Brazil . . . Winning the World Cup of Interest Rates

Conclusion: Brazil increases interest rates to 10.25%, which leads the G20. Investors applaud, the masses are less pleased.

From Brazil, we're seeing more proactive risk management from a central bank president not named Glenn Stevens. As widely anticipated, the central bank’s monetary policy committee voted unanimously to raise Brazil’s primary interest rate, the SELIC, by 0.75%, to 10.25%.  The previous rate hike – also 0.75%, from 8.75% to 9.5% - was put through in April.  The rate increase was in line with market expectations in the central bank’s efforts to combat inflation.  The monetary policy committee meets again on 20 July.


Labor unions and business owners have expressed displeasure, saying the bank has thrown a bucket of cold water on the economy at what should have been an auspicious moment.  Sao Paulo’s business federation (Fecomerico) said the rate hike is the bank’s way of compensating for the state’s inefficiency.  They said the country should get public spending under control and make investments that will provide productive stimulus, rather than seek to control demand through higher interest rates. Consumers are echoing the more of the same with their wallets. Consumer credit delinquencies rose 1.9% in May Y/Y and 4.3% M/M (the first increase since Oct. 2009). Burgeoning credit card debt, consumer financing and bank loans were seen as the principle cause of the rise in the indicator, as consumer indebtedness grew at an accelerated rate during the last three quarters.  Rising interest rates were also seen as a contributing factor.


While we’d prefer not to take sides here, we do have a soft spot in our hearts for countries that respect the cost of capital – particularly in the face of white-hot growth and above-target inflation. To recap, Brazil posted a China-esque +9% Y/Y 1Q10 GDP release on Tuesday and May inflation (CPI) came in up 5.22%, though down sequentially from 5.26% in April, which is above the target rate of 4.5%.


In short, this seems like a classic case of short-term pain for long term economic gain. While Brazil does indeed have its problems (crime, government wastefulness, dried up capital markets), it certainly deserves a pat on the back for this latest bout of risk management. With the Bovespa rallying 2.6% yesterday, it looks as if it is getting just that.


 Brazil . . . Winning the World Cup of Interest Rates - Bovespa


Moshe Silver

Chief Compliance Officer and Managing Director


Darius Dale



The Macau Metro Monitor, June 11th, 2010



According to DB analyst, Karen Tang, casino gambling revenue in Macau soared 70% in the first week of June. Seeing no sign of a slowdown she raised her forecast of 50% growth in 2010. 



Susan Macke, IGT's chief marketing officer,  believes the growth in slot machine uptake will be similar to that of Las Vegas.  Macke said only 1/2 of the 2,500 slot machines allowed for each casino in Singapore have been installed.  Macke is also bullish on South Korea and the Philippines.  For the US market, Macke does not see replacement rate for slot machines rising to the 10% level any time soon as cautious consumer spending will crimp operators' spending on slot capex; however, Macke does see an uptick in sales before the end of the year.


IM still believes the MOP 20 billion-a-month mark will be broken by October unless Beijing sends a strong signal that mainland asset prices must come down and strong capital flow into Macau is cut off.  Until that happens, junkets will continue to have plentiful working capital and credit to extend to keep the party going.













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US gaming revenues still haven’t reached a definitive recovery phase and investors are worried. That worry spreads to suppliers and their gaming ops segments. BYI looks the most protected.



Which supplier should you own given the current casino environment?  Well, that depends on your outlook.  If you are looking for a V-shaped recovery in gaming spend, then WMS or IGT is your best bet.  Close to 100% of WMS gaming operations revenue is on a variable revenue share basis, while for IGT it is 75%.  However, IGT generates approximately 57% of its revenue from gaming operations and WMS only 40%.  Thus, on a net basis, IGT has a higher exposure to casino variability at 43% versus 38%.


If you think casino revenue growth will stay sluggish/negative and potentially take a turn for the worse, then you short the operators and stay away from the suppliers.  If you must own a supplier stock, then BYI is for you.  BYI generates approximately 50% of its gaming operations revenue from fixed daily fee structures and 50% variable.  Moreover, only 36% of its total revenues is derived from gaming operations so net exposure to casino revenue variability is only 18%.


Of course, should US gaming revenues take the plunge, the recent acceleration in replacement demand will be short-lived and operators will cut back.  That will not benefit any equipment supplier.  BYI would be relatively better off in that scenario and is probably the lower risk slot play.



Austerity’s Bite

“Everything we hear is an opinion, not a fact. Everything we see is a perspective, not the truth.”

-Marcus Aurelius


Austerity is the new buzz word in Europe; from newly elected UK Prime Minister David Cameron in the north to Italian PM Silvio Berlusconi in the south, the issuance of austerity measures from European governments to combat bloated fiscal imbalances seems like a near daily occurrence.


The word austerity comes from the Latin austerus meaning “dry, harsh, sour, tart” and was originally used to describe fruit and wine, however in economics refers to a government’s reduction in spending and/or increases in taxes to reduce a budget deficit.  Over the last weeks, European austerity packages have included such provisions as civil servant wage freezes, extensions on the age of retirement, and levies on alcohol and tobacco to an additional tax on the price of an airplane ticket. In short, governments are trimming obvious “fat” and creating revenue streams to rein in over-extended budgets.


Here’s a quick recap of budget deficits (as a percentage of GDP) and the notable austerity packages issued in Europe over the last months:


Greece – (13.6%); plans to cut €30 Billion in spending over the next three years

UK – (11.5%); £6.2 Billion (or €7 Billion) in spending cuts this year

Spain – (11.2%); €15 Billion in spending cuts and 5% reduction in public worker wage this year

Portugal – (9.4%); plans to issue measures to save €2 billion this year

Italy – (5.3%); €25 Billion in cuts over two years (*strike planned for June 25th)

Germany – (3.3%); €11.2 Billion in spending cuts for next year, or ~€85 Billion by 2014.


The most obvious question to ask is will these measures be enough to reduce deficits and return “health” to Europe?


In both the immediate and longer term the answer to this question appears to be No and a qualified No. In the near term, Europeans are taking to the streets, with strikes over austerity measures already held in Greece and Spain. While the estimated 2.5MM strikers in Spain appeared mostly harmless (a colleague likened the visual displays on TV to a pre-game World Cup party), strikes in Greece had a very ugly undertone with the death of 3 protestors.  As Keith has noted recently, austerity will equate to civil unrest:  the confluence of a government’s need to tax its people versus the public’s cry that they aren’t responsible for the government’s fiscal mismanagement, and therefore refusal to bear the brunt of the measures. We believe that deficit reduction alone won’t solve Europe’s fiscal problems.


In the longer term there are numerous structural and fundamental concerns related to the Eurozone. We’ve pointed out in our quarterly theme work that the investment risk related to sovereign debt default or restructuring is not limited to Greece, but will spread to Spain, France, and Italy, much larger economies than Greece with debt exposure to European banks far greater than Greece’s obligations by a factor of 4-5 times. The outcome could cause further (and greater) downward pressure on markets. 


Importantly, it’s worth noting that the European and IMF-led €750 trillion “loan” facility to buy up toxic debt from European countries “in need” (and return investor confidence) has failed to buoy European markets largely because ECB President Jean-Claude Trichet has not outlined just how the facility works! As a result, we’ve tracked increases in government bond yields, sovereign CDS, and equity underperformance, along with the Euro-USD that broke through our immediate term support line of $1.20-1.21 earlier this week to a low of $1.1876 on 6/7 and is down 15% YTD.


Further, what we have seen since the facility was announced on May 10th is strong headline risk (think comments from a Hungarian official last week of a Greece-like debt crisis in his country that sent markets plunging) and continued day-to-day volatility. Also, the separate European/IMF funded €110 Billion aid package to Greece hasn’t made a dent in performance or sentiment: the Athex is down 33% YTD and the worst performing major index in the world.


Could it be that the experiment of uniting disparate economies is a losing effort?


As we see it, there are two main threads of questions that still need to be worked through to determine the path of the Eurozone:

  1. Should European officials revise the standards of the Stability and Growth Pact, which limits members to a budget deficit no greater than 3% of the country’s GDP?  Could more malleable standards be devised (alongside an oversight body) to limit fiscal imbalances across countries, to benefit both the individual country and the Union as a whole? Conversely, is there any merit in imposing harsh budget reduction mandates (that governments may likely fail to meet) at the expense of growth?
  2. Can the Eurozone, a union of 16 disparate countries that share the Euro as a common currency and are tied to the European Central Bank for monetary policy, exist at all, if countries cannot manipulate (devalue) their currency to inflate their way out of debt or independently adjust interest rates to spur or quell growth? 

Clearly these are big questions, all of which we don’t have the answer for.  What we can count on is the continued lack of political solidarity from European leaders to proactively address the region’s ails, which is risk we’re focused on managing around. Statements yesterday from EU President Herman Van Rompuy are case in point: “And if the plan [€750 Billion loan facility] were to prove insufficient, my answer is simple: in this case, we’ll do more.” This is not leadership! 


If austerity is the first start to something better, we caution that weaker growth prospects are ahead for much of Europe. In the longer term, it just may be that despite the Eurozone’s intention for the whole to be stronger than the individual parts, disparate parts may remain just that, or conversely, and to quote a line from William Butler Yeats’ poem “The Second Coming”: Things fall apart; the center cannot hold.


We’re currently short France in our virtual portfolio via the etf EWQ and have been short Spain (EWP) this year as a way to play the weakness we see in Europe.


Matthew Hedrick


Austerity’s Bite - EL CDS



On 5/19 we published a note titled, “WEN - Undervalued Yes, Where is the Opportunity?” that discussed WEN’s stock and provided a sum-of-the-parts analysis that suggested that the company’s stock was trading below its intrinsic value.


I said at the time, “Over the years, Trian Partners has been extremely successful at creating value from mispriced securities.  In the almost two years since creating the Wendy’s/Arby’s Group, it has now created one of those mispriced equities.  Can Trian and senior management fix WEN again?”


After the close yesterday, Train said in a 13D/A filing that it recently received an oral inquiry from a third party expressing interest on a preliminary basis in a potential acquisition involving WEN.  Our sum of the parts analysis from 5/19 values the WEN at $7.70.  We value the Wendy’s business at $6.30 per share and the Arby’s business at $1.40 per share.  Send me an email if you would like additional details.


Thus far WEN is the third company to announce some sort of value enhancing initiative.  Fist it was CKE, then CPKI and now WEN.  If you are looking for the next possible candidate I would bet on EAT...


Howard Penney

Managing Director

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