Coeur d'Alene bid up 1 point in gray market; Red Hat hits 103.25 bid; Duke rebounds

By Ronda Fears

Nashville, Jan. 7 - Convertible traders said buyers swamped the market Wednesday, pushing already rich valuations even higher amid raging demand as a result of having more money to put to work. There are skeptics of the runup, however, who foresee an eventual pullback.

"There were buyers of every name," one dealer said, echoing the sentiment of several other traders.

Thus, new paper was doing well, also.

Ret Hat Inc.'s new deal, which priced aggressively at 0.5%, up 37% and got bumped to $500 million, gained 3.25 points from par, which was steady with when-issued levels. Coeur d'Alene Mines Corp.'s deal also was boosted to $160 million from $130 million while pricing aggressively outside yield talk at 1.25%, up 24%. The deal was bid 1 point over issue price in the gray market.

In the secondary trenches, the convertible market in general was much firmer as well.

Duke Energy Corp. staged a big rebound after the company stood pat on its common dividend. The company's convertibles regained 1 point, propelled by a flood of buyers. The rebound was largely due to short covering, one dealer said, and a fairly large portion of that was by hedge funds that became big buyers of the converts as a result.

Elsewhere, traders mentioned that Mirant Corp. convertibles were better by a couple of points, with no news for support, and virtually all the airline paper was better bid. JDS Uniphase Corp., Sepracor Inc. and Hanover Compressor Co. also were mentioned specifically in trade, all moving north without any news.

Skeptics can't get satisfaction

Skeptics of the market runup are baffled, saying there is no value to be found. Merrill Lynch & Co. Inc. analysts put the convertible market's average theoretical discount at 0.02% at year-end amid a supply and demand imbalance while market volatility remains low.

One cynic doesn't think there will be any big blowups in convertibles but expects a "slow bleed."

"I don't know where you make money. I mean, single-Bs are at 200 bps over. That's ridiculous," the market source said. "It is a crazy world. Something's got to give, and I don't know what it is."

Market participants largely speculated spreads would be widening in 2004 from the dramatic tightening seen in 2003, at least at year-end. With the tightening seen this week, many have begun to rethink the matter, but none were entirely ready this early in the New Year to change their overall view.

In a report Tuesday, however, Banc of America Securities chief credit strategist Jeffrey Rosenberg said he expects "modest spread tightening should lead to relative outperformance of down-in-quality corporates relative to high quality issues."

"Higher quality issues should continue to lag, as interest rate risk and swap spreads widening risk hurts those issues the most, while declining credit risk benefits them the least," Rosenberg said.

For high-yield credits, he said, "Our base case forecast for 2004 performance shows a scenario of rising interest rates offset by a modest tightening of credit spreads. The result is a coupon clipper for high yield, with total returns centered on today's yield level of 8%."

New paper buzz in distressed market

Since spreads are so tight, there has been a surge of buzz in the convertible market this week that there could be a new deal soon from a very distressed company or one just exiting bankruptcy. HealthSouth Corp. and Adelphia Communications Corp. were two names mentioned specifically.

One market source noted that single-B convertibles are trading around 200 basis points over Treasuries and added, with sarcasm, "these days the definition of distressed is 400 over."

Certainly, with demand in convertibles running so high - one sellside analyst suggested there is a new convertible arbitrage shop on every corner, like those knockoff kiosks hawking designer look-alike handbags - a strong new issue market would be like a knight in shining armor.

So far, there hasn't been a jumbo deal emerge even though it is still early in the New Year; in the previous two years when convertible issuance was ultra-stupendous there was a jumbo deal launched within the first week. This year most sellside shops are forecasting a slight decline from 2003 but still a strong showing in the $80 billion neighborhood.

The head of convertible origination at a leading bank said that there probably will not be a big uptick in convertible issuance this year until after the 2003 earnings reports are released. Meanwhile, he expects two to five deals a week, and through at least the first half of the year the flow should be fairly constant.

The market buzz this week that there could be a fairly large convertible issue waiting in the wings with a name from the extremely distressed area, or some name coming right out of bankruptcy, is not beyond reason, sources said.

While Adelphia is still in bankruptcy, with no visible signs of emergence anytime soon, there has been market speculation recently that the bankruptcy could wrap up fairly soon, possibly by mid year, or that there could be a buyer for a good chunk of the company's assets.

That buzz is not really news regarding Adelphia, but a convertible trader noted Wednesday that just since the New Year began the Adelphia convertibles have shot up 11 points.

"Adelphia will be much stronger out of bankruptcy, a lot of the overhang will be gone," another market source said.

HealthSouth, so far, has avoided bankruptcy but said on Wednesday that it will hold a meeting for creditors and stockholders on Jan. 20 to "review its business plan and to provide an update on the status of its current operations."

"If there is enough float on the stock, a deal from HealthSouth would get bought. On a 95% or 100% hedge, it will get bid up," the market source said.

HealthSouth shares, which trade in pink sheets, closed Wednesday up a dime, or 2.1%, to $4.87.

"With the high yield market so hot and with the stock market where it is, anything is possible," said one capital markets source at a leading convertible underwriting shop.

"Look at the Red Hat deal. That used to be a penny stock."

Red Hat heads up out of gate

Red Hat's is the first deal of the New Year and by most indications was a rave, although buyside sources stopped short of calling it a home run.

The 20-year convertible senior unsecured notes, which are non-callable for five years, were boosted to $500 million from $400 million while pricing at the rich end of guidance.

The Raleigh, N.C.-based software and programming firm sold the notes at par to yield 0.5% with a 37% initial conversion premium - at the aggressive end of price talk of 0.5% to 1.0%, up 32% to 37%.

Sellside analysts not associated with the offering put it anywhere from 2.22% rich to 3.65% cheap.

UBS Investment Bank, sole bookrunner on the deal, closed the new Red Hat convertible at 103.25 bid, 104.125 offered. That is about where it was trading in the gray market before pricing.

Red Hat shares ended off 11 cents, or 0.59%, to $18.59.

Coeur d'Alene prices rich, too

The books were closed on the Coeur d'Alene deal shortly after the market closed, and it too was upsized. Demand was strong for the issue, which one buyside source said was heavily weighted toward outright convertible investors as opposed to hedge funds.

The Idaho-based mining concern sold an upsized $160 million of 20-year convertible senior notes at par to yield 1.25% with a 24% initial conversion premium. It was boosted from $130 million and priced aggressively outside of yield talk for 1.5% to 2.0% and at the rich end of premium guidance for 20% to 24%.

Merrill Lynch analysts put the Coeur d'Alene deal 3.62% cheap, at the midpoint of guidance with the stock at $6.25. The shop used a credit spread of 600 basis points over Treasuries and a 40% stock volatility.

Lehman Brothers analysts put it 2.71% cheap, at the middle of price talk with the stock at $6.66. A credit spread of 700 basis points over Treasuries and a 45% stock volatility were used.

Venu Krishna, Lehman's head of U.S. convertible research, said the cheapness was slightly better than recent new issue cheapness of 1.59% but also noted weak financials.

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