Shuffle Master drops on earnings; ImClone slips on downgrade; Wednesday's pains hurt outrights more

By Kenneth Lim

Boston, June 7 - Convertibles fell across the board on Wednesday as a double whammy of falling bond and equity prices left investors hurting on two fronts.

Shuffle Master Inc. took an extra hit outright after it missed analysts' second-quarter earnings estimates and stoked concerns that its recovery could take longer than expected.

ImClone Systems Inc. also fell following a stock downgrade by Morgan Stanley, which said the Street was too upbeat about the company's main drug.

Trading was scattered Wednesday with most convertibles better to sell as investors felt the heat of rising bond yields and falling stock prices.

"The quote for the day is 'I want my mummy,'" a sellside convertible trader said. "A lot of people on the buyside are panicked about the bond movement. A lot of things are better for sale, but I'm not sure if it's better for the market."

Bond prices fell on Wednesday after interest rate hikes at the European Central Bank and the New Zealand Reserve Bank snuffed hopes that the U.S. Federal Reserve would ease rates this year, and raised fears that the Fed could even raise interest rates if the economy is stronger than expected. The stock markets also fell on mixed retail sales data from May and concerns that higher interest rates will raise the cost of financing.

"The converts market tends to lag the bond market," the trader said. "I think some guys maybe sent out morning indicators that had bids that were higher than they intended, and people tried to hit those bids and people got a sense that the convert market is for sale...I don't find it sector related. The bond market affects for the most part every name."

The trader said Wednesday's markets displayed an undesired consequence of higher volatility.

"Everyone's been complaining that there's no volatility in the market," the trader said. "Well, we've seen volatility spike up in the last couple of days but the flip side of that is that when volatility increases interest rates move up and credit spreads widen."

Another sellsider noted the moody sentiment in the market.

"I wasn't doing anything today, just sitting here watching bonds get crushed," the sellsider said. "Vol went up, but when the cost of financing also goes up you suffer."

The sellsider said outright investors took a bigger hit than hedge funds.

"Outright guys get doubly pumped," the sellsider said. "When the equity goes down and the bonds go down they get an extra hit there."

The market is unlikely to improve soon, the sellsider said.

"Guys are going to run ahead of that and guys are going to take a look and think, this is only going to get worse," the sellsider said. "Nobody wants to buy anything in this environment, so even if vol is better you don't get anything. I think the market's going to be soft for three weeks to six weeks. But the key is it used to be that these things will last forever, but now these things don't last as long. Things happen so much faster now."

An outright trader said there may have been a little bit of overselling on Wednesday.

"It's just been a lousy day," the buysider said. "Bonds are falling and equities are falling, and if you're a convert holder the two components of your investment aren't providing support...But I do think a bit of this is overdone. It's still not clear whether the Fed will raise rates this year, and even if they do it's because the economy is better, which means on the whole you're going to be able to make up some of these losses from higher rates from somewhere else.

"If the economy's doing really well, equity markets will go up and your convertibles will participate in some of that as well."

Shuffle Master falls on results

Shuffle Master fell about 1 point outright after the company missed Street estimates for its second-quarter earnings.

The Shuffle Master 1.25% convertible due 2024 was marked at 95 bid, 95.5 offered versus a stock price of $17.50. Shuffle Master stock (Nasdaq: SHFL) closed at $17.51, down by 10.71% or $2.10.

"The Shuffle Masters looking interesting," a convertible trader said. "I heard there was an outright buyer in the name the last couple of days."

Shuffle Master late Wednesday reported second-quarter net income of $3.4 million, or 10 cents per share, from a $12.7 million loss, or 37 cents per share, in the year-ago period. Analysts were expecting a profit of 13 cents per share.

Las Vegas-based Shuffle Master, which makes card shufflers, roulette chip sorters and other gaming equipment, said it expects "sustainable profitability" in fiscal 2008 and moderate improvement in the second half of 2007. But the company declined to provide guidance, saying that the rest of fiscal 2007 "will be characterized by addressing near-term challenges."

The trader said the convertible appeared attractive after Wednesday's drop.

"They're not takeover protected, but at the delta at which they trade I don't think there's a lot of risk involved in this," the trader said. "Unfortunately for outright buyers if they bought it yesterday they must be crying today."

ImClone drops on downgrade

ImClone was about 1.5 points lower on Thursday after the stock took a hit following a Morgan Stanley downgrade.

ImClone's 1.375% convertible due 2024 was marked at 92.75 bid, 93.25 offered versus the closing stock price of $36.84. ImClone stock (Nasdaq: IMCL) finished the day lower by 7.37% or $2.93.

"ImClone was down after Morgan Stanley downgraded them, the common's down more than $2," a sellside convertible trader said.

Morgan Stanley equity analyst Steven Harr on Thursday downgraded the stock to underweight from equal weight, saying recently released data about ImClone drug Erbitux was "underwhelming." Erbitux, a colon cancer treatment, is the lead product of New York-based ImClone, a biopharmaceutical company.

ImClone said earlier in the week that a study suggested that Erbitux could prolong survival among colon cancer patients by about a month when used with other drugs. The study was designed to test Erbitux's potential as a first-line treatment for colon cancer.

The trial data showed only modest benefit and may not be enough to gain Erbitux significant ground in the early-stage colon cancer market, Harr wrote in a report. Harr also doubted that Erbitux can pass trials for lung cancer. The analyst has a $28 target for the stock if the drug fails the lung cancer trials, and a $40 to $45 fair value if the trials succeed.

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