Bear Stearns finds high yield converts in out-of-favor software, tech sectors

By Ronda Fears

Nashville, Tenn., Sept. 9 - Looking for high yielding convertibles with clean balance sheets and good cash positions, Bear Stearns & Co. came up with a preliminary list of eight names, mostly from the out-of-favor software and tech groups.

In the list, outlined in a report Monday, are BEA Systems Inc.'s 4% convertible due 2006 (B), CIENA Corp.'s 5% due 2005 (B-), Comverse Technology's 1.5% due 2005 (BB), Juniper Networks' 4.75% due 2007 (B-/B2), Mercury Interactive's 4.75% due 2007, NVIDIA Corp.'s 4.75% due 2007 (B-), Rational Software's 5% due 2007 and RF Micro Devices' 3.75% due 2007 (B-).

"We believe they are trading at attractive yields as some of the natural buyers (hedge funds) do not have any incentive playing in these names both from a traditional convertible arbitrage, given the high premium, or from a capital structure perspective, given that the convertible is the only debt outstanding - except for Ciena," said Rao Aisola, head of convertible research at Bear Stearns, in the report.

"Further, for all of the software and telecom equipment names, weak carrier capex and reduced IT spending is weighing heavily on the stocks. However, the common theme that holds true for most of the above companies is that they are leaders in their respective spaces and have proven operational models."

The Bear Stearns convertible group screened the convertible market for convertibles with yields of around 10% or greater that are cash rich and have clean balance sheets.

In some cases, names were included that deviate from the criteria modestly, usually because the convertible is the only debt outstanding, the company is net cash positive with minimal cash burn going forward, there is positive operating cash flow with at least a modest earnings visibility and there are no accounting issues.

Barring outright fraud, no significant balance sheet issues were found in the companies named in the report, the analyst said.

"Against the backdrop of weak corporate earnings and limited visibility, we feel that these convertibles offer total return protection should the markets trade sideways. Further, they offer some upside as credit sentiment towards technology/software companies improves with an improving economic backdrop," Aisola said.

"Some of the company's managements are actively buying back the convertibles (Mercury Interactive) while others like Juniper have not instilled any disciplined buy back program. If the top line does not pick up over the next few quarters, managements may come under pressure to put the cash to better use, including but not limited to buying back the converts.

"In the meantime, the convertibles offer the investor the ability to participate in a high yielding story without taking on credit risk being implied by the bond spreads."

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