Gap $1 billion convertibles price talk tightened to 5.75-6.0% yield, up 25-30%

By Ronda Fears

Nashville, Tenn., Feb. 27 - Guidance on Gap Inc.'s $1 billion of convertible notes was tightened just hours before pricing, as market sources said demand for the issue was running very high. Also just before pricing, Moody's rated the new deal at Ba3 and lowered Gap's senior unsecured bonds to Ba3 from Ba2. The new price talk puts the yield at 5.75% to 6.0% and the initial conversion premium between 25% and 30%. Original guidance put the yield at 6.0% to 6.5% and initial conversion premium at 22% to 25%.

None of the developments daunted interest in the deal, however. Traders said the issue kept going higher in the gray market even after the price talk revision, and was quoted 2.625 to 3 points over par in the gray market.

"This is definitely a home run. It's flying already, and even the new pricing terms won't stop it," said a convertible trader at a hedge fund in New York.

"It's really cheap and in a space that a lot of people see potential to get in ahead of a rebound rather than chase it. It wouldn't be a bit surprising if this deal wasn't upsized by quite a bit."

Banc of America Securities, JPMorgan and Salomon Smith Barney are joint lead managers of the Rule 144A deal, which is slated to price after the closing bell Wednesday. The seven-year convertible notes will be non-callable for three years. There also is a $200 million greenshoe available.

Moody's rated the deal, but lowered the ratings on Gap's senior unsecured long-term debt to Ba3 from Ba2, reflecting the expectation that material assets will secure the retailer's new bank agreement. Moody's had said on Feb. 14 that the senior unsecured long-term debt rating was likely to be lowered a notch given the collateral to support Gap's new bank facility, which could close as early as next week. The $1 billion senior unsecured convertible is a condition to the execution of Gap's new $1.3 billion bank agreement, Moody's said, and will further enhance Gap Inc.'s liquidity, which includes cash of about $1 billion, and will provide working capital financing, if needed, as the company works over the next 12 months to turn around its operating and financial performance.

The rating outlook was revised to stable from negative, Moody's said, reflecting the anticipation that comparable store sales, profit margins and cash flow generation will not deteriorate further. While Gap Inc. is refocusing its concepts' merchandise offerings, it will be some time before it is evident whether these merchandising changes are gaining traction with the customer, Moody's noted.

Gap posted a fiscal fourth quarter net loss of $34.2 million, or 4c per share, versus a profit of $272 million, or 31c per share, a year ago. Net sales dropped 11% to $4.1 billion from $4.6 billion for fourth quarter a year earlier, while comparable store sales decreased 16% versus a 6% decrease a year before. For the year, Gap posted a net loss of $8 million, or 1c per share, for the year, versus a profit of $877 million, or $1.00 per share, a year earlier. Net sales rose 1% to $13.8 billion from $13.7 billion in the year before, while comp store sales decreased 13% compared with a 5% drop a year earlier.

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