Fitch: Some issuers may improve balance sheet, ratings with convertibles conversion

By Matt Maile

Oklahoma City, Dec. 2 - Several issuers of convertible debt might be in a position to improve their balance sheet as their convertibles approach or have already reached parity with their equity, a new report by Fitch Ratings concluded this week.

Issuers identified by Fitch with convertibles at or near parity include Advanced Micro Devices, Corning Inc., The Gap Inc., GTech Holdings Corp., Interpublic Group of Cos. Inc., Lucent Technologies Inc. and Watson Pharmaceuticals Inc.

"The foundation has been set for a number of the recent vintage convertible instruments to convert," Fitch analysts Glen Grabelsky, Charlotte Needham and Henna Nordqvist said in a report entitled "Balance Sheet Repairs: Taking the Top Off Convertibles."

The Fitch analysts explain that with the convertibles at parity, the issues may be converted from debt to equity, thereby improving a company's balance sheet. The approach to parity has been seen most among issuers - particularly fallen angels or distressed issuers - that have experienced a financial turnaround since the convertibles were first issued.

Fitch said that for some issuers, the potential for the convertible issues to be converted to equity could improve a company's balance sheet, thereby increasing prospects for improved ratings.

In the case of Advanced Micro Devices, $402.5 million of outstanding 4.5% convertibles due December 2007 account for 21.4% of long-term debt. The issue, which has a conversion price of $7.37, had already reached 2.06 times equity parity as of Oct. 31.

Pro forma for the conversion of the convertibles to equity, the company's trailing 12-month interest expense for the period ended Sept. 28 would fall to $83.20 million from $101.31 million.

Watson Pharmaceuticals similarly could see an improvement to its balance sheet, Fitch said. The company's $575 million of 1.75% convertibles due March 2023 account for 79.6% of long-term debt. The issue, which has a conversion price of $40.05, was at 0.98 times parity as of Oct. 31.

Fitch said Watson Pharmaceuticals could reduce long-term debt by 79.6% and cut trailing 12-month interest expense to $14.23 million pro forma for a conversion from $24.29 million, if the notes were converted to equity.

Other companies with convertibles at or near parity on Oct. 31 included GTech Holdings' $175 million of 1.75% convertibles due 2021, at 1.62x equity parity; The Gap Inc.'s $1.38 billion 5.75% converts maturing 2009, at 1.18x equity parity; and Corning Inc.'s $665 million 3.5% convertibles due 2008, at 1.13x equity parity.

Fitch also noted that Interpublic Group of Cos. Inc.'s $800 million of 4.5% convertibles due 2023 were at 1.2x equity parity on Oct. 31, while Lucent Technologies Inc. had two series of convertibles at or near parity - the company's $750 million of 2.75% converts due 2023 and $880.5 million of 2.75% converts due 2025, at 0.96x and 1.03x parity, respectively.

"Fitch believes many of the specific credits mentioned in this report have strong prospects for conversion," the analysts said.

Fitch noted that certain factors must be present for the conversion of debt to equity to be "analytically significant."

"From a financial and rating perspective, the following three factors need to be present for convertible securities to be analytically significant: (1) Conversion to parity, so that the current market price is above or near conversion prices; (2) Convertible debt representing a large component of total debt (benchmark is 20%); (3) Call or maturity dates in six to 12 months."

Fitch said the ratings of some companies have already benefited from the conversion of convertibles.

"In the past 12 months, the conversion of a convertible debt instrument of Tribune Co. was a key factor in a Rating Outlook change to Positive from Stable," Fitch said.

Fitch said it expects additional rating decisions will be influenced by the presence of the so-called in-the-money convertibles. The agency said it is "actively monitoring candidates with these characteristics."

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