Convertibles market flat overall, but new issues gain ground

By Ronda Fears

St. Louis, Mo., Oct. 5 - Convertible traders said the market was rather flat overall Friday as stocks languished. But this week saw the primary market re-open after the Sept. 11 tragedy struck the heart of New York's financial district, and the new issues were higher for the most part. The four new deals, putting around $1.35 billion of new paper into circulation, were welcomed heartily. Market sources anticipate a heavy pipeline next week, but there are only two deals firmly set.

"New deals have really been the catalyst for a lot of secondary activity to come back. They always help the secondary," said the head convertible trader at one of the major investment banks based in New York. "The market is still very sloppy, though. Outside of new issues, we're still not seeing a lot of buying and quite a bit of selling."

As stocks were quiet and closed flattish, convertible traders said most of the focus was on new issues. Outside of the primary, the bulk of the convertibles universe is busted and trading remains thin. The Dow Jones Industrial Average ended up 58.89, or 0.65%, to 9119.77 and the Nasdaq closed up 7.99, or 0.50%, to 1605.30.

Telecoms were getting hammered this week, and Friday was no exception, traders said. Global Crossing, Corning and Nextel were among the biggest losers of the week in that group. While there was some lift in the media sector, traders said negative sentiment about the prospects of ad revenues rebounding have put a lid on those gains. AOL Time Warner and News Corp. suffered from the speculation that advertising will not recover anytime soon.

So, new issues took the spotlight.

Contingent conversion features continue to be the dominating trend, now with cash coupon bonds as well as zero-coupon and discount issues. Apogent Technologies Inc. sold a par bond with a 2.25% coupon and 32% initial conversion premium with a contingent conversion feature that restricts conversion until the issue reaches 120% of the initial conversion price. Up until the Apogent issue, the contingent conversion feature had not been used outside of zero-coupon or original issue discount converts.

Buy-side sources said there is a strong movement to push bankers selling new deals to throw in a kicker that would give some cushion on the credit end of these converts. The contingent conversion feature primarily benefits the issuer and current stockholders of the issuer since there are tax advantages to the structure and it is anti-dilutive to the underlying stock.

"What we want to see is something that would specify from the outset that if the bond falls below a certain point, then it becomes convertible," thereby nullifying the contingency threshold, said a convertible hedge fund manager in Connecticut.

Convertible market watchers say that's not likely to happen while there is so much competition among the investment banking community for the fees, which makes appeasing the issuer their primary motive for the deal structures.

"What we are trying to stress with the bankers is that oftentimes they end up holding a large portion of this paper, so it behooves them to have this sort of language," said the hedge fund manager.

High demand also makes it difficult to make much headway in lobbying for structures that appeal to buyers, the hedge fund manager admitted. Orders on this week's four new deals - the first since Sept. 6 - ran as high as 10 times the deal size. Allocations were as low as 8%, even though the deals sold at the aggressive end of pricing guidance, so the clamor for the paper continued well into the secondary aftermarket and pushed prices higher.

Apogent's deal, which priced after the close Thursday, was upsized to $250 million from $200 million and Electronic Data Systems Corp.'s deal, which priced before the open Thursday, was bumped to $752 million in proceeds from $500 million. Both sold at the aggressive end of price talk and had contingent conversion features. In the immediate aftermarket, the Apogent convert was up 1.25 points from par to 101.25 bid, 101.75 offered with the stock closing up 45c to $23.55. The EDS convert slipped 0.125 point on the day to 79.5 bid, 79.75 offered with the common down 41c to $58.09

Brinker International Corp.'s deal also priced with a contingent conversion feature late Thursday, and at the aggressive end of original price talk. The price talk had been revised Thursday to boost the yield, from a range of 2.75% to 3.25% that had been set out before the Sept. 11 catastrophe to a range of 3.0% to 3.5% just before pricing. Brinker's deal was not upsized from original plans to raise $225 million in proceeds, however. In the immediate aftermarket, the Brinker convert was up 0.375 point from issue price to 58.375 bid, 58.625 offered with the common stock off 28c to $23.10

A source working on the Brinker deal said, though, that orders ran about six times the deal amount. And, the source said, there was a healthy mix of fundamental, or outright, convertible investors as well as hedge funds participating in the deal.

The other deal that priced this week was also higher. Province Healthcare Co.'s 4.25% convertible - a straightforward traditional structure issue, added 1 point on the day to 103 bid, 103.5 offered with the common stock up 33c to $34.03.

Next week, the market is anticipating several new deals but only two are firmly set to price.

Community Health Systems Inc. is pitching $250 million of seven-year convertible subordinated notes and 12 million shares of common stock. The convert is expected to price to yield 4.5% to 5.0% with a 20% to 25% initial conversion premium.

Catharina Kusuma, convertible analyst at UBS Warburg, said the Community Health convert, at the mid-range of pricing guidance was about 10% cheap to fair value, assuming 45% volatility in the stock and a credit spread of 600 basis points over comparable Treasuries.

The registered deal is coming to market after the close Tuesday, or Oct. 9, via sole bookrunner Goldman Sachs & Co. and joint lead managers Credit Suisse First Boston and Merrill Lynch & Co.

Community Health shares ended Friday down $1.19 to $26.66.

Performance Food Group Co. is selling $125 million of seven-year convertible subordinated notes that are expected to price to yield 5.5% to 6.0% and carry a 20.5% to 24.5% initial conversion premium. Kusuma puts that deal about 8% cheap to fair value at the mid-point of the price talk, assuming 45% volatility in the stock and a credit spread of 800 basis points over Treasuries.

Performance Food stock closed down 54c to $24.96.

The only other primary market news of a more definite nature was that Cablevision Systems Corp. pulled its stock and mandatory convertible deals, which had been expected to fetch a total of $1 billion to $2 billion. Although Cablevision cited negative market conditions in its decision not to proceed with the deals, AT&T Corp. has filed to sell its stake in Cablevision though a secondary offering of the common stock and a mandatory exchangeable convertible totaling $1.75 billion.

No further details were available on the AT&T/Cablevision deal, except that the registered offering will be jointly managed by Bear Stearn, Merrill Lynch and Salomon Smith Barney.

Cablevision stock fell Friday $4.83 to $39.67.

There is still no firm update on two other deals that were left in limbo by the disaster at the World Trade Center. Those were proposed by Finisar Corp. and J.C. Penney Co. Inc.

Finisar shares, which ended Friday up 40c to $5.78, have been rebounding since Sept. ll. J.C. Penney stock had been, as well, but slipped Friday, closing down 7c to $23.20. End

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