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ZQK: Worst Trade of The Decade?

This Quiksilver ski asset sale might go down as one of the worst consumer M&A deal this decade – despite seemingly timing the FX trade perfectly. Now what are we left with? Check out the timeline…

3Q05: Buys Rossi for $501mm at face value, including deferred purchase obligations. Seemingly rich at 11x EBITDA.

Subsequent 18 months, needs to infuse about $250mm in working capital. Takes EBITDA multiple to 16-17x.

3Q05-3Q08: Absorbs over $100mm in operating losses. Implied multiple goes to 30x+.

3Q07: Sells Cleveland Golf for $133mm.

3Q08: Sells Rossignol and other ski assets for €100mm, or $147mm – subject to working capital adjustments. This is key, because ZQK got disproportionately stuck with the working capital adjustment on the front end, and will likely not see an offsetting benefit on the back end.

When all is said and done, we’re looking at about $850mm in, and around $275mm out -- $133mm of which has already been realized.

The big question now is what we’re left with. The answer? One of the best names in teen apparel, sans the seasonality and low-return characteristics of ski equipment. Even the sucker trade outlined above still leaves enough cash flow to take down debt to total cap by 10+ points. I think there’s more low-hanging fruit here to take up margins than any other company in the space.

I think that $1.50 in EPS and $425mm in EBITDA in 2 years is completely doable. That’s 4.2x EBITDA based on today’s price and post transaction debt.

The ONLY thing preventing me from going all-in at this point is that even after the Rossi sale, 50% of sales come from outside the US. The good news is that I think that ZQK is one of the companies that has been treating FX benefits appropriately – by reinvesting them back into the model. The bad news is that I think they’ve been reinvested largely into the Rossignol model – and now that’s gone.

This name is near the top of my queue again for the deep dive. Stay tuned…
Where'd the FX benefit go?

ACCOR PAINTS BLEAK PICTURE FOR GLOBAL HOTELS

While Accor has done a nice job with its cost cutting, it is not immune to the global slowdown. Kudos to management, however, for a realistic outlook on the significant hurdles facing the hotel industry. Most relevant in my view is the duration of the slowdown. Management of this global hotel company warned that 2009 and 2010 “could be more difficult”. The sell side needs to pay attention. Hope for a 2009 recovery is fading fast. Models need to be adjusted. Estimates need to come down, again. Valuations on current estimates are meaningless.

I’ve written extensively on the issues facing lodging investors. Some of these include:

• The underestimated margin impact from slowing RevPAR
• Inflated RevPAR in gateway US cities from a weak dollar and strong global economies – both trends are reversing
• Slowdown in travel and tourism globally
• Aggressive analysts’ estimates that assume 2009 recovery

Maybe the Accor commentary will open some eyes in the sell side community. Probably not. I guess we’ll have to wait for Q3 earnings reports to see estimate reductions.


Sofitel London St. James

Confused?

The Democrat attack dogs at the DNC were barking, and the US Stock Market bears were running. Yesterday was as good a day for the bulls as a low volume trading day in August gets – all they had to do was sit on the beach and watch everyone run from their own shadows.

If you’re doing all of the macro work right now, you have to be scratching your head here. I am. Here are the two big questions that I can’t shake: 1. Could an Obama Presidency be an ultra bullish American catalyst? And 2. Do markets away from the US need a bear market in the US Dollar in order to recover?

In some respects, asking myself these questions is counterintuitive – but usually that’s the only way to find an objective answer. Since the most relevant macro correlation I can find is the S&P 500 to the US Dollar, it’s un-objective to dismiss the 2nd, and 3rd derivative effects of the directional moves implied therein. The reference date to be focused on was July 14th, when both the US$ and the US stock market hit their respective year to date lows. As the US$ recovered, so did the market. It’s fairly easy to argue that the 2nd derivative effect of a strengthening domestic currency inspired deflation in commodities.

The problem of course, is that in every big macro “Trade” there is a winner and a loser. Since July 14th, America has been winning, and the rest of the world losing. This is a much different dynamic than what the “it’s global this time” crowd has become accustomed to. Since it’s a basket index, the US$ strengthening has equated to Asian and European currencies weakening. As those currencies weaken, they import the same kind of inflation that the US did when the US Dollar was in the thralls of a bear market.

Let’s look at short term trading in Indian stocks to amplify this divergence. The US market was +0.8% yesterday, and India’s Sensex closed down another -2% overnight. Since August 11th, the Indian stock market is down another -9.7%, and the US only down -1.8%. But hold on a second, India isn’t levered to commodities like say Russia is? However, India’s economy is levered to the political intensities associated with a world class bureaucracy; particularly as economic growth slows and currency driven inflation accelerates! Russia on the other hand has lost -20% of its value since August 1st, while the US market is +1% over the same duration. Russia started a war; China held the Olympics; but they, Brazil, and India (remember, the “BRICs”) have gone straight down since nominal commodity inflation began to deflate.

This is as confusing as it is to write – but these are the facts. And despite the structural issues currently associated with the US Financial System, in the end, America may very well be the safer place to invest in a global economy that is stagflating. Asian central bankers are being forced to support their currencies right now – both the Philippines and Thailand raised interest rates in the last 48 hours, the Koreans had to intervene and support the won, as did the Chinese. The Chinese Yuan is having its best up day in a month this morning as a result of government posturing. As Asians support their currency however, this virtuous circle of interconnected markets plays negative to both the US Dollar and her stock market. If the US$ deflates, imported commodity inflation re-flates... and Obama’s populist call to arms gets louder, alongside his chances of winning.

Now that I am right royally confused, I’ll submit a solution to stop gap this protracted global de-leveraging bleed – bring Obama into office, and have him behave like an economic Republican. The run-up in cheap money driven global economic prosperity is ending. Ask the folks in Pakistan, who had to plug in trading curbs again last night, after a 6 day -18% market decline. Or ask the Japanese management team at Toyota, who is guiding down their global auto sales numbers for 2009 to 2%, down from the long standing high single digits they ran when everything globally was growing.

The re-organization of global economic superpowers is in motion, and socialist countries with Keynesian monetary policies are going to finish last. Best of luck putting this all together, if you can! For now, patience and cash are kings.
KM



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SHFL: I-DEAL? I-DON’T

Management’s justification for abandoning its pure lease model was that it could expedite cash flow by creating a replacement cycle. A continuous release of new shufflers and proprietary table games (PTG) would spur replacement of previously sold products. That model didn’t work out as planned and the company recently communicated to the Street that it would move back to the lease model. However, as illustrated in my 7/31/08 post, “SHFL: LET ME KNOW WHEN THEY STOP SELLING STUFF”, SHFL continues to sell both shufflers and PTGs.

The company’s latest shuffler, i-Deal, was released in the fall of 2007 to replace 1999’s ACE shuffler. Unfortunately, placements thus far have been minimal. As a response, presumably, SHFL notified its customers that it would no longer service the ACE shuffler, thus attempting to force casinos into buying or leasing the i-Deal. This begs at least two questions: Did SHFL hurt customer relations with this stuff job and do casinos really need the i-Deal? Considering the low volume of placements to date the answer to the second question may be no. We did, however, get positive feedback on the i-Deal from one table game manager although his casino had not yet purchased the product.

SHFL has sold a lot of product over the past two years. Despite the talk, the numbers show the company hasn’t fully re-embraced the lease model. Without a pipeline of new PTGs, replacement demand in the entertainment segment looks limited. Thus far, on the utility side, the i-Deal has not been the replacement driver the company expected. That fateful decision over 2 years ago to adopt a partial for-sale model continues to haunt SHFL. The recurring revenues from a pure lease model would’ve smoothed out this new product trough.


i-Deal: Replacement savior?

Eye On Putin Power...

Putin's puppet, Dmitry Medvedev, will be meeting with China's leader, Hu Jintao, today. Post the Georgian attacks, what will come of this meeting? What are Russia's ambitions? Geopolitical tail risk is what it is - and the outcomes from this meeting should be watched very closely.
KM

This Is What Happens To Growth Stocks When They Slow

Today the Shanghai Securities News broke down some of the aggregate listed company profitability metrics for 2008 to date. For the 73% of companies who have reported, profits have put in a perfect Chinese Olympic nosedive. According to Xinhua, "reports showed they earned 323.14 billion yuan (47.2 billion U.S. dollars) in all, up 30.9 percent year-on-year. The year-earlier growth rate was 70 percent." If you are a mo mo global "growth" investor, and growth goes from great to good, watch out below.
  • China's stock market lost another -0.34% last night, taking the cummulative swan dive to -61% since the October 2007 highs.
    KM
chart courtesy of stockcharts.com

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