Short-dated puts are here to stay in convertibles market, Merrill says

By Peter Heap

New York, Oct. 30 - Short-dated puts have proved to be a valuable component of convertible financings and are not likely to disappear anytime soon, according to a new report from analysts at Merrill Lynch & Co.

"Despite concerns over the volume of convertible puts coming due in 2002 and how they were going to be financed, the flexibility of the convertible market and the good credit standing of companies has made rolling over of debt routine for most of these companies," wrote analysts Tatyana Hube and Yaw Debrah.

"Overall, if there are any problems with short-dated puts, they remain company-specific and do not signify a structural flaw in the product itself."

Issuers facing puts have "compelling reasons" to keep their convertibles outstanding, Hube and Debrah noted. In particular they noted the convertibles offer: cheap financing since many were issued at attractive levels which might be hard to replicate in the current environment; tax benefits since many are zero-coupon or original issue discount, allowing the company to deduct accrued interest while making zero or small cash payments; and lower cost when bankers' fees are taken into account.

Since September 2001, issuers have faced puts on 29 deals making up $20.7 billion of securities, three quarters of them potential or certain put candidates, according to the Merrill research.

Of these, eight issues were paid off either through a new financing or from existing cash or credit facilities.

Another 10 were in the money and consequently not put back, leaving 99.5% outstanding, and three were at or in the money and partially put back, leaving 12.3% outstanding.

For the remainder, the issuers offered sweeteners, consisting of an additional put in three cases, one example of a one-time cash payment, one addition of cash interest, two additional puts plus one-time cash payments and one additional put plus cash interest.

For the total of all issues, only $7.6 billion was redeemed, 37% of all convertibles with puts and 49% of the strong candidates, Merrill said.

In general one or two points of extra value over the put price has been sufficient to persuade investors to hold on to their bonds, according to Hube and Debrah. No issuers chose to redeem with stock when it was an option, preferring to pay cash to avoid further depressing the stock price. Similarly none of the sweeteners were equity based such as an increase in the conversion ratio.

"As ominous as they look, convertible put obligations appear to be quite manageable assuming that the issuers maintain a decent credit rating," the analysts commented. "The market place has provided them with a number of options to manager their financial obligations, despite tough business conditions."

Looking ahead there are 51 convertibles with $27 billion in puts coming due, the Merrill analysts said. Of the total, $25 billion or 93% are trading out of the money - although that could change if equity markets rebound.

Among these issues Merrill examined the likelihood of the put being exercised and the cost of any sweetener given the current stock price.

Hube and Debrah found "a relatively large number" of convertibles where they anticipate the issuer will have to seek cash or credit facilities to repay the debt.

In these cases, the company's creditworthiness becomes of "prime importance."

Elan's 0% convertible due 2018 was singled out by the analysts as causing greatest concern. The issue is putable on Dec. 14, 2003.

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