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.


Here are our notes from the Hyatt Q2 conference call.



"We are pleased with improved transient demand experienced by many of our properties in the second quarter. At several properties, particularly those in international markets, average rate increases resulted in strong RevPAR growth versus the second quarter last year. Our fees increased over 16% due to RevPAR growth and new hotels in our portfolio. The group booking cycle continues to be short but we saw increased levels of booking activity for future periods during the second quarter. We experienced strong margin performance in our owned hotels despite the fact that the revenue increase was driven primarily by occupancy gains."

- Mark S. Hoplamazian, president and chief executive officer of Hyatt Hotels Corporation



  • "The Company has begun renovations at these properties [5]and expects that displacement, resulting from a reduction in daily room inventory of approximately 400 rooms on average per day through year-end 2010, will negatively impact owned and leased segment results in the third and fourth quarters of 2010."
  • 2010 Guidance:
    • Capex: $270-280MM
    • D&A: $285-295MM
    • Interest expense: $50-55MM


  • Improvements that they have seen in the business this year has been driven by better demand. Rate improvements that they began to see in the first quarter continued in the second Q.
  • Group rates still saw a YoY decline, however, group demand increased
  • Expect to see higher corporate rates coming out of rate negotiations later this year
  • International managed & franchise strength was helped by the World Cup in Johannesburg, Shanghai expo and new openings
  • Plan to achieve earnings results by improving performance at existing hotels and growing their base of rooms
  • After the close of the quarter, they opened the Andaz on 5th Ave in NYC
  • Investing $60MM in a New Orleans asset in the form of preferred equity which will help redevelop the property
  • Exploring the sale of 11 properties / 4,500 rooms. Plan to keep them in the managed portfolio and sell them to owners who will invest in the assets. Expect the sale process to take several months.
  • Fees were partially higher by the increased number of rooms in the segment
  • Revenues from transient customers were (leisure and corporate) up 10% YoY, due to a 13% increase in rooms sold
  • Owned & Leased:
    • Results in NA were helped by the US Open (CA) & G20 summit in Toronto
    • Margin improvement was helped by productivity gains 
    • Lower cancellation and attrition fees YoY impacted margins by 40bps
  • Full Service North American mgmt/franchised - 45% of hotels showed rate increases. In June, rates were positive overall.
    • Corporate hotels were up while resort were down on rate
    • Group bookings pace is now ahead (from June)
    • In the quarter, bookings were up 35% for future quarters
    • Group rates were down in the single digits this q, but are up 5% on forward bookings made in the quarter
  • Booking window hasn't changed, so they are operating with low visibility
  • Select Service hotels:
    • Occupancy gains were driven by initiatives to increase midweek corporate and transient business
  • International business mgm'd & franchise:
    • Europe and Asia were very strong
    • RevPAR in China increased 50%
    • 45% of their hotels showed rate increases in the Q (compared to 35% in the first quarter)
    • Europe & Africa were strong
  • Higher incentive comp and professional fees drove the SG&A increase


  • Still expect to open 25 hotels this year
  • Expect expenses to continue to increase (bonuses and wage increases). Will keep staff constant for the short term, aside from cleaning staff - which varies with occupancy. Flow-through will depend on what ADRs do
  • M&A/ Uses of cash?
    • Focused across the capital structure 
    • Does believe that in the 2H2010 and 2011 there will be a pick up in M&A
  • Corporate group pricing and volumes in 2011
    • Working off a low base to begin with, so they definitely expect to see rate increases, but the amount depends on the account - range is low single digits to double digits. Expect high single digit increase
    • Still early to talk about 2011 - 50% of their bookings are within a 3 month window
  • RevPAR impact of 200-250bps by the renovations. Some renovations can push into 4Q2011
  • Property in San Diego and rumors around it?
    • They were in discussions with the current owner group (Manchester group) but there is nothing going on at this point
  • It's important for them to exit the base of Hyatt owners
  • Feel like they have a significant investment in hotels already and want to increase the velocity of recycling their capital
  • Why did they select the portfolio of 11 assets to take to market now?
    • The properties tend to be in suburban or secondary urban markets in the Midwest and West Coast
    • Some of them have capital needs
    • It comes down to value for them and their peak earnings potential
    • Part of it is that they can use this as an opportunity to get some more franchisees out of these properties
  • The 5 assets that they are currently renovating were at the top of their priority list, not sure if there are other big ones to come yet
  • Progression in China has been very significant so far. There is a significantly lower group component internationally - so the outlook is quite short. In NA, group business is 45-47% of total.
  • Thoughts on investing internationally vs. domestically?
    • Already announced a deal in India and are working on a JV deal in South America
    • Internationally, they are mostly JV deals.

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Chart of The Day: High-Low Society

Giving Americans who live on fixed incomes a ZERO percent rate of return on their hard earned savings will continue to have many unintended consequences, for an “exceptional and extended” period of time.


40.8 MILLION Americans, and counting…



Keith R. McCullough
Chief Executive Officer


Chart of The Day: High-Low Society - 9

Europe by the Charts

Below we provide a number of charts we’ve been looking at recently in Europe. Taken together, we’ve been impressed with the fundamental data from Europe over recent weeks (especially compared to the US).  However, we caution that:

  1. August Data - we expect to see a sequential slowdown (month-over-month) in the fundamental data following the exuberance of the World Cup.
  2. Comparisons  - European markets will be pinned against significant macroeconomic headwinds in the back half of 2H10, including suppressed growth, consumer demand, and confidence as a result of government austerity measures.
  3. Housing - continued downward pressure on the housing market, in particular in Spain and the UK.
  4. Legacy - ongoing uncertainty about European bank exposure to sovereign debt, which were largely unaccounted for in the 91 bank stress test, and continued fiscal and political weakness throughout the region (more recently seen in Hungary).

On the margin, we maintain a bullish bias on German Equities (EWG) and the British Pound (FXB).


See our commentary below on the charts:

  • Eurozone (16) Confidence has improved over the last three months. Can this trend be sustained, especially post the World Cup?

Europe by the Charts - m1

  • The DAX and FTSE are trading above our intermediate term TREND lines, a bullish leading indicator. We’re still looking for the FTSE to confirm its move on a TRADE basis (3 weeks are less) before we act in the Hedgeye Virtual Portfolio.

Europe by the Charts - m2

  • PMI Services have largely declined for western European economies over recent months, especially in Italy and UK. Germany and France, on the other hand, have shown strength and we’ll be looking to the next two months of data to determine a trend. We continue to believe that should Western European economies slide, Eastern Europe will follow due to its trade dependence on its western neighbors.

Europe by the Charts - m3

  • While the Manufacturing sector contributes a much smaller share than the Services sector across European economies, the manufacturing PMI is nevertheless an important leading indicator that we follow. Here, Germany is leading its peers.  Overall, we’d expect manufacturing to slip before services in 2H10.

Europe by the Charts - m4

  • Germany is one economy in Europe that we have a bullish bias on. For now, business confidence (below) and consumer confidence surveys have been decidedly bullish since the beginning of 2009. The recent weakness in the EUR-USD (compared to recent years) has bolstered sentiment for Germany’s export oriented economy.

Europe by the Charts - m5

  • One number we focus on is factory orders. On an annual basis we continue to caution that the recent moon shot numbers need to be considered in light of the compare—rock bottom trough levels. This “easy” compare will fade in September. However, the most recent data on a month-over-month basis saw factory orders improve 3.2% in June.  

Europe by the Charts - m6

  • The cash for clunkers programs issued in 2009 throughout European countries boosted sales for German automakers. Reviewing Q2 earnings calls from European automakers, sales were largely mild or flat on the continent, with sales growth particular strong from China. Due to the headwinds we’ve presented, our fundamental outlook suggests that demand from Europe and the US should stay low or erode further.  

Europe by the Charts - m7

  • On the TAIL (3 years or less) this chart below will continue to be an important one to return to. We expect Asia (in particular China) to increase its market share of imports from Europe as exports to the US decline.

Europe by the Charts - m8


Matthew Hedrick


Hyatt's 2Q results beat the Street's EBITDA estimate due to a $6MM Rabbi trust benefit. While the results were still "good," they lacked the "wow" factor from their 1Q, and RevPAR didn't show the same sequential acceleration as those of other lodging companies.



Owned and Leased Hotel revenues of $483MM were materially lower than we estimated primarily due to weak F&B and other revenues. Owned and leased EBITDA also missed our mark.  Here are our takeaways:


The not so great:

  • ADR was lower than we estimated – given that Hyatt’s ADR was only down 40 bps for full service owned hotels, we expected slightly positive ADR this quarter.
  • Unlike Host and HOT, Hyatt didn’t experience strong growth in their F&B and other revenues.  We estimate that this category was up about 1% YoY
  • Pro-rata share of JV properties was flat YoY at $18MM compared to a 40% YoY lift last quarter

On the positive end:

  • CostPAR was down 5.9%, compared to  down 5.3% in 1Q09 on a much tougher comp.  In 1Q09, CostPAR was down 2.1% vs. being down 6% in 2Q09.
  • Put another way total implied costs increased only 3% YoY despite the large occupancy increase

Management, franchise, incentive & other revenues were $2MM below our estimate, but margins on the business were much better.  Thus, EBITDA contribution was $3MM higher than we expected.  If you take the difference between the $64MM of fee revenue and $59MM of EBITDA, the implied costs of the business were only $5MM.  This compares to $12MM of implied costs last quarter and $40MM of implied costs in 2009.


Other stuff

  • If not for the $6MM Rabbi Trust benefit, Adjusted EBITDA would have missed the street by $2MM. Well, at least now we know that 3Q09 was negatively impacted by $7MM of rabbi trust expenses – so the clean SG&A comp is $59MM.
  • D&A was $5MM below our estimate- not sure why it would have declined $4MM sequentially either
  • Interest expense was $3MM lower than our estimate

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