Headwaters, Chesapeake Energy better; Best Buy slumps; Charming Shoppes up; Host Marriott higher

By Ronda Fears

Nashville, March 3 - With the broader markets showing mixed signals Thursday, albeit without much conviction either way, convertible players seemed to be content to sit on the sidelines. Traders said they were relatively busy but echoed recent remarks that the market felt cheaper despite some nice moves up on Thursday.

"The universal cry is that small/mid cap names with low coupons, long duration and no takeover protection are even more worthless than [the] already discounted converts," said the manager of a large convertible fund.

"The market still feels heavy with early euphoria - as everyone is sure [the] market is cheap - in the mornings, followed by liquidators in the afternoon. [That's] deflationary behavior! I'm waiting to see if there's any sector rotation: Do you continue to play defense (oil, metals, staples, commodities), or leg into some offense (retail, tech, biotech)?"

Retail was finding some buyers after an extended sell-off in that group, a sellside desk analyst said, after many reported gains in February comparable-store sales. But, players said the emphasis in on specialty retailers and off consumer items like gadgets and general merchandise.

Oil prices briefly flirted with the all-time high set last October and while most oil and gas issues in the convertible market are considered very rich, and the Big Oil names are recently the topic of merger speculation, there were some names active in the sector.

Lottery and gaming machine company Scientific Games Corp. convertibles slid Thursday by about a point after the company lost a contract to Gtech Holdings Corp., although Gtech's convertibles were little changed, a sellside market source said.

Another leisure name, Host Marriott Corp., saw its convertibles get better on the back of its junk deal, which was boosted Thursday to $650 million from $500 million with the 10-year notes pricing to yield 6.375% - at the middle of talk of 6.25% to 6.50%. Convertible players liked that the company was taking out some older bonds with fatter coupons, said a trader, who pegged the 6.75% preferreds up 0.5-point to 56 bid and the 3.25% bonds better by 1 point to 109 bid.

Primary market action in the convertible market, though, continued to be rather stagnant. Thus, synthetic convertibles have gotten more attention but provide little secondary opportunity and the interest is pretty much limited to an outright view rather than hedged, market sources said.

As for firm deals, Allied Waste Industries Inc. was on tap with its new mandatory, which was a tad above issue price in the gray market, while it sold a $600 million junk bond deal and a big new bank facility sits in the wings.

Allied Waste lifted at 251.125

Buyside traders said the new Allied Waste mandatory traded at 1.125 points over issue price in the when-issued market just ahead of the Scottsdale, Ariz.-based trash hauler pricing the $500 million issue, which was expected to show a dividend of 6.0% to 6.5% and initial conversion premium of 23% to 27%.

The last gray market on the new issue was at 1 point over on the bid side to 1.25 points over on the offer. At the middle of price talk for the new Allied Waste convertible, sellside analysts estimated it would be priced right at about fair value to 1.6% cheap.

Allied Waste's stock closed off by another 35 cents, or 4.24%, at $7.90. The existing Allied Waste 6.25% mandatory saw additional sellside, with the issue dropping by nearly 2 points Thursday to 46.625.

In the junk bond market, shortly after the market closed, sources informed Prospect News that Allied Waste's $600 million 10-year notes priced at par to yield 7.25%.

Synthetic convertibles gain appeal

With the supply of new convertibles so low against still healthy demand, market sources said there has been increased interest in synthetically created convertibles - both from an investment opportunity standpoint as well as a means to generate fees for the investment banks.

Merrill convertible analyst Tatyana Hube said in 2004 there were 200-plus synthetic convertible deals for an estimated $3.5 billion in proceeds. Going into 2005, with the convertible primary market still looking lackluster, the synthetic convertible product remains very relevant and popular, she said. Merrill analysts circulated a special report on the investment idea Thursday. (See full story elsewhere in this edition.)

"Yes - we do a few synthetics on the outright side," said a buyside market source out West. "We did one with [Goldman Sachs & Co.] into EMC, for example. We look for stocks in a sector to which we want exposure. Also, the derivative guys [are] always out pitching new ideas."

Convertible traders say synthetics have merit, but opportunity is limited in the secondary market because a lack of liquidity is a major obstacle although many of these issues are listed on a major exchange. Convertible traders at some of the big sellside shops, though, have noticed increased interest in synthetics for lack of much else to look at in the standard convertible market.

"There isn't much of a secondary market for synthetics and from what I've heard they haven't been very big with hedge funds, at least that I know of," said one sellside trader.

"I think they are an attractive way to buy a convert for something you could never get naturally, like an index, or a basket of stocks, or a company like MSFT, or something. But from a hedged/theoretical point of view, I don't think they are usually especially attractive."

Best Buy bested by tech slump

Best Buy, the big consumer electronics retailer, said Thursday that same-store sales rose 2.8% in its fiscal fourth quarter but warned that quarterly earnings would likely be at the low end or slightly below a range of $1.56 a share to $1.66 a share because of heavier promotions in a competitive pricing environment and higher inventory markdowns to move merchandise.

"A short while back we were hearing predictions that PC sales, handheld phone sales, stuff like that were going to go up this year," said a buyside trader. "We haven't seen any evidence of that; quite the contrary, in fact."

With many of the manufacturers of products Best Buy sells - Apple Computer Inc., Dell Inc., IMB Corp., Motorola Inc. - lower, he said investors were feeling less optimistic about Best Buy itself.

Another buyside source said Best Buy's news left him "a little cold to consumer discretionary names" altogether, but he was seeing "some interest in software and some specialty retail" situations.

Retail focus on specialty shops

Indeed, traders said there was a lot of interest in the smaller convertibles of specialty retailers, particularly apparel names despite the recent uncertainty surrounding Saks Inc. and its potential split of the upscale stores and modest priced department stores.

Charming Shoppes Inc. and Casual Male Retail Group Inc. were both mentioned by name.

Charming Shoppes posted a 1% gain in February comparable-store sales, which wasn't impressive but created a swatch of interest in specialty retailers. The company is an apparel chain specializing in women's plus-size clothing.

Casual Male, which sells clothes to big and tall men, has struggled during the recessionary years, as one trader put it, but has made "great strides" toward a comeback with its acquisition of the Rochester Big & Tall stores and the George Foreman clothing line.

Charming Shoppes' 4.75% convertible gained 4 to 5 points to 109 bid, 110 offered while the stock Thursday rose 74 cents, or 9.57%, to $8.47.

Casual Male's 5% convertible rose 1 point to 90 bid, 91 offered with the stock up a quarter, or 4.27%, at $6.10.

Energy names active on oil

Not only were oil and gas names active on the spike in oil prices, albeit cautiously as many of those issues are "extremely expensive, but also alternative fuels names such as Headwaters Inc., which does things like "wash coal."

After nearly reaching a new record high, the April futures contract for crude settled at $53.57 on the New York Mercantile Exchange, up 52 cents. The record was set last October at $55.17, though prices would have to surpass $90 per barrel to meet the inflation-adjusted peak set in 1980, according to the Associated Press.

On Wednesday, Headwaters announced it has developed a proprietary method for upgrading coal that uses existing dry coal cleaning technologies. This process produces cleaner, more consistent coal fuel, which can reduce the amount of new waste coal generated annually, reduces undesirable pollutants such as sulfur and mercury, improves the heating value of the fuel, increases the use of natural resources, and improves the fuel combustion characteristics

There was good two-way action in the Headwaters 2.875% convertible due 2016, a trader said, but it ended pretty much unchanged on a dollar-neutral basis. The stock closed off 7 cents on the day, or 0.21%, at $33.23.

Chesapeake was a credit story - described as "heady" by one trader - and only modestly impacted by oil prices as the company's reserves are heavily weighted to natural gas.

Moody's put Chesapeake Energy's Ba3 senior unsecured note ratings on review for upgrade, saying it would likely be raised to Ba2 with a stable outlook or get confirmed there with a positive outlook.

Chesapeake Energy's 5% perpetual convertible preferred shot up 2.75 points to 147 bid, 148 offered and the 4.125% perpetual convertible preferred gained 2.5 points to 144.5 bid, 145.5 offered. Chesapeake Energy stock closed up 53 cents, or 2.41%, at $22.55.

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