Corporate Express convertibles offer return potential on Staples takeover bid, analysts say

By Rebecca Melvin

New York, Feb. 20 - The convertibles of Corporate Express NV present a "ratchet opportunity" following the office supply company's rejection of an unsolicited €7.25-per-share offer from Staples Inc., according to a Barclays Bank convertibles research note on Wednesday.

Corporate Express' 2% convertibles due 2010 have change-of-control protection via a put at par plus accrued interest and a stepping ratchet, the research note said.

Corporate Express has been rumored to be in takeover talks with Framingham, Mass.-based Staples, and on Tuesday it received an unsolicited €7.25-per-share offer, which it rejected, reiterating that it desires to remain independent.

Barclays said that for a takeover prior to Dec. 18, 2008, the conversion ratio would increase by 6.52%. After that date, but before Dec. 18, 2009, the ratio would increase by only 3.16%.

Using a share price of €7.25, Barclays calculates a change-of-control parity of 102.5 prior to December 2008.

For a deal at the current share price of €7.55 or €8.00, the change-of-control parity would be 106.7 or 113.1, respectively.

On Monday the convertibles closed at 94.2, versus a €5.43 share price, according to Barclays.

"If a takeover were certain to proceed, then the appropriate delta hedge ratio would be 106.5% and the bond would trade at the change-of-control parity less accrued interest (currently 0.36 points)," the note stated.

Given the closing share price of €7.55, the market seems to view a higher offer as likely. However, this delta is too high in Barclays' view given the lack of certainty that a takeover will ensue.

"If it does not, and the share price remains at its current level, then we would obtain a theoretical value of 112.1 (73% delta) using a 40% volatility, 8% credit spread and 1.5% borrow," the note stated.

Even using more conservative assumptions of a 10% spread and 35% volatility, Wednesday's non-change of control theoretical value would be 108.6 (77% delta), the note stated.

Given the most recent mid-market price in the bond of 105.4 (mid) versus €7.55, the bank sees some delta-neutral valuation upside, of approximately 3 points if no deal occurs and of up to about 1 point if it does at the current share price.

"We would suggest a delta of [about] 85%, which we expect will result in a positive return for holders in most deal and non-deal scenarios. A protracted deal at a relatively low share price, especially if it eventually concludes after the ratchet steps down at the end of the year, would be a less favorable scenario for holders," according to the bank.

Another risk is that the stock borrow cost could eat into the potential upside, depending on the time until a deal is concluded. Lastly, the no-deal valuation of the bond could cheapen further, although Barclays' modeling assumptions are thought to be fairly conservative.

Corporate Express is a business-to-business office supply company based in Amsterdam.

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