Lucent preferreds climb on hopes of post-merger tender; Time Warner Telecom stock upgrade boost

By Kenneth Lim

Boston, March 27 - Lucent Technologies Inc.'s 7.75% convertible preferreds due 2017 gained sharply on Monday as investors bet on a possible tender offer if merger talks with France's Alcatel are successful.

Meanwhile, Time Warner Telecom Inc.'s new 2.375% convertible senior notes due 2026 stayed strong on their second day in the secondary market, trading at 7.25 points above par after the stock was upgraded by Morgan Stanley.

Cephalon Corp.'s convertible bonds were quieter but traded at around the same depressed levels as Friday last week as the market waited for further developments after the Food and Drug Administration rejected the company's bid to market its Sparlon drug for attention deficit hypertension disorder.

Cephalon's A tranche zero-coupon convertibles due 2033 were seen trading at 119 versus a stock price of $62.375 on Monday, roughly in line with Friday's levels. Its 2% convertible due 2015 changed hands at 145.5 against the same stock price.

"It's not overly busy," said a sell-side source about Cephalon. "There are a few trades here and there, but everyone's on hold."

Cephalon on Friday said an FDA committee decided not to approve Sparlon, which is currently sold as a sleep-disorder drug under the Provigil brand, for ADHD over concerns about incidents of a serious skin rash in children during drug trials. But the panel members had also agreed that Sparlon was effective against ADHD.

Cephalon lowered sales estimates for the year by $100 million to between $1.4 billion and $1.5 billion, but still guided for earnings per share of $3.80 to $4.

Other convertible names active on Monday included King Pharmaceuticals Inc., whose newly issued 1.25% convertible senior notes due 2026 changed hands at levels higher by under a point outright in line with a slight gain in the stock. The securities traded at 100.375 versus a stock price of $17.375 and reached as high as 100.625 on Monday, said a sell-side market source. Shares of Bristol, Tenn.-based King Pharmaceuticals (NYSE: KG) rose 18 cents, or 1.05%, to close at $17.38.

King Pharmaceuticals' older 2.75% convertible due 2021, which will be redeemed or repurchased with proceeds from the new issue, was marked at par against the closing stock price by another trading desk.

In the oil sector, Schlumberger Ltd.'s 1.5% convertible bond due 2023 rose about one point on an outright basis on Monday in line with the stock. The 1.5% convertible traded at 170.5 versus a stock price of 122, while the 2.125% convertible due 2023 changed hands at 158.875 against the same stock price. Schlumberger shares (NYSE: SLB) inched up 77 cents, or 0.63%, to close at $122.95. Schlumberger is a New York-based oilfield services company.

A new deal from India's Hindustan Construction Co. Ltd. is also in the pipeline. The $100 million offering of five-year, zero-coupon convertible bonds are expected to price on Tuesday and will be sold under Regulation S. JP Morgan and UBS Investment Bank are the bookrunners.

Lucent merger talks boost preferreds

Lucent's 7.75% convertible preferreds due 2017 were seen trading about 12 points higher than Friday's levels on an outright basis, reaching 1,007.5 versus a stock price of $3.10 on Monday as investors bet that a tender offer for the securities could emerge from a possible merger between Lucent and its French rival Alcatel.

But the convertible preferreds retreated slightly by the end of the day, and were marked at 996.24 against a $3.08 stock price on Monday. Lucent's 2.75% convertible due 2025 changed hands at 112.25 versus $3.10 early Monday, and ended at about the same level at the close. Lucent stock (NYSE: LU) closed at $3.08, up 2 cents or 0.65%.

"Obviously the 7.75s got a nice pop from the news," said a sell-side convertible bond analyst. "It's probably still worth looking at."

Murray Hill, N.J.-based Lucent and Paris-based Alcatel said on Friday last week that they were discussing a possible merger that would take place at current market prices. Market speculation was that Lucent chief executive Patricia Russo would lead the combined company if the merger went through.

The sellsider said the preferreds are non-callable until 2007 while the current 7.75% dividend represents a relatively high borrowing rate for Lucent. "The acquirer would say, 'That's some really high-cost debt there,'" the analyst explained.

Alcatel probably will not want to continue paying that amount if it acquires the smaller Lucent.

"Let's say this thing actually goes through. With preferreds there's no change of control put, so the only option for an acquirer is to tender for them," the analyst said.

That's good news for holders of the convertible. A tender offer may have to include some sweeteners to secure acceptances from convertible holders. And even if a merger takes two to three quarters to be completed, convertible holders can still collect a healthy half to three-quarters of the annual 7.75% yield at par.

"If you think about the technical dynamics around that, a lot of people were thinking that way," the analyst said. "Or at least the smart ones were."

A buy-side analyst who covers the telecom equipment sector agreed that Alcatel may prefer to tender for the preferreds than continue to pay the dividend. But he noted that if the preferreds rally to above the call price of 1,038.80, an acquirer would simply call the securities rather than tender for them.

The buysider said it still remains to be seen whether a merger will go through. "The chances are pretty high, but it's not a done deal," he said.

A merger will probably be good for Lucent, but the companies may have to overcome political obstacles stemming from the national security work each does for its respective government. Lucent, for example, may have to spin off its Bell Labs unit, and the French government may view Alcatel as a strategic company.

But both companies will benefit from better pricing power than if they were on their own, he added.

Time Warner Telecom stays healthy

Time Warner Telecom's new 2.375% convertible senior notes due 2026 traded at 7.25 points above par versus a $15.625 stock price on Monday after Morgan Stanley upgraded the stock to overweight.

Morgan Stanley, together with Wachovia Securities and Deutsche Bank, also ran the books for the upsized $325 million offering of those convertibles. The size of the deal was originally $200 million with a $30 million greenshoe option. The greenshoe is now $48.75 million. The convertibles, which made their secondary market debut on Friday, were priced within talk with an initial conversion premium of 27.5%.

Morgan Stanley equity analyst Vance Edelson said in a report that Time Warner Telecom's "growth prospects are at their highest level in years," and set a target price of $20 on the stock.

"The company is ready to leverage its existing network infrastructure and last week's convertible bond offering should accelerate free cash flow profitability," Edelson wrote.

The convertible bond offering, in particular, lowers Time Warner Telecom's interest expense and improves its cash on hand, he wrote.

Time Warner Telecom shares (Nasdaq: TWTC) closed at $16.87 on Monday, up $1.22 or 7.8%.

A buy-side analyst said Time Warner Telecom's fundamentals were healthy, given that the IT services company operates in a niche market and has strong operating leverage. In the short term, Time Warner Telecom is also looking at improving margins and growing revenue.

But the analyst was more cautious about the market that Time Warner Telecom was operating in, particularly in offering fiber-optic networks for businesses. Market giants like Verizon are beginning to enter the picture with competing products, and Time Warner Telecom may have a tough time ahead.

"The argument is they're [Time Warner Telecom] going after more medium to large businesses, and Verizon will be going after the larger Fortune 1,000 companies," the analyst said. "They do have a nice offering, but they're dealing with huge competitors."

Hindustan Construction plans $100 million deal

India's Hindustan Construction proposed a $100 million of five-year, zero-coupon convertible unsubordinated unsecured bonds talked to yield 6.2% to 6.95% with an initial conversion premium of 50%.

The final terms are expected to be set on Tuesday, and the redemption price is talked to be 135.702% to 140.72% of the principal amount. Hindustan Construction shares closed at Rs. 180.55 on Monday.

Bookrunners JP Morgan and UBS Investment Bank have a greenshoe option of a further $25 million for the Reglation S deal.

Hindustan Construction plans to list the convertibles in Luxembourg.

The issuer is a Mumbai-based construction company. Hindustan Construction plans to use the proceeds for capital expenditures, acquisitions and investment in its real estate subsidiary Hincon Realty Ltd.

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