Merrill Lynch (MER): To Short Or Not To Short?

From Wall Street’s vaunted CEO’s, we’ve all seen our fair share of what my favorite hockey Coach used to call “misinformation” in 2008. Most of these CEO’s have either been fired or are currently under fire, however. Save one John Thain, who is actually Merrill’s new face, but not a new one to the Street.

Goldman Sachs has produced some interesting politicians as of late. John Corzine, is suffering from bad public opinion polls as the Governor of New Jersey. Meanwhile, Hank Paulson is doing his best to admit that he has no idea what to do for the next 3-6 months before he loses his job as the Secretary of the Treasury. Then we have Mr Thain, another Goldman alum, who is one of those guys that apparently thinks he is so smart that he can fool everyone with “misinformation”, including himself.

In Merrill’s recently filed 10Q, Thain’s latest disclosure was that the $4.3 Billion stake that he announced Merrill was selling back to Bloomberg wasn’t exactly a cash deal. In fact, Michael Bloomberg didn’t really give Merrill any cash at all. Merrill gets $110M in cash, and the rest in long term notes! Yet, John Thain was waiving Merrill’s sale of their 20% stake in Bloomberg as a liquidity event? I don’t get it. I guess he is hoping no one does.

We have our eyes on Thain’s concept of transparency. This is the 2nd time he has been ‘You Tubed’ in less than a month. For one, that’s hard to do; secondly, it’s just embarrassing. Insiders bought a pile of MER stock at $22.50/share at the end of July, but that certainly doesn’t mean much to me. Insiders have been buying stock in poorly managed companies at terrible prices since November of 2007.

Merrill is one of those companies that I am looking to re-short into this latest market rally. I like to sell high, and cover low – I do not have a position currently, but I will if the stock fails at my resistance line of $28.66. At 4.1% of the float, the stock has a shockingly low short interest relative to the risks implied in their equity valuation. This company has negative cash flow from operations and will have no visibility on paying their dividend if the US economy deteriorates to the extent that it has the potential to from here.

My math says that a drop from $28.66 to $22.50 is a -21.5% decline, and I’ll happily cover the stock alongside any insiders who are brave enough to buy more on that downside test. If the stock can close above $28.66, I’ll stay on the sidelines and refresh this point of view as the facts change. For now, be weary of what this company states as facts.
  • If MER fails at $28.66, I'll be shorting it.
(chart courtesy of

Footwear Market Looking More Stable

The footwear industry finally seems to have stabilized in the US after nearly 10 weeks of cycling one of the most intense periods of discounting in years. Undoing last year’s sins when aggressive pricing drove clearance activity, we’ve recently had +10-20% selling price gains offset by commensurate unit sales decline.

We’re finally back at zero barrier – at almost the exact point when back-to-school sales start to pick up. Translation? We’re back to a point where these numbers gain increased relevancy on many fronts. My team and I will be watching them like a hawk.

Given the conservative fall buying I’m seeing out of many of the footwear retailers, I like how things are shaping up. I’m, still liking FL.

What Nike Does Not Want You To See

I am floored by the list below showing the top 10 NBA Jerseys in China ranked by sales in ‘07/’08. Nike has only 40% share of the top 10 NBA jerseys sold in China over the past year. 40% might seem respectable -- -but not when Nike/Jordan and Converse collectively have 90% share of the basketball footwear market in the US.
  • Just as alarming for Nike is that the other 60% is held by AdiBok. Kobe is Nike, which is nice given his #1 slot. LBJ is too, but he’s #7. Not good. Paul Pierce (Nike) is an amazing player, but does not connect with US consumers. Wade is Converse (Nike sub). But Garnett, McGrady, Iverson, Howard, Arenas and Yao? They’re all AdiBok.
  • Basketball has been the single most impenetrable franchise inside Nike. To say that Nike’s Asian sales and marketing team is feeling massive pressure to face this challenge is an understatement. Nike does not like to lose. But so far, it is losing…
  • With 10 out of 11 US players on the US Olympic team donning the swoosh, let’s hope the team makes a lasting impression in Beijing.
Nike's better hope that NBA Jersey sales don't lead basketball footwear market share in China.
40% Nike, 60% AdiBok.

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We all should be congratulating the financial management teams (gaming not bank managements) for negotiating significant liquidity, loose covenants, and low rates in their credit facilities. Most of these deals were struck in 2005-2006. Unfortunately, all good things must come to an end. With maturities concentrated in 2010-2011 and capex spending still high, these guys have to be at least a little worried. Do they capitalize on any open credit window to refinance early at significantly higher rates or wait and hope that the environment improves markedly over the next year or two. This will be the classic rate vs. liquidity tradeoff. It’s all about risk management. Given the significant risks (declining fundamentals, higher LIBOR, CAPEX, etc.), the risk averse path may be the road most traveled. I guess analysts projecting 5% borrowing costs in perpetuity need to adjust their models.

I believe low interest rates have allowed these companies to over earn during the past several years. The following chart quantifies the amount by which these companies may be over earning. The analysis is based on the assumption that credit facilities were refinanced at estimated prevailing rates for all of 2008. In many cases the impact is huge. Most at risk going forward is Ameristar Casinos. ASCA’s revolver matures in November, 2010. The interest rate is strikingly low at LIBOR plus 1.63%. The prevailing rate in today’s environment would be 3-4% higher, all due to risk premium, essentially cutting ASCA’s EPS in half. If they opt for long-term bonds the impact will be greater.

Due to its CityCenter obligations, high leverage, and a 2011 maturity, MGM is another company to keep an eye on. MGM could be over earning by at $0.40 or 25% of current EPS. This story has a lot of risk. I continue to be worried about the Las Vegas fundamentals and the coming cancelation wave on the residential piece of CityCenter. Refinancing at the next window has to be considered. Look for significantly higher interest expense definitely not contemplated in analysts’ current estimates.

BYD and ISLE appear a bit scary on the surface but won’t see maturities until 2012 and 2013, respectively.

PENN and WYNN look solid due to low leverage and high liquidity. No worries here.

Risk aversion suggests refis, higher interest expens, and lower EPS


Yesterday, the London Times reported that Starbucks UK and Ireland managing director Phil Broad has resigned. According to the company, Darcy Willson-Rymer, VP of Starbucks Europe, Middle East and Africa, will assume his position. This is not healthy sign for SBUX, and is clearly a sign of the times. Relative to the news flow over the past two weeks, management changes should not come as a surprise.

Consider the following time line:

July 29th - Starbucks Coffee International Inc. appointed Martin Coles as president, replacing Jim Alling. Martin Coles was the COO of Starbucks Corp. The COO position was eliminated.

July 30th SBUX 3Q08 EPS conference call - “I think we want to be very cautious. I think there are signs in the U.K. that are difficult to predict, but there are signs that remind us of what happened here in the beginning of ‘08, and those signs kind of bode downward in terms of consumer spending. We want to be very careful, and in markets like Spain and Greece, specifically in Spain, they are experiencing a very, very tough economy, and in view of that, we want to be as cautious as possible and not over-expand at a time when the consumer may be under significant pressure. But offsetting that, the openings in the last six months or so in Brazil and Argentina, the ongoing success we’re enjoying in Mexico, and although it’s only six stores in Russia, there’s a lot of places where we can make that up. We’ll just see how the year goes.

Aug 8th - Phil Broad, the Starbucks UK and Ireland managing director, has resigned less than a week after he assured The Times that difficulties facing the coffee shop chain in America and Australia had not spread to Europe.

Martin Coles is one of Howard Schultz’s key executives and his return to Starbucks Coffee International Inc. was a disappointment to Phil Broad, if not the end of the road for him.
Martin Coles

China Moves Away From Currency Basket: What Does It Mean?

For one, this is a major shift in China's FX trading policy. They are officially moving to a market based policy of "managed flexibility."

Looking back at the massive moves in the global currency markets this week, we have to consider this Chinese decision as being one of the more relevant factors. The US Dollar Index traded up +3.4% on the week alone, closing at 75.85, catching plenty of global macro investors off guard. Asian currencies we’re under siege.

In plain English, this move by the Chinese is the 1st explicit one that moves them towards a free floating exchange rate. The announcement came on Wednesday, and that coincided with huge volatility in global currency trading immediately thereafter.

Since 2005, the Chinese used "reference currencies" as a basket. In addition to the US$, the major currencies in that basket were presumably the Euro, the Yen, and the South Korean won.

This important decision marks the third of consequence that the Chinese have made since 1997 on the FX front, where they went from a single regulated rate, to a managed floating rate relative to a "basket", to this most recent one.

It is global this time, indeed.
  • Wisdom Trees Chinese Yuan Fund (CYB) Is Breaking Down...
(chart courtesy of

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