Yahoo! stumbles on product delay; airlines better on earnings; New River's poor borrow hampers deal

By Kenneth Lim

Boston, July 19 - The convertible bond market saw a broad-based pickup in activity on Wednesday, but Yahoo! Inc. was a sour note for outright investors as its stock and convertible tumbled after the company delayed the release of a key search-advertising platform.

"Someone called me and said, 'You must be happy, the market's up today,' but I said, 'No, have you seen Yahoo?'" said a buysider whose firm has an outright position in the convertible.

New River Pharmaceuticals Inc.'s proposed $125 million offering of seven-year convertibles, expected to price Wednesday evening, was absent from the gray market with limited interest in the deal from hedge funds amid a poor stock borrow.

In the airline sector, JetBlue Airways Corp. and ExpressJet Holdings Inc. were better outright as their stocks rallied on strong sector earnings and cooler oil prices.

The convertible market in general was better in line with equity markets, which rallied after U.S. Federal Reserve chairman Ben Bernanke's remarks to Congress were seen to suggest an impending end to interest rate hikes.

"Things were mixed but slightly better to buy," a buyside convertible bond trader said. "Credit was definitely better."

An outright convertible fund manager said the Fed's interest rate hike campaign was probably "getting closer to an end than a beginning," although there was still a good chance that rates would be raised by another 25 basis points in August.

"The numbers are still coming in kind of inflationary," the fund manager said. "The real problem is you've got so many bigger picture fears out there...and clearly the market's emotional."

The equity markets are already discounting expectations of a slowdown in earnings, so the equity market is not too rich at the moment. Convertibles should end the year on a positive note, although the summer session is "still jumpy," the fund manager said.

"Still, I'd rather own converts than stock," the fund manager said.

Yahoo! gets no cheers

Yahoo!'s convertible dived with the stock on Wednesday after the internet portal operator delayed the release of a highly anticipated search advertising platform and guided slightly below expectations.

The company's zero-coupon convertible due 2008 lost about 25 points outright, trading at about 132 against a stock price of $25.625. Yahoo! stock (Nasdaq: YHOO) closed at $25.20, down by 21.84% or $7.04 - its largest ever one-day drop.

"These things are pretty far in the money, so they're definitely going to trade down on sympathy," a sellside convertible analyst said. "They're down from about 150 on Monday, so they're getting hit pretty good."

Sunnyvale, Calif.-based Yahoo! reported late Tuesday that net sales for the second quarter rose to $1.12 billion, in line with Street expectations. For the third quarter, Yahoo! expects sales of $1.1 billion to $1.2 billion, just shy of analysts' estimates around $1.2 billion.

The company also said that a new advertising product it has been developing will be released only in the fourth quarter, one quarter later than expected. The delay fueled concerns that Yahoo! will continue to lag rival Google Inc. in the profitability of its search services.

"Clearly Yahoo! did not have one of their better days," a sellside convertible bond analyst said. "A lot of it is the pushback of the new search software. There's some fear that there's going to be execution risk."

Yahoo!'s credit is still "perfect," the analyst said, but the convertible is so far in the money that it is reacting to the stock movement.

"It's an equity play, and right now equity is not good," the analyst said.

The convertible and the stock could still bounce back if Yahoo! can give assurances in the next few months that the delay is not going to be a major issue, the analyst added.

A buysider whose firm has an outright position in Yahoo! said the note has always been worrisome because of its equity sensitivity, but the convertible still offered a defensive position against the index.

"Yes, it hurt," the buysider said. "It was a surprise. It was a pretty bad miss on their part."

Airlines climb on earnings

Airline plays JetBlue and ExpressJet were better outright on Wednesday as strong earnings in the sector and easing oil prices fueled stock rallies.

JetBlue's 3.5% convertible due 2033 was about half a point better outright, trading at 90.5 versus a stock price of $11.75. The Forest Hills, N.Y.-based low-cost carrier's 3.75% convertible due 2035 changed hands at 96.75 against the same stock price. JetBlue stock (Nasdaq: JBLU) closed at $11.79, up by 9.27% or $1.

ExpressJet's 4.25% convertible due 2023 also added about half a point outright, trading at 89.125 against a stock price of $6.90. ExpressJet stock (NYSE: XJT) rose 4.65% or 31 cents to close at $6.97.

"Airlines did well today," a sellsider said. "The stocks rose after a couple of earnings came out."

American Airlines parent AMR Corp. and Southwest Airlines Co. reported better profits, with Southwest Airlines' more-than-doubling of earnings significantly beating analysts' estimates.

Oil prices also slid on Wednesday, with a barrel of light sweet crude for August delivery dropping 88 cents to close at $72.66 in New York.

New River deal has poor borrow

New River's proposed $125 million offering of seven-year convertibles was seen as a tough sell for hedge funds and just interesting enough for outrights.

New River planned to price the deal Wednesday after the market closed. Price talk was for a coupon of 3.25% to 3.75% and an initial conversion premium of 22.5% to 27.5%. There is a greenshoe option for an additional $18.75 million.

Merrill Lynch is the bookrunner of the Rule 144A offering.

Market sources said there was practically no stock borrow in the name, and the only hedge funds that would be interested in the deal would be those fortunate enough to get their hands on a borrow facility that the bookrunner is setting up using $40 million of repurchased stock.

"The borrow is very, very limited," a sellside convertible analyst said. "We valued this as: it's a reasonably attractive name if you're willing to own it outright, and it's reasonably attractive if you're a hedge fund getting your allocation from Merrill, but if you're getting it from the market and you're a hedge fund you're not getting the borrow."

The sellsider said the deal could be about 2% cheap for outrights in a tough-borrow situation, making it fairly interesting, but acknowledged that there were risks.

New River's credit profile is "not all that great, they have no sales, no earnings," the analyst said.

"I think their EBITDA was negative over the last 12 months, and I think the only cash flow that they have is I think from Shire [plc] that has given them some money for hitting a milestone...aside from the cash infusion from Shire, it's still one of these orphan dug companies for the most part."

A Connecticut-based analyst said New River was "not a bad little company," with a product that "everybody thinks is going to make it to market and behind that they've got something that's going to be starting phase 3 trials."

But the analyst did not think the downside protection looked great from an outright perspective, and the problem with the stock borrow cut out interest from the hedge investors.

A buyside convertible bond trader said the deal was "a nicely priced security."

"But it's going to be illiquid, probably placed in a minimal number of hands, and there is no borrow," the trader said. "But if you want exposure to the company, the bond is a very good way to do it."

New River is a Radford, Va.-based specialty drug maker. The proceeds of the deal will be used to buy back about $50 million worth of New River stock, of which $40 million will be used for the borrow facility. Some of the proceeds will also be used to fund convertible note hedge transactions, and any remaining monies will be used as working capital to develop New River's attention deficit hyperactivity disorder drug NRP104.

New River stock (Nasdaq: NRPH) closed at $27.51 on Wednesday, down by 1.93% or 54 cents.

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