Sure, equipment sales were awful but the most important takeaway may actually be positive.



The BYI quarter and guidance was pretty much in-line with our expectations – obviously lowered following the IGT and WMS releases.  The segments were off, however, but in a positive way.  Low international shipments drove a pretty big miss in equipment sales.  Systems beat slightly but the big upside surprise was in gaming operations.  Given the recurring nature of gaming operations revenues vis-à-vis equipment sales, this surprise was a positive one.


Assuming the forward numbers are reasonable, the stock looks pretty cheap, particularly given the 3-5 yeah outlook we see for new markets.  Of course, if the domestic casino markets do not recover and replacements continue to suffer, the slot market recovery will be delayed.  Under this scenario, the casino operators will be in even worse shape.


Here are the details of the quarter:

  • BYI reported equipment sales revenues of $63.5MM and gross margin of $31.6MM, missing our estimate by $7MM and $4MM, respectively
    • Interestingly, the miss versus our numbers was on the international shipments.  Actual international units shipped was 1,225; our estimate was 2,000 units.
    • After IGT and WMS reported, and it became obvious that our initial estimate for replacement units in the quarter were too high, so we took down our NA unit estimate to 2,450. 
    • ASP’s were much better than we expected – out of the top 3, BYI was the only manufacturer to report strong ASP growth
    • Our best estimate (until ALL reports) is that the total shipments to NA in the quarter were approximately 16k, which pegs BYI’s ship share at 16%, up from 13.5% last quarter.  Per usual, Konami’s March quarter market share was inflated.
  • Systems is always a crap-shoot.  Revenues were $0.6MM below our estimate, while gross margins were $1.4MM better. Next quarter will be weak because of timing, but full year guidance looks fine.
  • Gaming operations revenues of $77.4MM and gross margins of $54.1MM, were very solid – beating our estimates by $4MM on both revenue and gross margin.
    • The beat came from better than expected net placement of premium rental & daily fee products
    • Yield also increased due to the mix shift towards premium pay products. Most of the legacy units have a daily fee of $50/day while some of the new products that BYI is releasing have a daily fee of $75/day.  The margins on these products are very high since there is no jackpot funding.
  • Other stuff:
    • SG&A, R&D and D&A were all low… but that was expected
    • The other expense of $2.1MM was FX related and on an after-tax basis, cost BYI 2 cents per share
    • The tax rate of 37.8% was above their normal range of 35-36.5%.  It cost them about 2 cents in the quarter.
    • It would have been nice to see an actual decrease in the share count given that they spent $47MM on buybacks in the quarter.
  • Thoughts on the guidance:
    • Given where stock prices are and the 8 week visibility window on replacements, we think the low end of BYI’s guidance assumes 50,000 industry replacement units, delays and low ship share in IL, some delays in Italy, and very little traction in Australia… the latter 3 are all back-end loaded.
    • While the Street was up at $2.48 for FY2011, we think that the whisper was in-line with the new guidance.


The Macau Metro Monitor, August 13th, 2010



Marina Bay Sands sees nearly full occupancy this weekend when the Youth Olympic Games opens and high levels of occupancy for the next weekend.  In Singapore, hotel rates have spiked, and the Youth Olympic Games and the Singapore Grand Prix are likely to keep rates high until the end of September.  SA Tours senior executive Dan Lim said: 'It's difficult to get more rooms as all the hotels are almost fully booked. The only way is to try a walk-in booking, or to book through the Internet, which can cost a bit more." However, Singapore's high prices in general, coupled with higher room rates, are shutting out tourists with lower travel budgets.



A division of PBOC reported Shanghai's loans plunged by 11.4 billion yuan ($1.68 billion) to 270 million yuan, 98% lower YoY and 91% lower MoM.  “Because of recent policies on the property market and low transaction volume, individuals’ demand for mortgages continued to contract,” PBOC said.



Macau package tours surged 167% YoY to 489,023 in June 2010, as visitors last year were still influenced by swine flu fears.  Visitors from Mainland China (337,558), Hong Kong (23,357), Japan (22,591) and Taiwan (22,152) rose substantially by 210.6%, 51.5%, 142.3% and 75.4% respectively.


603,004 guests checked in, 35.3% YoY.  The average occupancy rate of hotels and guest-houses rose 15.2% points to 75.7%. 



Per-capita spending of visitors increased 3% YoY to MOP 1,575 in 2Q.  52% of the interviewed visitors in 2Q claimed they had participated in gaming activities during their stay in Macau.  The average length of stay of visitors shortened by 0.2 days to 0.9 days.


According to a Credit Suisse study, higher China urban household income than what was reported in official government data, due to unreportable income from "illegal or quasi-legal activities," could partly explain the soaring gaming revs in Macau.  The report suggested Galaxy would benefit since its Galaxy Cotai project is aimed at the Chinese middle class.

Friday The Thirteenth

“Dude, that goalie was pissed about something.”

-Freeburg (Freddy vs. Jason, 2003)


It’s certainly been an interesting week and its ending with a flurry of shots on goal for global macro risk management net-minders. Sophisticate coaches from Mass call them “net-mind-ahs” by the way. Canucks call dem de goalies, eh.


Today is also Friday the 13th, and de goalies with de coaches who got dem-selves lee-verd up long last week are feeling shame. The most infamous American goalie mask of them all has to be Jason’s. He’s seen a lot of red rubber as of late.


Another American who found fame on this day in 1907 was a stock market manipulator from Massachusetts by the name of Thomas W. Lawson. Ole Lawsy tried to slip one by de goalie back then by publishing a book titled “Friday The Thirteenth”, which attempted to scare the horses into believing that the market was setting up for a crash on that very day (his book sold 28,000 copies in its 1st week).


Per Wikipedia, Lawsy was “a highly controversial Boston stock promoter – he is known for both his efforts to promote reforms in the stock market and the fortune he amassed for himself through highly dubious stock manipulations.” He was a hybrid Barney Frankenstein - fear mongering Americans, then flip flopping his position to the other side of the trade. All the while forgetting that people would remember what he said/did on the last go around.


While stock market futures have whipped around a great deal this morning, the Dodd-Frankenstein reform bill doesn’t appear to be today’s excuse. Germany reported a blockbuster Q2 GDP report (+2.2% sequential growth) and Europe’s “net-mind-ah” has apparently left the building on the news. European markets are being chased lower by the old Friday The Thirteenth fear that we call ‘selling on the news.’


In addition to the week-to-date Nightmare on Wall Street drop of -3.3%, here’s what is legitimately scaring US equity investors (in the order that the data points occurred):

  1. China bought 456B Yen worth of JGB’s (Japanese Government Bonds) in June = most since 05’ (and remains a net seller of US Treasuries).
  2. Goldman Sachs (Jan Hatzius) cut his US GDP growth estimate to 1.9% for 2011 (that’s the closest estimate to Hedgeye’s 1.7%).
  3. Chinese Imports dropped 1100 basis points sequentially in July to 23% (vs. 34% in June) = Chinese demand continues to slow.
  4. Chinese property prices dropped to +10.3% y/y in July versus +11.4% in June.
  5. USA’s NFIB survey for small business confidence hit another sequential low this month dropping to 88.
  6. Bernanke’s QE2 was met with selling of both US stocks and get this, Treasuries!, with this morning’s 2-year yields trading UP versus Tuesday.
  7. China’s bank regulator ordered the transfer of off-balance sheet loans to its books by 2011 (and make provisions for defaults)
  8. US MBA mortgage applications held flat week-over-week, enforcing the reality that Americans refuse to lever themselves up again.
  9. Chinese industrial production, retail sales, and money supply growth (M2) all slowed again sequentially in July versus June.
  10. Chinese inflation hit a 20 month high, accelerating +3.3% in July versus +2.9% in June = oil, food… you know… the things they need.
  11. Venezuelan and Argentinean bond yields pushed higher as their dysfunctional governments try to issue the world sovereign debt.
  12. America’s budget deficit tacked on another $165 BILLION loss in July, taking spending up +10% y/y with tax revenues barely flat.
  13. Russian Bond sales saw only 44% of the demand de goalies in de Kremlin were looking for (25 BILLION Rubles) = Russian bond yield up.
  14. General Disaster (GM) announced their pending $12-16 BILLION Dollar IPO = 2nd largest IPO in US history; what is wrong with America?
  15. US weekly jobless claims ripped higher to 484,000 = representing the highest jump in rolling weekly claims for 2010 YTD!
  16. The Fed’s Balance sheet expanded again week/week going up to $2.33 TRILLION DOLLARS after Ben bought $1.7B more MBS this week!

Sorry, for penmanship’s sake I tried to go with 13 bearish points, but I had to print 16 as pushing Hedgeye’s own book of ideas trumps my literary aspirations.


Look on the bright side, Monday will be a new day for the professional storytellers in Washington and it won’t be Friday The Thirteenth either. By the way, Thomas W. Lawson died poor.


On a fair amount of bearish global macro news, I’ll call the SP500 fairly oversold at 1080 or lower. As a result, we’ll open up the Hedgeye Asset Allocation coffers and move from 70% cash (last Friday) down to 55% on this Friday the 13th, 2010 by going to a 6% allocation to US Equities.


My immediate term TRADE lines of support and resistance for the SP500 are now 1080 and 1197, respectively, eh.


Best of luck out there today and have a great weekend with your families,



Keith R. McCullough
Chief Executive Officer


Friday The Thirteenth - 13

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July same-store sale of 8% are some of the best in the industry.


While COSI did not make the kind of improvement in profitability that was hoped for, the top line trends are surpassing all expectations.  The company reported last night that since the end of the quarter, July represented the 5th consecutive month of positive same store sales, up 8%.  It would appear that August will make it 6 straight months. 


For 2Q10, system same-store sales increased 3.1% with franchise sales up 2.6% and company-owned sales up by 3.3% (traffic increase 3.1% in the quarter).  Near the end of 2Q, COSI took a menu price increase which benefitted same-store sales by 0.5% in 2Q.  Going forward, pricing will add 3% to same-store sales. 


The improvement COSI is seeing in the top line is coming from all day-parts: catering, breakfast, lunch, snack and dinner.  In 2Q, sales growth was driven by increases in, and more efficient use of, marketing dollars.  With the help of a new advertising agency, COSI has increased spending on “out-of-store” media to increase awareness of the brand and drive incremental traffic.  COSI also has a newly designed website, menu boards and a new social media team in place to drive the marketing effort. 


For the balance of 2010, COSI will focus on two new sales channels to help drive incremental sales - online ordering and online catering.  In 2Q10, COSI invested in catering a couple of sales people and in store teaching of catering sales to all restaurant teams.


While the improvement in sales is critical, bringing it to the bottom line is an important step.  In 2Q10 there was a balance of banking profits and investing for future growth.  Efforts undergone to increase through put and improve customer service caused labor costs to increase 170 basis points in 2Q10.  In addition, incremental labor was needed to support the increased volume during new day-part hours. 


The COSI turnaround story is on track.  With 3Q10 nearly done and same-store sales running up 8%, profitability looks to be just a few month away.  In addition, with COSI operating around 60% of its store base in 2Q10, there are further opportunities to refranchise more stores, thereby raising cash and enhancing the business model.




Howard Penney

Managing Director

MACRO: Structural Unemployment

This insight was published on August 9, 2010. RISK MANAGER SUBSCRIBERS have access to SELECT MACRO content in real-time.





Conclusion: Even though Hedgeye is hiring, unemployment in the United States is becoming an increasingly structural issue as evidenced by the percent of unemployed that have been out of work for 6-months or more.
We are going to keep this note short and tight even by Hedgeye standards.  I asked my teammates Darius Dale and Matt Hedrick to look at longer term unemployment as a percentage of total employment going back as long as the data would allow us.  The output of their work is the chart below.
The chart highlights the percentage of total unemployed that have been unemployed for more than 6-months.  As can be seen in the chart below, more than 45% of unemployed have been unemployed for more than 6-months.  This is the highest level we’ve seen for long term unemployed going back to 1948.
The conclusion is simply that the unemployment in this nation is becoming structural.  While the credit boom created employment in the housing and construction sector, that entire industry has gone away and been replaced by . . . well, not much at this point.
As the non-partisan Congressional Budget Office stated in a recent paper:
“As a result, gains in employment after this recession will probably rely more than usual on the creation of new jobs, possibly in new firms that are located in different places and require workers with different skills than those needed in the jobs that have disappeared. For workers who have lost jobs to which they cannot return, acquiring new skills can take time. (In contrast, it is easier for workers who have been laid off temporarily to return to their jobs because the employers already know the workers and the workers already have the right skills and are familiar with the work.) For workers who need to move to different regions to find new jobs, the sharp declines in home prices during this recession, combined with the high loan-to-value ratios on many mortgages before the downturn, will hinder relocation. With a significant share of homeowners now owing more on their mortgages than their homes are worth, many people may not be able to sell their house for enough money to enable them to buy one in a new area.”
Further, this trend of longer unemployment comes with major issues because the longer unemployment lasts, the more likely it becomes that complacency sets in and the unemployed person becomes less willing to pursue employment in a traditional sense.
Maybe it’s just me, but I’m not sure quantitative easing is going to get us out of this one.



MACRO: Structural Unemployment - chart1



Daryl G. Jones
Managing Director

MACRO: In A Story State, Indeed

This insight was published on July 21, 2010. RISK MANAGER SUBSCRIBERS have access to SELECT MACRO content in real-time.





Conclusion: Bearish data points regarding state and local government budgets spell incremental trouble for U.S. GDP growth in 2H10 and 2011.

The first sentence of the executive summary of the latest National Association of State Budget Officers (NASBO) Fiscal Survey of State Budgets reads: “Fiscal 2010 presented the most difficult challenge for States’ financial management since the Great Depression and fiscal 2011 is expected to present states with similar challenges.”


The reason many (if not all) States around the country have such long faces is because they are having to do just the opposite with their budgets: shorten them. As mandated by federal law, every State except Vermont is required to balance its budget and as a result of declining sales, personal income, and corporate income tax collection (80% of States’ general fund revenue) States and municipalities have had to undertake very drastic measures to combat this – including laying off over 200,000 state and local government employees since June 2009.



MACRO: In A Story State, Indeed - chart1



The pain is likely to intensify, with States facing a $140 billion budget gap in fiscal 2011, according to the Center of Budget and Policy Priorities. Federal stimulus is expected to fall by $55 billion and recently, the Senate failed to pass a measure to provide States $16 billion for extra Medicaid funding. Furthermore, States have already spent 89% of their American Recovery and Reinvestment Act of 2009 funds, which accounted 30% of state spending in 2010.
Despite the erosion of Federal government spending tailwinds, Governor’s recommended budgets imply a 3.7% Y/Y increase in spending, which, by law, has to stem from their estimates of an 3.9% Y/Y increase in tax collections in 2011. Easy comps are what they are (tax collections declined  -2.3% Y/Y in fiscal 2010), but the fiscal 2011 budget implies a 2Y-trend increase of 0.8%.
An increase of any magnitude seems lofty based on current trends regarding state level personal income taxes (see: 9.5% unemployment and jobless claims hovering well above the 400,000/week needed to see improvement in employment). Perhaps that’s why fiscal 2010 revenue collection from sales, personal income taxes, and corporate income taxes are below original projections in 46 States. Expect that trend to continue in fiscal 2011 if we have any semblance of slowing growth and/or federal government austerity in 2H10.
Luckily for local governments, which have been feeling the negative effects of State budget balancing, they mark revenue collection to model, particularly regarding property taxes. As I pointed out in a note back in April, home appraisals for municipal property tax collection (roughly 35% of local government revenue) lag market prices by 2-3 years. As a result, property tax revenue has been positive throughout the housing downturn.
Well, that tailwind is becoming a headwind and a rather large one at that. Recent data shows that 1Q10 marks the first time property tax receipts declined on a Y/Y basis since 2Q03. Backtrack three years from 1Q10, and we see the first of an accelerating series of declines in housing prices. Again, this will become a major 3-5 year headwind for local government tax receipts – especially when factoring in our bearish outlook for housing prices in the next 12-18 months (see: Hedgeye’s Q3 Macro Theme of Housing Headwinds). Expect this to be a double tax on the consumer as falling home values are paired with rising property tax rates as municipalities across the country hike property taxes to try to hold flat income from this important source of revenue.



MACRO: In A Story State, Indeed -  chart2



In summary, waning federal funding, slowing tax receipts, and declining home prices will put additional strain on State and local government budgets, which have an incremental negative effect on the U.S. economy at large. Job cuts at the state and municipality level are affecting all areas of the economy – from public transportation to private companies that work with state governments. Research from the Center on Budget and Policy Priorities suggests that a total of 900,000 private sector jobs could be lost as a result of State and local government cost shedding. All told, further job losses will make it even more difficult for State and local governments to meet revenue estimates, which will force them to cut even further.
As a result of this self-perpetuating cycle, U.S. GDP growth in 2H10 and 2011 may end up even lower than our current 1.7% forecast.
Stay tuned.
Darius Dale

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