I’ve just updated Keeping Score. If you’re on the blog, you can also just click the tab at the top of the page.
My intention is to publish each day from Sunday through Friday. I normally write my post the night before and set WordPress to publish automatically around 5am, New York time on the following day. Sometimes, though, I write the morning of and publish immediately.
That hasn’t happened over the past several weeks. Early one morning, a fire in a generator in our small town took down the internet for an entire day. Also, on two occasions I hit the Publish button and went on to other things–only to find the next day that my post was still a(n unpublished) draft. I’m not sure whether the problem was with WordPress or with me, but I now know I’ve got to double-check the publishing process.
Anyway, power failures, tornadoes or other disasters aside, I think I’ve got the issue under control. So be sure to keep reserving that special spot in your day for reading my blog. It’ll be there.
framing the issue
1. In round terms, the Federal government is taking in $2.5 trillion a year and spending $4 trillion. It borrows the $1.5 trillion difference by issuing Treasury securities.
The main areas of government outlay are:
–welfare payments 13%.
Interest payments on Treasuries amount to around $200 billion. That’s 5% of total outlays, or 8% of tax receipts. This isn’t a near-term concern, but imagine what would happen if fates started to rise.
2. Congress periodically passes laws setting a maximum allowable level of federal government borrowing. The current limit is $14.3 trillion (including things like government agency debt in addition to Treasuries). The Treasury Department estimates Washington hit that limit in mid-May. The Treasury can create wiggle room for a while–like keeping the proceeds of maturing Treasuries in federal government employee retirement funds under the mattress instead of reinvesting them. Such stalling tactics will probably run out within a couple of weeks.
what can happen
Let’s look at the rating agencies first.
S&P is saying that it wants to see some evidence that Washington will do something now to address the budget deficit and the accompanying buildup of federal debt rather than pushing action back until after the November 2012 election. In the latter case, S&P argues, legislation will be passed in 2013 at the earliest and probably won’t take effect for some time after that.
If it doesn’t see action, chances are it will downgrade Treasury debt from AAA. It has also said that if congress doesn’t act like grownups, it may downgrade for that reason alone.
Downgrade is unlikely to come as a shock to an institutional buyer of Treasuries, domestic or foreign, who will have seen US government finances steadily deteriorate over more than a decade, from surplus in 2000 to the current situation.
In theory, downgrade means that the US will have to offer higher interest rates to induce investors to continue holding Treasuries. Maybe, maybe not.
To my mind, there are two big practical issues with downgrade:
1. The more important is whether/how the role of Treasuries in the working of global financial markets will change. This is a question of the rules that financial players have to follow, either because of legislation in their countries or their contracts with customers.
Will institutional borrowers have to put up more Treasuries to collateralize a given transaction than before? Will investment companies be forced by their contracts with customers to hold fewer Treasuries than before? Will they have to sell, or just let their holdings mature and not reinvest? How will this affect the ability of corporations to get short-term finance?
At the very least there may be a period of adjustment that reduces the speed of financial transactions–and therefore economic growth.
2. The second is how domestic retail investors will feel about Treasuries after a downgrade. Will they withdraw money from money market funds that concentrate on government paper? As I mentioned in an earlier post, money market funds are already bracing for withdrawals by emphasizing the shortest-term securities. This is having a negative effect on the ability of some EU banks to tap short-term sources of funds.
This is a separate issue from downgrade. It’s much more serious.
Mr. Geithner has been careful to say that if the debt ceiling limit isn’t raised the government will default “on its obligations.” This is very different from saying that the government will default on its debt–either by failing to make interest payments or by not returning principal on maturity.
Without the ability to borrow, the federal government won’t be able to pay 40% of its bills, or about $130 billion worth a month. Given that failing to service existing debt would be disastrous–also, given the fact that interest payments on Treasuries are only a drop in the bucket at present–the Treasury Department would certainly have debt service as its number-one priority. So, as a practical matter, default on government debt is out of the question.
Which bills don’t get paid? The Treasury Department decides. One open question is how sophisticated its computers are. Can they, say, pay every government employee below a certain pay grade and no one above? Can they sent out checks to Social Security recipients for 60% of their entitlements? Can they do the same with all defense contractors?
The choices Treasury might have to make would all be intensely political. …don’t pay Congress, but pay the administration and the courts?
From an investor’s point of view, however, no matter where the cuts come, they would represent an immense fiscal contraction. Whether cuts happened by accident or design, the damage to the economy would be substantial.
I don’t think that stock prices, either in the US or the rest of the world, contain even the slightest discount for the possibility that this could actually occur.
Why the current weakness in stocks?
I think it’s mostly uncertainty. Worries about a possible economic contraction are causing companies and state and local governments to put spending plans on hold. Citizens who rely on Social Security or unemployment benefits are also likely conserving, to the extent they can.
I also think that some investors are looking back to the TARP debate, when it took a plunge in the stock market to persuade congress to vote to prevent the domestic financial system from failing. So they’re raising funds on the idea that the same pattern will recur. I suspect, however, that in the convoluted way that Wall Street minds work, other investors are taking the contrary position. They’re saying to themselves that the obvious pattern is the TARP episode; therefore, that’s the least likely outcome in the present situation.
Who knows what will actually happen? The only thing I’m confident of is that congress would come under intense pressure to act if the flow of money from Washington were cut dramatically. A partial government shutdown might also lead to substantial turnover in congress in the 2012 election. Therefore, I think a possible period of shutdown would be very short.
In 2Q11, LVS had unusually bad luck in its gambling operations in Singapore and in Las Vegas. That happens occasionally. Give a properly run casino enough time, however, and the odds even out. 2Q11 was a more normal quarter for the company from an odds point of view. Combine that with stunning growth in Singapore, and the result was revenue for LVS during 2Q11 of $2.35 billion, up 47% year on year. Eps of $.54 weere more than triple the net during the comparable period of 2010, and 25% ahead of the Wall Street consensus.
To my mind, the biggest story is Singapore, where EBITDA (earnings before interest, taxes, depreciation and amortization–I’m not a fan of this metric, but it’s the one this industry uses) was $405.4 million, up 42% quarter on quarter (up “only” 30% if you adjust 1Q11 results up to reflect normal “luck”). July may turn out to be the best month ever for the Marina Bay complex–which, strictly speaking, isn’t even finished. Singapore is now by far the most valuable part of LVS.
I wasn’t floored by the Macau results, which–at EBITDA of $391.6 million–were up 27.5% year on year and about 4% quarter on quarter (market growth rates were 40%+ and 12%+, respectively, during those periods). The issues are new capacity that opened recently right next to some of LVS’s operations, and the time it tales to recover from the actions of an inept CEO (since fired; he’s suing). The Hong Kong stock market, however, regards the earnings report as very good news. Sands China was up 10% in overnight in a flat market.
Las Vegas continues its slow recovery. LVS posted EBITDA of $92 million in 2Q11 for Nevada operations. The lion’s share of the $30+ million quarter on quarter gain is a return of casino “luck” to normal.
$10 billion in debt no longer looks like such a big problem
Roughly speaking, $4 billion of that amount is borrowed against Singapore operations, $3 billion against Macau and $3 billion against the US. LVS has just renegotiated the Macau debt to extend maturities and lower interest expense by close to $100 million yearly. LVS will likely refinance Singapore soon, as well.
My back-of-the-envelope guess is that the LVS empire will generate $2.5 billion-$3 billion in cash flow over the coming 12 months. Call it $2.8 billion. Assume calls on that cash of $1 billion for capital expenditure plus $300 million for interest expense and $200 million for extra working capital. That leaves $1.3 billion to go to debt repayment. If LVS could manage twelve months without major capital outlays, borrowings would be more than cut in half in under three years.
Also, were LVS to sell 15% of Marina Bay in an IPO, I think it would raise enough to wipe out all its US debt. I doubt this will happen until the property is more mature, but the possibility has to make lenders–and investors–feel more comfortable about LVS’ debt level.
And, of course, LVS has $3 billion or so in cash on its balance sheet.
A sum of the parts calculation is probably the most reasonable.
At yesterday’s closing price, LVS had a market capitalization of $33.8 billion. The company’s share of publicly traded Sands China is worth $17 billion. If we assume that Marina Bay would trade on the same valuation as Sands China–which could prove much too low–then that 100%-owned property is worth $24 billion.
This means Wall Street is valuing LVS’ US operations at -$7 billion. This compares with a +$7 billion implied valuation for WYNN’s US operations and +$3.3 billion for those of heavily indebted MGM.
LVS shares (which I own–I may sell some today, though) would have to rise by about 30%, just for the implied valuation of its US properties to match those of MGM. It would take a 20% rise just to get the value up to zero.
Why the disconnect? I don’t know. The former CEO of Sands China is suing, and claiming all sorts of improprieties by LVS management. It’s also possible that some investors are uncomfortable with LVS’s debt–I know I have been–or don’t understand that the earnings disappointment in 1Q11 is just one of those things that happen in the gambling business.