Grey up 3 points in gray after talk tightened; Lucent issues soar 6-9 points on buybacks

By Ronda Fears

Nashville, Oct. 22 - Buyers emerged for several issues Wednesday as the deep slump in stocks amid fairly pleasing earnings cheapened lots of convertibles. Many convert arb players also were adding stocks as prices plunged in the sell-off.

Airline paper was among the sectors showing the most severe price swings, with the underlying stocks dropping as much as 14.75% on profit taking.

"AirTran [Holdings Inc.] converts came in just about 0.25 point while the stock took a big hit, so I added on a little bit of stock on that weakness," said a buyside convert trader at a hedge fund in New Jersey.

"There was a lot of people adding to some positions as a result of this sell-off, because it cheapened the market quite a bit."

Grey Global Group's new deal also was seen pretty cheap, cheap enough that the indicative terms were tightened before pricing and even then it was very strong in the gray market.

For next week's business, PMI Group Inc. brought its planned deal off the shadow calendar where it had been sitting for a couple of months, after it reported better-than-expected earnings Wednesday.

PMI's $250 million of convertible units are talked to yield 6.0% to 6.5% coupon with a 20% to 24% initial conversion premium.

Meanwhile, on the immediate agenda, guidance on Grey Global Group's $100 million of 30-year convertible subordinated notes was tightened to a 5% yield with a 28% to 32% initial conversion premium. Initially, it was talked to yield 5.0% to 5.5%, up 23% to 27%.

On the new terms, the issue came in 1 point in the gray market, buyside traders said, but was still bid 3 points over issue price with the offer at 4 points over.

Lehman Brothers analysts put the Grey Global Group deal 8.4% cheap, using a credit spread of 550 basis points over Treasuries and a 20% stock volatility.

The cheapness is warranted, Lehman analysts said, given the long duration of the bonds.

Grey doesn't have any public debt so Lehman used advertising peer Interpublic Group of Cos. Inc. as a starting point on the credit. The Grey spread was based on a discount of 300 bps discount to Interpublic's five-year credit default swaps, which were quoted at 210/220bps over Libor.

Lehman analysts also noted their credit assumption may arguably be too tight given Interpublic's $5.4 billion market cap, versus $1 billion or less for Gray. For reference, the analysts said the Interpublic 1.87% convertible due 2006 (Ba1/BB) was quoted at 91 bid, 92 offered, suggesting an option-adjusted spread of 340 bps.

"I'm putting it on because it's cheap, but it's cheap for a reason. My analyst doesn't like the credit on a fundamental basis," said a convertible hedge fund manager in New Jersey.

"It's also going to be very illiquid; once you're in it, you're in it. It's probably going to be closely held in a few hands. But it's not a bad one to have sitting around.

"We didn't short the common at the open, but should have. There's a small float on the common and that makes it a little tougher, by probably 100 bps or so."

Grey Global Group shares on Wednesday lost $83.02, or 10.44%, to $712.

There was considerable selling in stocks, forcing the Dow Jones Industrial Average down 1.53% and the Nasdaq lower by 2.21%.

Credit analysts noted that spread contraction in the high-grade universe also stalled, and the negative sentiment by the rating agencies on automakers was the main scapegoat.

But, overall, convertibles are holding their own and many players are applauding any cheapening.

"It could have been worse, if the stock market was any indication," said Citigroup convertible analyst Stuart Novick.

"Most converts seemed to hold up pretty well. The few issues that came in found buyers fairly quickly.

"I'd say that the actual [earnings] numbers had little to do with the sell-off today. It was just investors taking some recent profits off the table, I think."

Earnings aside, there was quite a bit of excitement in the convertible universe on the prospects of Lucent Technologies Inc. making some convertible repurchases and/or exchanging the convertible preferreds for convertible debentures.

Lucent said it has bought back $500 million during the quarter, although that includes a big chunk of straight debt. (See full report elsewhere in this issue.)

Lucent's newest 2.75% converts were both trading up sharply on the news. The 2023 issue gained about 8.75 points to 109.375 bid, 109.625 offered and the 2025 issue added about 10 points to 114.625 bid, 155.125 offered, mainly due to the stock gain of 33c, or 13.5%, to $2.78, one dealer said.

The airlines suffered among heavy selling as investors took profits from the recent run-up in those stocks, which also somewhat cheapened the converts. The airline paper also offers some of the fattest yields.

"AMR [Corp.] had traded as high as 111.5-112.25 when the stock was up at $15. Now that it's down to $13.80, the converts are probably more like 106," one market source said.

"Northwest [Airlines Corp.] bonds were up at 123.5-124.25 with that stock at $14."

Continental Airlines Inc. also saw some action, a sellside trader said, as the new 5% due 2023 convert came in 3.5 dollar points to 126.5 bid, 127 offered as the stock lost $1.34, or 6.84%, to $18.24.

AirTran Holdings Inc.'s 7% converts, though, only lost about 0.25 points on swap while the common shares fell $2.84, or 14.75%, to $16.42. Thus, some hedgies were adding stock on the weakness.

Markel Corp. also traded on the company's guidance, which forecasts a loss for third quarter as the company boosted its loss reserves.

The Markel 0% due 2031 was finding buyers as it dropped 0.5 point to 34.5 bid, 35 offered with the shares plummeting. The stock lost more than $8 to $265 at one point of the session, but recovered during the final hour of trading to close down by $6.44, or 2.36%, to $267.01.

A sellside source also said there was some customer interest in Schlumberger Ltd. after they reported earnings late Tuesday and the shares were downgraded by a couple of big firms Wednesday morning.

Schlumberger's converts were down by about 2 points each, with the 1.5s at 94.375 bid, 94.875 offered and the 2.25s at 93.75 bid, 94.25 offered. The oilfield giant's stock fell $3.41, or 6.64%, to $47.95.

Placer Dome Inc.'s new convertibles and Inco Ltd. were also mentioned, along with Eastman Kodak Co.'s new issue.

Kodak's new 3.375% convertible due 2033 traded a little firmer early in the day, roughly at 107, with the stock at $23.75, but the issue settled out the session off by 0.5 point to 106.25 bid, 106.5 offered as the stock ended down 38c, or 1.61%, to $23.26.

Kodak posted third quarter net income of $122 million, or 42c a share, down from $334 million, or $1.15 a share, in third quarter 2002. Revenues edged up to $3.44 billion from $3.35 billion.

Standard & Poor's said Kodak's ratings (BBB-/stable/A-3) would not be affected by the decline in net earnings. But the rating agency said it is important for the company to restrict the decrease in fourth quarter EBITDA to a similar level, or about 24%, continue to maintain strong discretionary cash flow and adhere to its planned dividend reduction to increase cash flow.

Kodak's 72% cut to its common dividend has come under fire by several institutional stockholders, which were meeting late Wednesday to discuss a possible alternative proposal to the company to boost shareholder value.

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