Lehman analysts evaluate the convertible versus risk arbitrage trade of EDS-HP deal

By Rebecca Melvin

New York, May 13 - Holders of the $690 million face value of Electronic Data Systems Inc.'s 3.875% convertibles will be entitled to a change of control put plus accrued interest to the fundamental change purchase date, with payment to be made within 30 days of that date, Lehman Brothers convertibles analysts said in a report on the EDS-Hewlett-Packard Co. merger announced Tuesday.

Hewlett-Packard and EDS announced that HP plans to acquire EDS for $25 in cash per share for a total transaction value of $13.9 billion at a premium of 33% to the May 9 closing EDS price.

After the company has provided all holders notice of the change of control and the resulting purchase right, holders must deliver the notes by the 35th day after the date of the notice of the fundamental change.

So, holders who choose to put the bonds will receive par plus accrued interest after the potential consummation of the transaction. However, the date on which the total payment is received is uncertain.

It can be as early as immediately after the transaction closes or as late as 79 calendar days after the transaction closes. Essentially, the issuer has certain flexibility with regards to when it wants to pay the par put plus accrued interest after the transaction closes, the Lehman report stated.

In a recent precedent, Solectron-Flextronics, the issuer was obligated to give notice of a change in control within 30 days of deal closing and required to repurchase the convert within 45 days of the notice date. Flextronics actually delivered the notice 30 days after the closing of the merger and the repurchase price was payable 44 days after the notice date.

Holders are not required to exercise the purchase right. If they don't exercise the put and the deal closes, Lehman anticipates that the notes will become a debt obligation of the acquirer.

The next put date on the EDS senior unsecured 3.875% convertibles is July 1, 2010.

The Hewlett-Packard senior unsecured floating rate notes which pay Libor plus 6 bps and are non-callable, mature on June 15, 2010 are quoted at 99.01 with a current coupon of 2.86% and a yield of 3.28%.

If an Aug. 15 purchase date is assumed, and if "we equate the EDS convert's yield to put to 3.28%, the implied convertible bond price equals to 101.08 (valuing it as a straight bond with no optionality). This is above the par put price," the report stated.

The Lehman Brothers analysts assume two scenarios: either the deal goes through at $25 or the deal breaks with EDS trading down.

The breakeven probability in a risk arb trade is higher than in a convert trade, the report shows. The breakeven probability in a risk arb trade with the EDS trade at $20 is 91.4% and the breakeven probability of a convert trade with the stock at the same price is 67%, according to the report.

Lehman Brothers is acting as a financial advisor to Hewlett-Packard in its potential EDS acquisition, the reported noted.

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