Hutchinson Technology 2.25% convertibles provide for good upside potential, new report says

By Evan Weinberger

New York, Aug. 29 - Hutchinson Technology Inc.'s 2.25% convertible subordinated notes due March 15, 2010 provide solid upside potential to both hedged and outright investors, according to a new report released Wednesday by Paul Berkman, senior vice president at J Giordano Securities Group.

The convertibles' rapidly approaching maturity and 5.2% yield to maturity independent of common stock levels, the direction of interest rates and credit spreads make the bonds especially attractive, according to Berkman.

The convertibles have a relatively low conversion premium - 25% - that indicates a "high degree of upside participation," Berkman notes.

Despite the lack of a make-whole matrix, Berkman believes that Hutchinson Technology convertibles are a safe bet. "There is no question in my mind that the lack of this protection is the single biggest reason for the apparent cheapness of the convertible," Berkman said.

The convertibles are trading at around 93 despite Hutchinson being a consistently well-performing stock since it bottomed out at $18 in June. The stock closed at $22.19 Tuesday.

Ratings agencies and stock analysts have upgraded the Hutchinson, Minn.-based disk drive producer. Standard & Poor's recently gave Hutchinson a B+ rating, although the bonds themselves are not rated.

Hutchinson is not a heavily indebted company. Its $350 million in outstanding debt through two convertibles issues represents almost all of the company's existing debt, according to the report. Using a 500 basis point credit spread, which Berkman calls conservative, the interest value is estimated to be around 85, and will accrete to 100 as the bond matures.

Berkman also gives the bonds an implied volatility of about 26%.

Berkman recommends a 35% hedge ratio on the convertibles, which he believes is market neutral.

"This can be expected to generate profits on a common move in either direction, and allow for lots of opportunities for delta trading," Berkman said.

The change of control put at par for the Hutchinson 2.25% convertibles allows for a profitable hedge "if a cash takeover was effected below 28¼ or above 303/4."

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