-Day Moving Monkeys are flailing. Throw them a banana, buy some stocks, and cover some shorts. You’ll find happiness that way.

 

Yesterday, my inbox started heating up mid-afternoon. I had a lot of questions about price, volume, and volatility. As is usually the case, there aren’t a lot of moves to make after the fact, so I went and got a haircut.

 

This morning was nice, because I don’t have to use hair product anymore. I have revealed some change in the volume of greys relative to the story that my Canadian hockey hair was hiding. Changing my hair color and market positioning this morning is good. After all, a great strategist once said we “must often change” if we’d like to strive to “be in constant happiness.”

 

My long term TAIL line (3 years or less in duration) for the SP500 remains 1070. While the plan is always that the plan is going to change, for the next 3-days of market trading I’ll be doing a lot of waiting and watching for that line to hold. There is now a full 6% of immediate term upside in the SP500 to 1136, despite the market’s intermediate term TREND line of 1144 remaining broken.

 

For now, the largest of the Fiat Flashes in both upside to volatility (VIX) and downside in the market (SPY) appears to be behind us.

 

Have a great weekend and best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Fiat Flashes - 1


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Fiat Fools (the lyrics)

As I mentioned in this morning’s Early Look, we have an army of you reading our work that believes in proactive risk management using real-time prices as leading indicators. We are looking for change in this business – and the change starts with being the change you want to see.

 

Below I have attached the most creative response to our call to arms, from a sharp Hedgeye subscriber.

 

Enjoy,

KM

 

 

Hi Keith,

 

I thought you would like – I put together a bailout version of Curtis Mayfield with a hint of hedgeye in it :) 

 

Sisters, Brothers  
Central Bankers And Their Backers
They're All Political Actors

Hurry, People Running From Their Worries
While The Judge And His Juries
Dictate The Law That's Partly Flaw.

Educated Fools

From-Uneducated Schools
Keynesian Fools

Bailing out is The Rule
Polluted Water In The Pool

And Obama’s Talking About hope
He Says Change is coming
He Says Change is here
He Says Don't worry

But They Don't Know There Can Be No Show
And If There's A Hell Below We're All Gonna Go
Everybody's Praying And Everybody's Saying
But When Come Time To Do
Everybody's Laying

Educated Fools

From-Uneducated Schools
Friedamite Fools

But They Don't Know
There Can Be No Show
If There's A Hell Below
We're All Gonna Go

 

Educated Fools

From-Uneducated Schools

Fiat Fools

 

Lord What We Gonna Do
If Everything I Say Is True
This Ain't No Way It Ought To Be
If Only All The Mass Could See

But Everybody Keeps Saying Don't Worry

 

 

Thanks,

Bennet


Deflating Inflation's V

If our global macro risk management process had to be boiled down to 2 words they’d be prices rule. We feel that its critical to maintain data dependence. As prices change; we better change – that’s the model.

 

In recent weeks, one of our Macro Themes for Q2 (May Showers) has eroded the momentum embedded in one of our other Macro Themes for Q2 (Inflation’s V Bottom). Now this doesn’t mean that the V-Bottom recoveries in the charts Darius Dale has prepared below cease to exist. It simply means that the slope of the year-over-year price moves in both US Consumer and Producer Prices is setting up to rollover in the coming months.

 

As market prices go, so does inflation/deflation. There is no ideology here. There are no weightings. The mathematical slope of a line is absolute. As we head into the last month of Q2, if commodity prices were to stay where they are today ($65/oil and $2.95/lb copper), Inflation’s V will most likely deflate.

 

Now, to be clear, inflation is like politics – its local. So what I am talking about here is all about sequential probabilities in US CPI and PPI (as Trichet trashes the Euro, the Europeans will likely see inflation rise, like the British did this week with the highest inflation reading in 17 months at +3.7%).

 

For the month of April, both CPI and PPI in the US ticked down by 10 basis points sequentially. Yes, even by the government’s compromised and conflicted calculations, these were still inflationary (year-over-year) readings for both the CPI and PPI at +2.2% and +5.5%, respectively. But, and this is a big but, everything that matters to our prices rule model happens on the margin. On the margin, sequential decelerations (month-over-month) in Inflation’s V, are what matter most.

 

From a modeling perspective, timing the Deflating Inflation’s V is critical. Don’t forget that the lowest deflationary reading of Bernanke’s said “great depression” occurred in July of 2009 at -2.1% (ooh, ahh… what a great deflation reading that was in hindsight… I know, its sad). This mathematical reality only enhances the probability that Inflation’s V starts to deflate against the last of those very easy summer of 2009 deflation compares.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Deflating Inflation's V - 1

 

Deflating Inflation's V - 2


RRGB – 1Q10 TURNING POINT

1Q10 should give us more of an indication of whether the company’s LTO promotions are effectively driving same-store sales higher and whether current estimates are achievable.

 

RRGB is scheduled to report 1Q10 earnings after the close today.  RRGB’s 4Q09 earnings release and call left me with more questions than answers.  During 4Q09, same-store sales fell 10.5%, decreasing about 40 bps on a 2-year average basis from the prior quarter.  In the first 7 weeks of 1Q10, comparable sales declined 7.8% (including -0.8% impact from unfavorable weather) versus -4.6% in the same period in 2009, implying a 275 bp sequential improvement in 2-year average trends from 4Q09.  Despite this -7.8% result, management guided to flat to slightly lower same-store sales growth for 1Q10 and +2.4% to +3.4% growth for the full year. 

 

Management’s guidance is aggressive relative to what we have heard from its competitors and is completely reliant on the success of the company’s Spring LTO which was rolled out the week of February 15, combined with the supporting national advertising campaign launched on February 22.  The Spring LTO was scheduled to run 8 weeks supported by 4 weeks (over a 5-week timeframe) of national advertising that was expected to cost $6.7 million in 1Q10.  For reference, RRGB’s total FY10 TV advertising expense is expected to increase to $16-$17 million, up from $2.3 million in FY09.

 

Based on RRGB’s Fall 2009 LTO promotion, which ran in about one third of its company units, management is comfortable with its current guidance.  In 4Q09, same-store sales growth was -5.1% in the 10 markets which ran the Fall LTO supported by local TV advertising versus -14.9% in the non-TV markets.  This success is driving management’s optimistic growth goals for 2010.  Specifically, RRGB’s FY10 same-store sales growth guidance assumes a 5%-6% lift from its expected three LTO promotions.  I found this guidance slightly questionable because management, themselves, are not yet fully committed to the three promotions as they want to measure the success of the Spring LTO in 1Q10.

 

It is important to remember that a 1% change in reported same-store sales growth equates to about $0.18 per share on a full-year basis, which is why reported 1Q10 sales results are so important.  If the Spring LTO promotion proves as successful as management hopes, the company will follow with two more.  If it is not, they have said they will not invest the additional $10 million in advertising costs to support two additional LTOs, which would significantly impact management’s full year same-store sales guidance relative to the 5% to 6% lift expected from running all three.  Management also said that depending on trends during the Spring LTO, it would decide whether the two remaining LTOs would be focused on a specific price point, and if so, that it would prefer to move prices higher than the $5.99 price point used in 1Q10.  I can understand management wanting to raise the price point but moving away from a specific price point all together would likely be a mistake from a traffic perspective.

 

As I said earlier, management guided to a flat to slightly down same-store sales comp in 1Q10 and the street is at -2.2%.  A flat comp would assume a 490 bp sequential improvement in 2-year trends from 4Q09 relative to the casual dining industry’s 215 bp improvement, as reported by Malcolm Knapp.  Given that same-store sales were down 7.8% in the first 7 weeks of 1Q10, a flat comp implies that same-store sales improve to +6.1% in the back half of the quarter (16-week quarter).  The company is facing a much easier comparison of an estimated -10.8% in the back half of the quarter versus -4.6% in the first 7 weeks of 2009.  The +6.1% in the last 9 weeks of the quarter would imply another 385 bps of sequential improvement in trends on a 2-year average basis from earlier in the quarter.  That being said, RRGB has a lot riding on this Spring LTO and reported 1Q10 results could be a real turning point for the company from a top-line perspective, for better or for worse.

 

From a margin standpoint, it will be important to hear what RRGB says about commodity costs for the remainder of the year.  As of 4Q09, the company was guiding to 2% to 2.5% commodity deflation for FY10.  During the fourth quarter, lower food costs helped restaurant margin by 20 bps on a YOY basis and management commented that its average price of ground beef in the back half of 2009 was below 2008 prices.  Hamburger, which the company does not have under contract, accounts for about 11% of the company’s food and beverage costs and beef prices are moving higher.  Management pointed out on its last earnings call that beef burgers have increased as a percentage of the company’s sales mix as a result of the recent LTOs which have been focused on the company’s gourmet burger offerings.

 

RRGB – 1Q10 TURNING POINT - rrgb sss

 

RRGB – 1Q10 TURNING POINT - beef prices

 

Howard Penney

Managing Director


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