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BC REFINANCING: IMPLICATIONS FOR GAMERS

Brunswick just raised $250 million in 5 year notes to pay off its floating rate borrowings due in 2009. It was the classic rate vs. liquidity trade-off I’ve been talking about. Yes, BC is now liquid but at a cost of 5-5.5% or $12.5m to $13.8m in incremental borrowing costs. I’m not making a call on BC. Rather, this is a real world illustration of what is likely to happen to some of the gaming companies, particularly ASCA and MGM. Last I checked, analysts are generally projecting current low borrowing rates in perpetuity.

I know. Brunswick is not a gaming company and doesn’t own hard assets so its borrowing rate could be higher than casino operators. However, BC is free cash flow positive and maintains a ton of cash and low leverage, unlike virtually every gaming operator. The obvious exception, of course, is PENN which remains our favorite stock.

ASCA is of particular interest in that this company negotiated one of the most attractive credit facilities, which is contributing to the lowest cost capital structure in the gaming industry (see the chart). The problem is the credit facility matures in 2010 (the earliest among the operators) and right now comprises almost all of the company’s debt structure. You can bet ASCA will be looking for liquidity at the next open credit window. My guess is long term fixed rate debt to offset its overreliance on variable rate debt. In my “GAMERS OVEREARNING: REFIS TO KNOCK EPS DOWN, ASCA AND MGM AT RISK” post on 8/10/08 I noted that ASCA’s EPS could be cut in half with a credit facility refinancing 3-4% higher. Obviously, to the extent the company opts for the safety and liquidity of long-term fixed rate debt, the EPS impact may be greater.

ASCA has been over earning due to unsustainably low borrowing costs

Chart of the Day: Japanese GDP

Japanese GDP shrank last quarter as diminishing export levels and domestic inflation weighed on the world's second largest economy like an anchor in the arms of a swimmer treading water. This chart says it all – an economic moonshot stretching from the end of the occupation into the 80’s followed by decades of stagnation resulting from weak political leadership and easy money.

Andrew Barber, Director

*Full Disclosure: Keith remains short Japan via the EWJ etf.

REVISITING OUR LIST OF QUESTIONABLE RESTAURANT TRANSACTIONS!

On July 20th, I published a list of 13 restaurant transactions over the past three years asking the question; how many companies on this list will need to raise equity or file bankruptcy in the next 12-18 months? Today, the WSJ highlighted some of the companies on the list.

According to the WSJ, the parent of Uno Chicago Grill will skip a bond payment on Friday as it tries to negotiate more financial breathing room. The issues at Uno are a common theme in restaurant land – UNO is being squeezed by declining customer counts, rising food costs and an overleveraged balance sheet. Not surprisingly, Uno was acquired in a leveraged-buyout in January 2005 by Centre Partners and management. Uno Chief Financial Officer Louie Psallidas commented that "We are not in any imminent danger of filing for bankruptcy."

The article also cited Chevy’s Fresh Mex, Perkins and Marie Callender's chains are also in talks with their lenders. Additionally, Real Mex Restaurants Inc., which owns the Chevys, El Torito Grill, Acapulco Mexican restaurants and other regional chains is also struggling. Real Mex and its subsidiaries is one of the largest operators of full-service Mexican restaurants in the country with about 200 restaurants. Another positive data point for EAT?

Real Mex was acquired in August 2006 for $359 million by private-equity firm Sun Capital Partners. Perkins & Marie Callender's Inc., the parent company of the two namesake chains are owned by private-equity fund Castle Harlan.

On top of all this, Bennigan's, Steak and Ale, Vicorp Restaurants Inc.'s, Bakers Square and Village Inn chains have filed for liquidation or bankruptcy protection.
The Chart we published on July 20th

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LIZ: It's Time For A Sit-Down

LIZ’ 2Q was lousy in almost every way. Even though the co came in ahead of my estimate and consensus, it narrowed FY guidance and picked a bad market day to do so. In other words, the market is telling me today that I need to eat some crow. There were a few bright spots that the market completely looked through today. But I need a little sit-down with management to make sure that LIZ is not missing them either.


I’ve made no secret that have been liking LIZ more and more in the mid/low teens. My Partner Keith McCullough cautioned me on the timing of the call given his near-term view (based on quantitative models) that it was headed to $12. Well, today it hit 12.50. Lesson learned… Respect timing.

Enough excuses. Let’s evaluate the model as it exists today. My view has been based not on strength in the business, brands, or industry positioning. But simply that this company was so poorly run for so long, and with a 40%+ SG&A ratio has among the biggest cost levers to pull in the business – by a long shot. The board has changed incentive targets for ’09 to be the breakout earnings year, and my view is that we’re at a point where either a) CEO’s (on the job for 1.5 yrs) recent investments start paying off in the form of profitable growth, b) growth does not come, so LIZ pulls back on costs and prints higher margin, or c) new CEO becomes ‘old’ CEO.

Believe it or not, we’re actually making progress in climbing the decision tree.

A) We know that growth is not working. Period. Now we move on to the next branch.

B) Pull back on spending and print higher margins? I definitely heard management move forward here to some degree. Inventory in the quarter was –26%, and more importantly, LIZ cut its capex budget by 7% for this year, and will cut store growth (Lucky, Juicy, Kate Spade) by 50% in ‘09.

What this basically told me is that LIZ is thinking “maybe we really don’t have the right to grow after all. Let’s fix the capital base we already have in place, increase debt paydown, and focus on margins.” Granted, I’d rather see growth plans come down by 100%. But it’s a start. Hindsight shows that most ‘Big Ideas’ for mature retailers over time have stemmed from this type of action.

The flip side is that the company is hiring people left and right. As much as it seems to get the ‘capital allocation focus’ on its balance sheet, there seems to be a complete disconnect on the P&L.

What’s the earnings power? Take capex down by 50%, close 25% of retail stores, write off another half of the core brand, and get rid of Mexx. Even if at a fire sale price. We’re seeing a bid at some price on mid-upper tier assets as evidenced by Li & Fung buying Van Zeeland today. That gets me to near $3 in EPS power on a reduced capital base.

The problem is that the plan I just articulated does not synch with management’s plan as outlined this morning. One of us has gotta give.

The bottom line is that the timeline for getting to the next branch on the decision tree is extremely close. I’m not talking 3-4 quarters. I’m talking 1. Time is running out for this team. Either capex comes down further and we see more discipline on the P&L, or the Board needs to cut bait on this team.

The market will not be patient here, and though I rarely bow to the broader tape -- in this case I agree.

US Consumer Confidence Retrenching To Its Lows

This morning's weekly ABC/Washington Post Consumer confidence reading came in lighter again (week over week) for the 2nd consecutive week. At -50, the reading is revisiting it’s all time lows.

What's most interesting about this retrenchment is that it is occurring in the face of declining gas prices and a "Trade" up in the US stock market.

When people on Main Street are losing their jobs, at an accelerating pace, maybe that trumps Wall Street's perpetually bullish narrative.
KM

GIL: '09 Question Mark

GIL's quarter was in line with pre-announcement -- so nothing to comment there above and beyond what I said last night. But the simple fact that the company said it should see a positive mix shift in '09 and would continue to rationalize its sock business, yet it cannot provide guidance for '09 as it needs to take up prices for the year to offset (yet-to-be-procured/hedged) cotton and energy costs. This is the first time in GIL's recent history where factors like this are part of the equation. It had ample visibility under its old model -- but not the new one. I still think sales are slowing, GM% is rolling, SG&A ratio is headed higher, and the Street's 140bp EBIT margin improvement expectation for '09 is in the clouds.

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