Convertibles stall with stocks; oils, financials gain

By Ronda Fears

Nashville, Tenn., March 7 - Convertibles stalled along with stocks after Federal Reserve chairman Alan Greenspan's remarks pointing to economic expansion, which could signal a shift in policy and eventually lead to an uptick in interest rates. Traders continued to see buyers in financials and utilities and some oil and gas issues also got a lift from higher oil prices due to the Middle East warfare. Several retail issuers were also higher on comparable store sales.

To the negative side of the market, Sepracor was slaughtered after surprise news that a new drug's approval hit a snag. And, Hewlett-Packard's convertible fell sharply on a downgrade by S&P due to the Compaq merger.

Merrill Lynch's new convertible floater was a home run, doubling to $2 billion, and onlookers said it could stimulate a new convertible product that would be popular in a rising interest rate climate. The new issue was up 1.75 points in the immediate aftermarket, although Merrill shares dropped in response to the offering.

"On whole, the market sort of stalled out, but there were lots of gainers today. Oil was higher, retail issues were very strong, and power names were up again, too," said a convertible trader at a major investment bank in New York.

Dealers said the tilt toward quality was more pronounced after stocks stalled on Greenspan's comments that signs of the U.S. economic recovery are becoming clearer. Market pundits believe that will signal a shift in Fed policy to neutral, which could open the door for higher rates. As stocks stalled, traders said convertible investors continued to be in a flight to quality mode, focused somewhat on financials and utilities.

Regardless of Greenspan's comments, traders said many market watchers believe there has not been enough strength in corporate earnings yet for investors to be more comfortable. Many believe the market has not yet reached capitulation and there are still valuations out of whack. And, a shift toward rising interest rates would only compound the profits dilemma.

"There are too many companies in restructuring mode, balance sheet mopping up, that sort of thing for people to be taking a sigh of relief," said a convertible trader at another major investment bank in New York.

Tyco was unchanged, traders said, as the market awaited the outcome of an auction Friday to sell the plastics unit. Sources at Deutsche Banc Alex. Brown and Goldman Sachs, which are said to be handling the bidding process, said it was not certain the bidding would be concluded this week.

"The time frame really was mid-March to mid-April, so it seems slightly premature to see it getting wrapped up this week," said a source at one of the investment banks. "It would be a positive development, though."

Then, there are surprises like that which Sepracor came up against Thursday in a development reminiscent of ImClone System's disastrous FDA rejection on New Year's Eve. Sepracor was crushed after disclosing regulators were not going to approve its new antihistamine, Soltara.

The three Sepracor convertibles (CCC+), roughly $1 billion outstanding, plunged on a huge selloff by 25 to 31.5 points as the stock lost close to 60% on the day. The Sepracor 5.75% due 2006 fell 25.875 points to 58.75 bid. The 7% due 2005 lost 31.5 points to 64 bid. And, the 5% due 2007 dropped 26.125 points to 52.125 bid. Sepracor shares plunged $27.63, or 58.45%, to $19.64.

Since ImClone's demise at yearend, however, the converts have recovered considerable ground with the stock on advances in getting its Erbitux cancer drug approved, as well as some outside financial support. ImClone's 5.5% convertible due 2005 added 0.125 point on Thursday to 89.5 bid, 90.5 offered with the stock up 12c to $28.75. A month ago, the convert was at 65.5.

So, some analysts say that for those who believe the Sepracor story, this could be a buying opportunity.

Buyers turned out in droves for the Merrill convert.

The 30-year 0% convertible, which priced at par with a floating yield-to-maturity of 3-month Libor less 200 basis points, was doubled from $1 billion. The yield has a floor of 0% and is capped at 7.5%. The initial conversion premium is 33%, at the aggressive end of guidance.

In the immediate aftermarket, the new Merrill convert (Aa3/AA-) was up 1.75 points to 101.75 bid, 102 offered while the stock closed down $1.61 to $52.79. The old Merrill 0% convertible was down 1 point to 51 bid, 51.25 offered, traders said, as some investors switched into the new issue.

Otherwise, the primary market watched issuers that have been the subject of potential new convertible deals hit the straight bond market. But, onlookers said that does not mean those issuers have ruled out convertibles altogether.

Qwest and Sprint both launched big deals in the corporate bond market. Qwest was pitching $1.5 billion of 10-year notes and Sprint $2 billion of 10- and 30-year notes. Both had been the subject of potential new deals in the convertible market, with Qwest's more certain since the company announced a month ago that it was contemplating a $1.25 billion convertible offering.

S&P's downgrade on Hewlett-Packard rattled investors and the convertibles were hit, traders said. The controversial merger got past regulatory approval this week, but faces shareholder votes on March 19 and 20. The rating downgrade was irrespective of the merger, S&P said, although the rating agency did mention the event and possible repercussions.

Hewlett-Packard took issue with S&P's comments, but could not avert the market's reaction. The convertible saw a bigger selloff than the stocks, traders said. The 0% due 2009 lost 2.25 points on the day to 81.75 bid, 82.75 offered as the stock closed down 18c to $20.

Among the gainers were power and utility concerns Calpine, AES and Advanced Energy Industries. In oil and gas, Pride International's new convert saw the biggest advance, with the 2.5% due 2007 adding 1.125 points to 106.25 bid with the stock up 19c to $14.19.

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