The brand management story of a few years ago hasn’t materialized.



Was anyone wondering where those supposedly lucrative resort division and the CityCenter management fees were hiding?  We were and we’ve discovered they reside in the $102.3 million revenue line item Management Operations.  Not bad until you look at the profit, or should I say loss contribution of the division.  Management Operations lost $3.7 million in the quarter.  And we thought development fees and management contracts brought fat margins.


That is why we had a chuckle when one analyst suggested that MGM should look at spinning off that part of the business to get a Four Seasons multiple.  Oh yeah?  I don’t recall Four Seasons generating negative margins on their fee business.  To be fair, no MGM branded hotels have opened yet so there is potential.  However, MGM has a long way to go before their brand moves into the same category as Four Seasons.  On second thought, MGM isn’t even known for non-gaming hotels so Sheraton would even be a stretch at this point.


We’ve gotten comfortable with the higher R&D. Here we’d like to address the incremental $40m in capital investment.



Unlike the R&D which is expensed as incurred, WMS will capitalize the $40 million in incremental Capex.  Investors are not freaking out about that as much as the $10 million R&D ramp which is strange as both expenditures are investments with real ROI.  Oh well, we thought we’d address the additional spend here:



The $40MM of incremental investment

It’s actually 3 buckets:

  • Italy (1/3)
    • Concessionaire is in the US right now as we speak finalizing the details of their contract with WMS, with initial placements expected in December
    • Since Italy will be lease market, initial December placements won’t have much impact in the quarter but will ramp through the year.
  • Leased games (1/3)
    • Operators want to lease more games from WMS rather than buy all of them 
    • As they extend their efforts in Class II, they’re willing to commit capital to that 
    • Don’t have any specific deals in mind, but there are many operators that prefer to lease right now rather than commit capital to purchases
    • For example, Harrah's preference at the moment is to lease vs. purchase.  While their budget for game purchases is almost zero, they did make a huge increase in their capital budget for leasing games this year.
    • Florida is another market where the preference is to lease vs. own, since leases are tax deductible. 
    • WMS can always recycle leased boxes for use in their participation install base should they roll off in a short period of time.
  • Growing and refreshing their participation base (1/3)
    • WMS's entire participation base is on the Bluebird 1 ("BB1") platform, which was first released in December 2003
    • As those games age and need refreshing, WMS will replace them with fresh content on the Bluebird 2 cabinet, transitioning the base to their new platform over the next few years.
    • The reason that they have continued to put out their participation content on BB1 is because BB1 has been a cheaper platform for them and customers don't care since the content was so unique. 
    • So for example, even the new Lord of the Rings, which was created to run on a BB1 or a BB2 platform, is initially being released on repurposed BB1 cabinets that are only 2-3 years old


Headlines on the soaring price of wheat abound this week, but prices across the board are trending higher.


Back in November 2009, I wrote a post titled “RESTAURANTS – CHART OF THE WEEK”, detailing the risk to forward earnings for the restaurant space by rising food prices.  Looking at an updated version of the same chart I posted that day, the CRB Foodstuffs Index, it is clear that the risk is still very much alive. 


The CRB Foodstuffs Index is made up of the following: butter, cocoa, corn, hogs, lard, soybean oil, steers, sugar, and wheat.  


The index reflects spot prices and not the highly volatile prices for future delivery.  As you can see below, the index is only 15% below the peak reached in July 2008.


The prospect of food inflation and how the industry/individual companies deal with it (do they raise prices or not) will separate the have and have not’s.  To be sure, inflation pressures and the potential impact on margins in 2011 will be a hot topic in the 3Q10 earnings season. 


IT’S NOT JUST WHEAT - foodstuffs


Howard Penney

Managing Director

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As we look at today’s set up for the S&P 500, the range is 19 points or 1% (1,115) downside and 0.7% (1,134) upside.













Bad To Worse

“I toil beneath the curse,

But, not knowing the universe,

I fear to slide from bad to worse.”

-Alfred, Lord Tennyson


Keith was off managing domestic risk last night taking his wife out for their anniversary dinner, so I’ve been handed the pen for the Early Look this morning.  Later today our firm will be having our annual picnic at our colleague Todd Jordan’s lake house in rural Connecticut.  It has just been over two years ago since we welcomed our first client, and the growth trajectory since has been meteoric.   On behalf of all of my teammates I’d like to thank all of our clients that have helped make this possible.  It has been a pleasure working with every one of you.


We now have close to forty employees.  We have three offices around the globe, with plans to open our fourth this fall.  And with the pending launch of Energy Sector Head Lou Gagliardi in September, we will have seven senior sector heads who cover close to 50% of the SP500.  Following our firm meeting yesterday, I can tell you this, we are just getting started.


So, as I was contemplating our firm’s growth yesterday at the Hedgeye Happy Hour following the firm meeting, I was also mulling over the future economic growth of the United States.  While I’m not in the double dip camp, I do “fear to slide from bad to worse”.  As Lord Tennyson would say.  (Incidentally, Tennyson is the second most quoted person in the English language after Shakespeare.)


Earlier this week, Keith and I presented to our clients on the topic of U.S. Sovereign Debt.  Debt and deficit issues in the United States are not exactly non-consensus as they are widely discussed and contemplated.  In fact, in the spirit of “watch what they do and not what they say”, we had the second Obama administration economic official resign today in Christina Romer, the chair of the Council of Economic Advisors.  This of course comes on the back of the July departure of Peter “The Paparazzi” Orzag, who ran the Office of Management and Budget.  Watch what they do and not what they say . . .


Undoubtedly, both Orzag and Romer have come to the same realization as us, which is that U.S. economic growth is poised to slow in coming years.  In our presentation on Tuesday, we narrowed this projection down to one key variable in our multi factor, chaos theory based model.  This factor is sovereign debt.  So if you are staffed with managing the budget or the economy in a slow growth environment, you better either wave the white flag and go back to teaching at Berkeley (Romer), or prepare your stomach for the new reality of Bad To Worse.


While many of you have read Reinhart and Rogoff’s book, “This Time is Different”, which studies the long term implications of large sovereign debt balances,  the professors also wrote a fascinating paper earlier this year, “Growth in a Time of Debt.”  This paper looks at over 210 years of data relating to sovereign debt balances and future economic growth.  The key conclusion is that as debt-as-percentage-of-GDP crosses the Rubicon of 90%, future growth slows.  And in dramatic fashion.


According to their paper, from 1790 to 2009, for 20 of the most modern economies, as debt exceeded 90% of GDP, average annual economic growth was 1.7%.  This was compared to economic growth of 3.7% at less than 30% of debt to GDP, economic growth of 3.0% with debt to GDP from 30% to 60%, and economic growth of 3.4% with debt to GDP of 60% to 90%.  In effect, as debt as a percentage of GDP passes the Rubicon of 90%, growth falls below the average by more than three standard deviations.  As the quants will tell you, that is statistically significant!


Being the industrious young analysts that we are, we actually applied this thesis to Japan.  In the attached chart of the day, we outline this point graphically. In the last three decades in Japan as we see a step up in debt, we see a corresponding step down of economic growth with the inflection point being . . . you guessed, it 90% debt-to-GDP.  Specifically,

  • 1981 – 1989 – Japan has average economic growth of just 4.6% and an average debt to GDP balance of 64%;
  • 1990 – 1999 – Japan had an average economic growth of 1.5% and an average debt to GDP balance of 92%; and
  • 2000 – 2009  - Japan had an average economic growth of 0.8% and an average debt to GDP balance of 179%.

As they say, facts don’t lie, politicians do.  And the facts as it relates to debt and growth are quite clear, as debt climbs and exceeds the Rubicon of 90%, economic growth will slow.  If you don’t believe me, believe the 200+ years of data.


It is clear to me that, “The old order changeth, yielding place to new.”  With the new order being a meaningfully different growth trajectory for the United States than the prior thirty years.  


But as always, “Tis better to have loved and lost, than never loved at all.”


The Poet Laureate of Hedgeye,


Daryl G. Jones

Managing Director


Bad To Worse - DJEL


The Macau Metro Monitor, August 6th, 2010



SJM has started putting up fences encircling an area near the Macau Dome, in Cotai. However, CEO So said no land concession approval has been received. So also said that its future Cotai resort  will maintain SJM's theme but with some "diversification".



As part of a facelift for Sydney's only casino, Star City, CEO Elmer Funke Kupper of Tabcorp Holdings Ltd said the company will send $146 million to woo high rollers from Crown Ltd, Macau, and Singapore.  The new look would include new luxury suites, private gambling rooms and its first two jet planes. The Star City refurbishment is being overseen by Larry Mullin, who joined the company from Borgata Hotel Casino & Spa.


Macau is no longer a top 5 destination for mainland visitors. According to the Visa and PATA travel association's "Travel & Tourism 2010 Outlook", the top 5 destinations this year are: Australia, Japan, HK , Singapore and Taiwan.

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