AMR deal grounded, but two others at bat; buyers emerge as market begins to cheapen

By Ronda Fears

Nashville, Aug. 4 - AMR Corp. canceled its $250 million convertible deal after a day of marketing, with the standard "market conditions" complaint. Buyside sources said it's just a matter of pricing power shifting away from issuers after a lengthy pricing party featuring "free money."

In the secondary arena, overall, players are beginning to find some comfort in the market as it cheapens, largely thanks to the beating the bond market has been taking. Traders reported buying interest has picked up in the secondary, and some fund managers said they were wishing for new capital campaigns.

"I'm glad to see some rationality come to the market," particularly among new issues, said Anu Sahai, portfolio manager of the ING Convertible Fund.

"Overall, this market is looking a lot better. The market's starting to look a little cheaper, I'm seeing some more value."

The American Airlines Inc. parent pulled its deal - one that had been speculated about for some time - but two others were poised to price after the close.

Yellow Corp. and Andrew Corp. both shopped deals throughout the session and Yellow's was an obvious home run, getting upsized and trading up 1.5 points in the gray market.

AMR's $250 million deal had been modeled very cheap, but apparently not cheap enough. The 20-year discount cash-to-zero notes were talked to yield 6.25% to 6.75% on the issue price, estimated at 38.308, with a 40% to 45% initial conversion premium.

The premium range was sweetened to 30% to 35%, but still it was scrapped right after the closing bell. There was enormous activity in the stock, which perturbed hedge funds that were shorting the stock to play the convertible, and the shares closed down 91c, losing 10.17% on the day, to $8.04.

At the middle of original price talk, Deutsche Bank Securities put the AMR deal about 8% cheap, using a credit spread of 1,100 basis points over Libor and a 55% stock volatility. Lehman Brothers had put it nearly 10% cheap, using a credit spread of 1,200 bps over Treasuries and a 50% stock volatility.

Merrill Lynch and Morgan Stanley, joint lead managers of the AMR deal, both declined to comment about why the deal was canceled, except to say market conditions were not cooperative.

In a company statement, AMR chief financial officer Jeffrey Campbell said that "with the significant improvement we have seen in AMR's operating results beginning in May, and with our strong cash balance of more than $2.7 billion, we felt it made no sense to proceed with this transaction in market conditions as they evolved today."

On Friday, AMR reported a record high July load factor of 81% and estimated unit revenues had grown 9% to 11% year-over-year.

"My instant analysis is that the convertible market is becoming more selective," said one buyside source.

"Moreover, if one wants to take a flyer on an airline, it's a bit like buying a ticket - there are several airline convertibles to choose from."

There are nine conventional airline convertibles in play, including ExpresJet Holdings Inc.'s deal from last week along with America West Airlines inc. and JetBlue Airways Corp. from in July.

In any event, Yellow seemed to steal the show, with several hedge funds that also play in risk arb very interested in the deal, as the proceeds are earmarked to help fund a portion of the Roadway Corp. acquisition.

Yellow wheeled out $150 million of 20-year convertible notes talked to yield 4.75% to 5.25% with a 50% to 55% initial conversion premium early Monday, and it was "way oversubscribed," market sources said. Not long after the market closed, it was done and parked with a 5% coupon, up 53% - and upsized to $200 million.

Several trades were made at 1.5 points over issue price in the gray market, traders said, and it was pegged at the close with a bid of 1.5 points over and offer of 2.25 over. Yellow shares ended off 44c, or 1.69%, to $25.65.

Not much was heard about the Andrew deal, however. The $200 million issue was talked to yield 2.75% to 3.25% with a 37% to 42% initial conversion premium. At the midpoint, Deutsche put it 4.2% rich, using a credit spread of 500 bps over Libor and a 50% stock volatility. Andrew shares closed off 59c, or 5.58%, to $9.98.

Last week, many buyside sources were talking more about convertible investors showing some pricing muscle, pushing back after what one fund manager referred to as a "three-month tear during which issuers were getting free money."

The Vishay Intertechnology Inc. and Flextronics International Ltd. deals were reoffered below par and Dynegy Inc. had to pony up some 100 bps of yield.

There were buyers at the cheaper levels, however, and hopes of a trend developing for wider terms on new deals encouraged players.

"The bond [Vishay 3.625% convertible] was at 97 5/8 this morning, and we're bullish," said F. Barry Nelson, a portfolio manager at Advent Capital Management.

"The company has favorable prospects and the new convertible models cheap even on conservative assumptions of a 500 bps spread and 40 vol. Moreover, the issue includes a change-in-control put at a premium price of 105 - not the traditional par value of 100.

"Convertible terms are improving. The future is looking up."

On tap for later this week is a small $75 million deal from Artesyn Technologies Inc. and on the horizon, The PMI Group Inc. is planning a $200 million mandatory to partially fund its portion of the $1.875 billion investor buyout of Financial Guaranty Insurance Co. from General Electric Co.

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