Salomon convertible analyst encouraged by new issue flow

By Ronda Fears

Nashville, April 4 - Salomon Smith Barney convertible analysts are encouraged by the new deal flow so far this year, but note very aggressive pricing terms and conditions with little room for improvement as demand remains high.

"Convertible issuance continues on what we see as a healthy pace. Year over year comparisons remain weak, but the most recent trends [in issuance] are encouraging," said Salomon convertible analyst Stuart Novick in a report.

"And while we understand that more than one new convertible in March was re-priced downward at issue, perhaps indicative of new issue terms crossing the line, recent issue terms are extremely unattractive by historical standards for the most part.

"Yet issuers continue to anticipate and encounter robust demand for new converts almost regardless of issue terms due to a shortage of new paper and a picked-over secondary market."

While first quarter issuance trailed last year's first quarter by a wide margin - $16.5 billion compared to $29.9 billion - Novick said it bodes well for hitting Salomon's projection of 2003 new issue proceeds of $65 billion to $75 billion.

Deal proceeds rose sharply in March to $6.2 billion versus $3.7 billion in February.

But new issue terms continue to be extremely aggressive by historical standards, he noted, with the average yield at 1.8% and an average 45.9% initial conversion premium in March, versus 3.7%, up 49.3%, in February.

"There might be a limit as to what convertible investors will ultimately buy," Novick said in the report.

"Indeed, a few deals in March were met with less than enthusiastic demand from convertible buyers leading to what we understand was a re-pricing below par for a couple of them. One or two others simply traded lower after they were issued."

But most indicators suggest very strong demand, he said, and investors are getting compensated to some extent with call protection.

"Greenshoes continue to be filled for the most part, overnight deals are becoming more common, and even 'overbreakfast' deals are hitting the tape, reflecting the market's appetite for new convertible paper," he said.

"Despite the quick-to-market nature of many of these issues, there have been several upsizings, as well."

To the plus side for buyers, issuers are offering more in the way of call protection to boost the value of the embedded call option to offset erosion resulting from high strike prices, he added.

"In fact, adding call protection has kept new issue valuations on the 'cheap' side," despite the low yields and high premiums, he said.

"Indeed, no single new issue last month looked ridiculously cheap, but most modeled out as being undervalued, if only slightly so."

Onerous conditions like the rapid marketing periods for new deals haven't stemmed demand either.

"Lately, deals are coming with less and less time between initial announcement and actual issue, including a pair of deals announced pre-open for issue that morning, and those deals are being announced without any real price talk ranges, so relatively few deals are coming aggressively priced," Novick said.

"The same goes for another demand metric we track, pricing advanced. Since deals are coming as quickly as two hours after they've been announced, it would be difficult to move pricing ahead in the calendar. Thus, for the time being anyway, this specific metric and the lack of issues that were moved ahead is not particularly important.

"On the other hand, the large percentage of overnight offerings, upsizings and greenshoes filled all remain relevant and telling statistics with regard to convertible new issue demand."

But with cash continuing to flow into the convert market, mostly through convertible hedge funds, and with a large supply of paper exiting the domestic convert universe due to calls, puts, maturities and repurchases, not much is expected to change.

"Despite the poor out-of-the-gate performance of some of these recently issued, aggressively priced new deals, we would expect to see terms remain stiff," Novick said.

"Demand for new convertible paper is still strong as hedge funds need to put cash inflows to work."

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