KKR Financial opens lower; REITS in trouble?; energy convertibles draw eyes; market skittish on subprimes

By Evan Weinberger

New York, July 18 - With Wall Street taking a decided downturn, convertibles investors who played the market Wednesday looked to play it safe. Energy and energy services firms like Peabody Energy Corp. and Goodrich Petroleum Corp. saw action in their outstanding convertibles as oil prices rose near record highs again.

A new issue from KKR Financial Holdings Ltd. failed to gain much traction in the market as poor housing news dominated headlines Wednesday.

KKR Financial priced $300 million in convertible senior notes due 2012 at the cheap end of talk with a 7% coupon and a 30% initial conversion premium. They had been talked at a coupon of 6.5% to 7% with an initial conversion premium ranging from 30% to 35%.

The San Francisco-based real estate investment trust and specialty finance firm didn't say what it would use the proceeds for, because it was a Rule 144A transaction and it didn't have to.

Overall, traders and analysts reported mixed levels of activity Wednesday. While some reported that "nothing interesting" happened on their desks, at least one said that the day was particularly active. "Everybody showed up this morning ready to trade some bonds, so good two-way flow in a lot of sectors," one sellside analyst said.

The mixed activity on the day may be attributed to a general wariness that some traders and analysts have reported in recent days.

"There's nervousness," one sellside trader said. "A lot of financials down today. Bear Stearns' hedge funds really knocked the market."

Internationals look to play

While new issues appeared to be slowing within the United States, foreign companies are filling the breach, with three more either pricing or announcing new deals Wednesday.

Adding a little flair, Dana Gas PJSC began a roadshow Wednesday for its $1 billion Sukuk. A Sukuk is an Islamic financial instrument that fundamentally works like a bond while maintaining the Sharjah, United Arab Emirates-based natural gas driller's commitment to abide by Islamic religious guidelines.

The Sukuk is being talked at a coupon of 6.5% to 7.25% with an initial conversion premium of 0% to 10%. It is expected to price July 25 or 26, after the roadshow's completion.

Dana plans to use the proceeds for strategic acquisitions and to develop new natural gas projects.

Moving to Europe, German steel and metal distributor Klöckner & Co AG priced €325 million in convertible bonds due 2012 Wednesday. There is a further €25 million greenshoe. The offering was upsized from an original announcement of €300 million.

The bonds came in at the mid range of talk with a coupon of 1.5%. They had been talked at a coupon of 1% to 2% with an initial conversion premium of 35%. Klöckner is based in Duisburg, Germany and plans to use the proceeds for general corporate purposes and external expansion.

Coming out of East Asia, Golden Agri-Resources Ltd., a Singapore-based owner of palm oil plantations in Indonesia and China, announced plans to sprout $400 in convertible bonds. The company didn't say when the bonds would mature, or provide any coupon or initial conversion premium talk. The bonds are scheduled to price July 27, and the company says details will be available then.

Are REITs out for outrights?

Credit concerns voiced prior to its pricing appear to have pulled KKR Financial's convertible senior notes down a little bit as trading progressed Wednesday. One sellside trader said he saw the bonds trading at 99 as trading drew to a close. A sellside analyst saw the bonds hovering just below par but above 99 at closing time.

"That KKR thing looked like a dud," the sellside trader said.

In the run-up to pricing, traders and analysts consistently pointed to credit as the potential stumbling block on the bonds.

With Bear Stearns announcing that two of its hedge funds heavily playing in the subprime arena essentially being worthless, and Federal Reserve chairman Ben Bernanke saying that housing looked like it would get worse before it got better, KKR could not have asked for a worse climate in which to price a convertible.

Coming on the heals of Health Care REIT, Inc. seeing its convertible reoffered at 98.25, the question is whether the subprime mortgage crunch is turning convertibles investors away from REITs, even those not involved in housing or mortgages.

"I would say that area is certainly very vulnerable," said one longtime convertibles analyst. "That had been a very strong group for a very long time."

To be clear, KKR and Health Care REIT are involved in very different activities. KKR invests in residential mortgage loans, mortgage-backed securities and other loans.

Health Care REIT, based in Toledo, Ohio, invests in hospitals and senior centers. The two REITS will behave differently in a swirling credit storm.

"Ultimately, they're not going to be affected the same," the analyst said. "The market will distinguish. There's a lot of specialty REITs."

The sellside trader said that while outrights may be steering away from certain classes of REITs, hedged investors may stay and play if REIT dividends decline a bit. "I think in general, you're seeing a little retrenchment from risk," he said. "To me, those aren't terrible plays at all, if you don't mind a negative cash flow for a little while."

KKR Financial Holdings stock (NYSE: KFN) finished Wednesday lower, joining most of the rest of Wall Street. The stock dropped $0.03, or 0.12%, to close at $24.72.

Health Care REIT stock bucked the trend and finished up 39 cents, or 1%, at $39.50.

Overall, Wall Street finished lower Wednesday, although not nearly as low as it could have been. After hovering around a 100 point drop, the Dow Jones Industrial Average rallied to only lose 53.33 points, or 0.38%, closing at 13,918.22. The Nasdaq also had a down day, finishing at 2,699.49, a drop of 12.80 points, or 0.47%.

Gas, food never out of style

Even with lodging convertibles possibly losing steam, gas and food still have convertibles investors' attention.

One sellside analyst said he saw significant activity in the energy and energy services sector Wednesday, highlighting what he called an active day of trading. "Energy, just with the oil getting close to all-time highs, not inflation adjusted...People are focusing on energy and energy services because of that," the analyst said.

Two convertibles in particular were played at his desk, the analyst said: Peabody Energy's 4.75% convertible debentures due 2066, Goodrich Petroleum's 3.25% convertibles due 2026.

Peabody bonds closed at around 105.5 versus a closing stock price of $47.14. They finished Tuesday at around 105 versus a closing stock price of $46.83. Stock in the St. Louis-based coal miner closed up 31 cents, or 0.66%.

Goodrich Petroleum's bonds closed at 88 5/8 Wednesday versus a closing stock price of $32.01. The bonds closed Tuesday at 90 versus a closing stock price of $31.77. The Houston-based oil and natural gas exploration and drilling company's stock finished up 24 cents, or 0.76%.

Light sweet crude's price rose $1.03 on the New York Mercantile Exchange Wednesday. A barrel finished the day at $75.05.

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