IGT 3Q2010 Preview

IGT is now officially cheap but near term catalysts remain elusive. Whisper expectations for the quarter are pretty low. The focus will be on replacement demand.



The sell side remains stubbornly above IGT’s fiscal 2010 guidance of $0.77-0.85.  We suspect that buy side expectations are lower, however, so a reiteration of guidance should not disappoint.  For FQ3, our projection of $0.21 is in-line with the Street.  Replacement demand should be a major focus for both the quarter and the outlook.  Despite investor pessimism, replacements have been accelerating, which should bode well for next year’s earnings.  Of course, if casino revenue trends don’t recover, all bets are off.  In that environment, no gaming company will do well but the suppliers should be better off.


Here are the details of our projections:


FQ3 Detail


Product revenues of $231MM with gross margins of 49%

  • North American product revenue of $146MM and gross margin of $73MM
    • 6,350 new units ( 4,700 replacement) at $14.4k.
    • As we wrote about on 7/1/2010, “Q2 AND Q3 MARKET SHARE COULD BE MISLEADING”, IGT typically sees a big sequential increase in ship share in the June quarter, which is also typically a seasonally stronger quarter for replacement orders than March.  Since 2006, IGT’s replacement orders have seen some sequential pick up in June. 
    • While new and expansion shipments are nothing to write home about, we estimate that June shipments will be roughly 1,200 better than March shipments.
    • IGT’s Dynamix package offer, which was supposed to expire in May, was extended through the end of June, so we expect similar pricing to March.
  • International product revenue of $88MM at a 47% gross margin
    • 5,300 new units at $10.8k.
    • Our sequential decline is due to the removal of 2,200 units shipped to Japan in March, and less units shipped to Asia, since March included shipments to Singapore, and is offset by higher shipments to Australia, UK, and S. Africa.
    • Better margins due to the removal of impairment charges related to Japan last quarter.  Pachislot also had lower margins.

Gaming operations revenue of $281MM and gross margin of $171MM

  • Average install base of 60,300 with an average win per unit of $51.30.
  • June has seasonally lower yields than March for IGT.
  • Given the shipment of a lot of new product, we assume a small pickup in D&A and therefore, a small tick down in margins.

All the other stuff:

  • SG&A (including bad debt) of $89MM.
  • R&D of $52MM.
  • D&A (expensed) of $19.8MM.
  • Net interest expense of $23MM.
  • Tax rate of 38%.


The dollar continues to look as awful as the underlying health of the USA’s balance sheet.




As we look at today’s set-up for the S&P 500, the range is 26 points or 1.9% downside (1,052) and 0.6% upside (1,078).  Equity futures are trading below fair value this morning. 


One of our 3Q Macro Themes, Bear Market Macro, continues to find support in the data and GDP estimates on the Street are being cut accordingly.  While there are two sides to this debate, our view is that data related to earnings and housing will continue to shape this debate and we are not bullish on either area.


The dollar continues to slide and looks bearish from an intermediate term perspective; Hedgeye Risk Management’s TREND line of resistance for the USD Index is 84.13.


Following Monday’s session, there are only three sectors bullish on TRADE: Utilities (XLU), Consumer Staples (XLP), and Technology (XLK).  Utilities (XLU) remains the only sector positive on TREND.


On the MACRO front today, Housing Starts came in below expectations: 549k reported vs. 580k consensus. Based on our Q3 Macro Theme of Housing Headwinds, we expect reporting risk to be to the downside for housing data points over the next 6-9 months, barring further government intervention.



















The Macau Metro Monitor, July 20th, 2010



According to a source close to the deal, HSBC has pulled out of a US$850m five-year loan for MGM Grand Macau.  HSBC was committed for US$100MN.  The move comes as a surprise because while the facility is a club-style loan, HSBC worked behind the scenes on coordination and promotion of the deal.  A banker said HSBC's exit will not affect the outcome of the loan since it was  “comfortably” oversubscribed.

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In preparation for the HST Q2 earnings release tomorrow, we’ve put together the pertinent forward looking commentary from the company’s Q1 earnings release/call and subsequent conferences.



Trends & Forward Looking Commentary

  • “Our top line results improved on a relative basis in each period of the quarter and turned positive in March. As you may remember, due to the timing of our reporting period, our first quarter does not include the operating results for a significant portion of our portfolio for the month of March.” 
  • “For the third straight quarter, we experienced year-over-year growth in our Transient business with an overall increase in Transient room nights of more than 12%. More importantly, this increase in demand was led by our Special Corporate business where room nights increased more than 28%, and our Premium and Corporate segments where room nights increased for the first time in nine quarters at a rate of nearly 9%.”
  • “On the group side, frankly, we were pleasantly surprised by the pace of our short-term bookings during the quarter.” 
  • “RevPAR growth for period four exceeded 5%, continuing the recent trend of improving results. Group bookings continue to be strong as bookings in the first quarter for the second quarter have more than tripled when compared to last year and even slightly outpaced our 2007 level of activity. Transient bookings for the second quarter are also trending ahead of last year. Overall, improvement is still relying on the strength of the economy, but we are optimistic that businesses are beginning to loosen their travel budgets, spurring a recovery in lodging demand.”
  • “Overall, wages and benefits decreased 1.3% or 8.2% on a per occupied room basis, and unallocated cost declined by 2.7% for the quarter as hotels reduced management headcount and lowered other controllable costs. Utility costs also decreased 8.4% through a combination of lower usage, lower rates and the impact of energy saving capital improvements. For the quarter, real estate taxes were flat.”


  • “We are increasing our estimates for RevPAR for the year to an increase of 1% to 4% with a comparable adjusted margin decline of 125 basis points to 50 basis points. Based on these assumptions, full year adjusted EBITDA would be approximately $750 million to $800 million and FFO per diluted share would be $0.58 to $0.65.”
  • “We are increasing our expected capital expenditure estimate for the year to $300 million to $340 million, and we'll continue to evaluate other projects as we work through the year.”
  • 2Q 2010 Guidance:
    • “We expect the Philadelphia market to underperform the portfolio due to lower levels of both transient and group demand.”
    • “As expected, the Miami Fort Lauderdale market performed very well with a RevPAR increase of 10.3% …We expect the Miami Fort Lauderdale market to have a weaker second quarter but still have positive RevPAR.”
    • “We expect San Antonio to have a decent second quarter and a strong second half of the year.”
    • “We expect our Boston hotels to have a great second quarter with double-digit RevPAR growth due to strong citywide activity and improvement in transient demand.”
    • “We expect the Orange County market to continue to perform well in the second quarter.”
    • “We expect New York City to have an outstanding second quarter due to high levels of business transient demand.”
    • “We expect Chicago to perform much better in the second quarter and for the outperformance of the Swissotel to continue.”
    • Hawaii: “We expect the hotels to perform much better in the second quarter but we need to see further increases in airline capacity versus stay in recovery.”
    • “Our DC hotels had positive RevPAR in period three and we expect DC to have positive RevPAR in the second quarter.”
    • “We expect the San Diego market to continue to struggle in the second quarter but improve in the second half of the year.”
  • “Looking out through the rest of the year, we expect occupancy to increase further, which will likely lead to growth in wage and benefit cost at inflation after taking into consideration the benefit from productivity gains. We expect unallocated cost to increase at inflation except for utilities where rates will increase and occupancy improvements will drive higher utilization, and sales and marketing where higher revenues will increase cost. We will also incur cost for the implementation of new sales and marketing initiatives. We expect property insurance to increase at inflation and property taxes to rise in excess of inflation. As a result, we expect comparable hotel adjusted operating profit margins for the year to decrease 50 basis points at the high-end of the RevPAR range and decrease 125 basis points at the low end of the range." 
  • “For all of 2010, cancellation and attrition fees will be significantly lower than 2009. Adjusting 2009 to a typical year of cancellations would result in an improvement of the above margin guidance of 70 basis points.”
    • 2009 attrition: “It's $40 million incremental, over a typical year.” 
  • “On the margin front, I think our estimate is that we are looking at a 50 basis point decline tied to a 4% overall full year RevPAR growth rate."


  • “Earlier this month, we purchased the junior tranches of a mortgage loan secured by a 1,900-room portfolio of hotels in Europe. The par value of the tranches we purchased are approximately EUR 64 million and we purchased the notes at a meaningful discount. While we cannot get into more specifics regarding this investment, the return we expect to generate on the notes meets or exceeds our return target for a levered investment.”

Weimar Republic

“I must begin by saying something about the old Germany. That Germany, too, suffered from superficial judgment, because appearances and reality were not always kept apart in people's minds.

-Gustav Stresemann


Last night in thinking about a theme for the Early Look I read an article by John Williams and the concerns he has about the current economic policies.  The article was an extreme view, as he believes that the U.S. economic and systemic solvency crisis of the last two years are just precursors to bigger problems: this crisis and others in the past are being brewed by the federal government and the FED’s malfeasance.  


One of our key themes for 3Q10 is “American Austerity”, a key tenant of which is that the “Fiat Fools” in Washington are dedicated to preventing deflation and the subsequent debauching of the U.S. dollar. The article by John Williams takes this to an extreme and uses the period in German history called the Weimar Republic as a case in point. 


According to Wikipedia, the Weimar Republic is the name given by historians to the parliamentary republic established in 1919 in Germany to replace the imperial form of government.  It was named after Weimar, the city where the constitutional assembly took place.  In its 14 years, the Weimar Republic was faced with numerous problems, including hyperinflation, political extremists on the left and the right and their paramilitaries, and hostility from the victors of World War I.


Post-World War I, Germany was a country that was financially and economically depleted as a penalty for losing the war.  By late 1922, the German government could no longer afford to make reparations payments, in keeping up with the Treaty of Versailles.  As such, paper money was printed, the market collapsed and foreign investors withdrew their capital.


The Weimar circumstances and its heavy reliance on foreign investment reminded me of our relationship with the Chinese and how dependant we are on them and their confidence in the US Dollar.  Unfortunately, this may not always be the case.   See our post from 7/16 “Watch What They Do, Not What They Say . . . The Chinese Are Selling Treasuries.”  There is a reason why Timmy has taken a kind and gentle approach with the Chinese and their Yuan policy.


For the time being, the “Fiat Fools” in Washington can rest knowing the government contrived reporting of inflation is benign.  Last week the BLS reported that consumer inflation appears to be under control - but for how long? 


It’s only a matter of time before inflationary pressures will begin to surface from the debauching of the US Dollar.  A weakening U.S. dollar will continue to put upside pressure on dollar-denominated commodity prices, which in turn push inflation higher in the system.  The key here is that it’s not inflation generated by strong economic demand, but by policies driven by “Fiat Fools.” 


The implications of the recent rebound in the Euro (and the subsequent decline in the Dollar) suggest that market concerns already may be shifting from European solvency issues to those of the United States, but not so fast. 


Since the Euro’s low on 6/7 it has rallied 8.5%, but it does not look like the Euro zone is out of the woods yet.  As Daryl Jones, Head of Hedgeye Macro Strategy, noted, “three month Euro LIBOR is up over 30% in the last three months.  The credit worthiness of European banks is being question by their very own peer group.  That’s not good for liquidity in the Euro zone.”


As MACRO trends continue to point us in the direction of another recession, the implications of worse-than-expected ballooning federal deficits will bring the issues of U.S. solvency and U.S. dollar soundness front and center.  The Hedgeye Macro team will address this topic on a conference call in the coming weeks.


For now, on center stage is the tug of war between the strength of corporate earnings and the weakness in the economic numbers, and the battle is leaning toward MACRO trends.  So far this earnings season, 32% of the companies that have reported have missed on revenue expectations (60% of the companies that reported yesterday missed on the revenue line).  This compares to 32% for all of 1Q10. 


Relative to earnings expectations, only 20% of the companies that have reported have missed.  Top-line trends, however, are more indicative of real consumer demand and the sustainability of earnings trends as companies cannot cut costs forever.  Relative to current guidance, the storytelling continues. 


If we assume that the best of the best typically report first, the balance of the earnings season will not be supportive of equity prices.


I don’t claim to be a German historian or that the USA is going to feel anything like the pain Germany felt between 1.  At Hedgeye Risk management we like to keep history is perspective and our eyes open every morning to the realities of the day ahead.   


Function in disaster; finish in style


Howard Penney


Weimar Republic - mark

Fire In the Hole! European Libor Exploding to the Upside

Conclusion: European LIBOR is signaling that the European banks stress tests to be released this Friday may have some negative surprises.


While we have transitioned our short eyes to the U.S. dollar and the U.S. markets, European liquidity issues remain an important topic in global risk managment.  Below we have highlighted a chart of three month Euro LIBOR, which is the rate at which European banks will lend to each other in Euros.  Most market participants view it as a measure of fear and counter party risk between European banks, and rightfully so.


As we can see in the chart below, despite all the rhetoric from government officials about banks passing stress tests and the such, the banks themselves are voting.  And with three month Euro LIBOR up over 30% in the last three months, and projecting upwards and to the right, the statement is fairly obvious.  The credit worthiness of European banks is being question by their very own peer group.  That’s not good for liquidity in the Eurozone.


A few weeks ago we highlighted the allocation by banks to the ECB deposit facility as it was reaching record levels.  Our point, then, was that rather than lending to other banks overnight, many European banks had opted to store Euros with the ECB.  That facility has fallen from its peak of $384 billion to $58 billion Euro.


Typically this decline would be perceived as positive in terms of liquidity within the system, but taken in conjunction with intra bank lending rates increasing it actually suggests just the opposite.  In combination, there is less money in the intra bank system and it is being lent at a higher rate.  So less money, and a higher cost.


I asked our Financials Sector Josh Steiner if there were any financials specific information that we should be thinking about when considering the above data points.  His response was: “It all goes back to the sovereign debt. Euribor rising is because banks are nervous, and if banks are nervous it’s because of counterparty risk which itself is a derivative of sovereign risk. All interconnected.”


In the mining industry fire in the hole is yelled out prior to an explosion in a confined space.  Even though Europe isn’t a confined space, Hedgeye is officially yelling, “Fire In The Hole”, ahead of the results of the stress tests of European banks to be released Friday.


Daryl G. Jones

Managing DIrector


Fire In the Hole! European Libor Exploding to the Upside - EUR LIBOR

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