Red Hat rises dollar-neutral, falls outright; new Vector bid higher; CNET, Intel gain; Nexans prices deal

By Kenneth Lim

Boston, June 29 - The convertible bond market was fairly busy on Thursday, but activity was spread across the board as investors took positions ahead of the coming July 4th holiday.

Red Hat Inc. was among the most active names Thursday as its convertible improved on a dollar-neutral basis but fell outright after the software developer reported higher first-quarter profit that fell below analysts' expectation.

"That's the only sizable mover," a buyside convertible bond trader said.

Although no other names were especially active, a sellsider said a fair amount of trading took place across the board.

"It was actually pretty busy," the New York-based sellsider said. "Obviously the Fed decision had a lot of people trading up until that time in anticipation, and a lot of folks traded after the rates were raise. A lot of it was also people getting ready for what may end up being a five-day weekend for a lot people."

The new Vector Group Ltd. variable-interest convertible debenture due 2026, which currently has a yield of 11.3%, did not trade on Thursday despite better bids in the absence of sellers.

"People were trying to buy it, but there were no sellers," the buyside trader said. "It was 105 bid versus $16.30, but no sellers."

Shares of Miami, Fla.-based Vector Group (NYSE: VGR) closed at $16.29 on Thursday, up by 38 cents or 2.39%. Vector is a cigarette maker that also controls real-estate businesses.

In the tech sector, internet publisher CNET Networks Inc.'s 0.75% convertible due 2024 was about a quarter-point higher on an outright basis as the stock recovered slightly from the previous day's diver. The convertible changed hands at 90 versus a stock price of $7.90 on Thursday, while CNET stock (Nasdaq: CNET) closed at $8.01, up by 3.09% or 24 cents.

"It's moving with the stock," a sellsider said.

San Francisco-based CNET saw its stock decline Wednesday after the company said it received federal subpoenas for an investigation into its stock option granting practices.

Intel Corp.'s 2.95% convertible due 2035 was about a point higher on an outright basis as chip stocks mostly gained across the board. The Intel convertible traded at 84 against a stock price of $19. Intel stock (Nasdaq: INTC) rose 3.54% or 66 cents to end at $19.32.

Santa Clara-based Intel makes semiconductor chips widely used in computers.

In the biotech sector, Cubist Pharmaceuticals Inc.'s 2.25% convertible due 2013 was unchanged at 101 versus a stock price of $24 after the company reported late Wednesday that it has repaid all the outstanding principal and interest on its 5.5% convertible subordinated notes due 2013 for $170.3 million using proceeds from the 2.25% convertible. Lexington, Mass.-based Cubist is a drug maker. Cubist shares (Nasdaq: CBST) closed at $24.84 on Thursday, higher by 3.76% or 90 cents.

Sepracor Inc.'s zero-coupon convertible senior subordinated note due 2024 was slightly lower outright despite a modest gain in the stock after Credit Suisse initiated coverage on the stock with a neutral recommendation. The convertible traded at 102 versus a stock price of $56.375. Sepracor shares (Nasdaq: SEPR) added 1.4% or 79 cents to finish at $57.39.

Credit Suisse stock analyst Marc Goodman wrote in a research note Thursday that current valuations and expectations in the specialty pharmaceuticals sector have come down, and the "risk/return trade-off appears compelling" in the sector.

"We also recommend exposure to Sepracor, which we rate neutral (relative to our coverage universe) with a positive bias," Goodman wrote.

Meanwhile, investors and market observers were happy about the rapid issuance rate in June, although most noted that the quality and terms of the new convertibles were not always ideal.

In Europe, Nexans' newly priced €243.8 million offer of seven-year convertible Oceanes bonds arrived within talk, while ahead of pricing Barclays analysts recommended a long position on the security only if it came at the cheap end.

Red Hat firmer on results

Red Hat's 0.5% convertible due 2024 was better for hedged investors but worse for outrights Thursday after the stock tumbled on a mixed bag of news from the software developer's fiscal first-quarter results.

The convertible was quoted at 106.25 bid, 106.75 offered versus a $22.60 stock price, about 0.625 points better on a hedged basis but about 8 points lower on an outright basis. Red Hat stock (Nasdaq: RHAT) closed at $23.40 on Thursday, down by 6.44% or $1.61.

Red Hat, which distributes open-source Linux software, said it earned $13.8 million or 7 cents per share in its first quarter, a gain of almost 11%, but analysts were expecting earnings per share closer to 9 cents. The company also raised its 2007 revenue forecast to between $400 million and $405 million, from the previous guidance for $370 million to $375 million.

"It was a disappointing quarter in some ways in the sense of coming in a little in terms of the earnings and mixed guidance in terms of more dilution, but maybe raising numbers for 07," a sellside analyst said. "So net-net maybe a little on the negative side."

The analyst said Red Hat's stock was already enjoying a "big, fat" valuation before the earnings were reported, so it did not take much to spook investors.

"It's just coming up a little bit short on growth expectations," the sellsider said. "I don't think there's anything fundamentally wrong... there's no real credit impact to these, it still has a very strong balance sheet."

A buyside analyst said the main problem with the results was the amount of drag that Red Hat's recently acquired JBoss was putting on the company's finances.

"They need more cash to integrate and to invest in infrastructure, which basically means they didn't do their due diligence very well," the buysider said.

Red Hat's core business is doing well, and the decision to buy JBoss, which makes open-source "middleware" products, was probably good, the buysider said. But Red Hat still needs to demonstrate that it can make the acquisition work and that it can survive any backlash from potentially new competitors such as Oracle and IBM.

"So overall I think once the dust settles maybe it'll be clearer," the buysider said, adding that it may take one more quarter to for the dust to settle.

Meanwhile, the stock is likely to "bounce around" its current level, and could drift down to $20, the buysider said.

Nexans attractive at cheap end

Nexans on Thursday priced €243.8 million of seven-year 1.5% convertible unsubordinated Oceanes bonds within talk, to yield 3.75% with an initial conversion premium of 35%, but analysts at Barclays think the deal is only attractive outright at the cheap end of talk.

The bonds were sold at par of €73.80 apiece and each Oceanes is convertible into one Nexan share. Price talk guided for a yield of 3.5% to 4% and an initial conversion premium of 30% to 35% over Nexan's volume-weighted average share price on Thursday. Nexan stock closed at €56 in Euronext Paris on Thursday.

There is an over-allotment option for a further €36.2 million.

BNP Paribas and Societe Generale Corporate and Investment Banking were the bookrunners.

Nexans, a Paris-based cable specialist, will use the proceeds of the deal to finance acquisitions as part of its external growth strategy.

Barclays Capital's Heather Beattie, Haidje Rustau and Luke Olsen said the deal modeled at just 101.1 at the cheapest end of talk.

"As such, we would not recommend a long position unless the deal prices towards the better end of the range," the analyst wrote in a note, adding that the implied volatility and credit spread assumptions could change for the worse.

June's issuance big

Convertible bond players were delighted with the high volume of new issuance in June although some noted that terms and performance in the secondary market were less than ideal in some cases. Market observers also expect June's blistering pace to slow down in the next two months as the market enters the heart of summer.

"I'm a broken record, but I'm always saying the more the merrier whether I like them or not," a New York-based buysider said. "The after market is inevitably going to provide more and better opportunities if we have more issues...I take heart in the variety of companies, big and small, strong and weak."

Issuers sold $9.43 billion of convertible bonds in June, the most prolific month for convertibles since July 2003, when $11.04 billion of convertibles were issued, both figures according to data compiled by Prospect News (both figures include exchangeables issued by investment banks).

The buysider noted that while previous issuance waves three to four years ago were driven by a "hedge fund fad" that saw companies issue paper just because there was so much eager money out there, this time issuance was driven largely by economic conditions and companies needing capital.

"It's back to normal," the buysider said.

A sellside analyst said the "appetite for new deals was pretty strong" as well.

"Money has flowed out of high-yield funds and maybe back into converts, it's all working in issuers' favor," the sellsider said.

Investors also are willing to pay more for volatility, and interest rates are still rising, although "I don't think investors were thrilled with the terms on all of them," the sellsider added, noting that low coupons and long put structures appeared in quite a few issues.

The sellsider expects issuance to slow down month-on-month in July and August, although volume could still be higher when compared to the previous year.

Another convertible bond analyst said most of the deals "did not hold up on an outright basis, but on a hedged basis a lot of these deals did hold up."

A sell-side convertible bond trader said the high issuance volume in June may mean less than the numbers suggest at first glance, explaining that a large chunk of the proceeds raised went into stock and debt buybacks.

"It's high because of all the happy meals, which are a lot easier to issue," the trader said. "But those trade less when they get issued."

"They issue maybe $1 billion in converts, then they buy back $400 million in their common, so how much do they actually raise?" the trader said. "It's like a cosmetic-looking deal."

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