By Ronda Fears
Nashville, July 18 - Merrill Lynch & Co. convertible analysts added Liberty Media Group's 0.75% exchangeable due 2023, which converts into AOL Time Warner Inc. stock, to the firm's recommended convertible portfolio.
Convertible analyst Marc A. Malloy said in a report that the issue would be an equity alternative holding and was added in light of Merrill's upgrade to the common stock plus an attractive convertible valuation.
Merrill entertainment analysts Jessica Reif Cohen upgraded AOL shares from neutral to buy earlier in the week with a one-year $24 price objective.
Moreover, Malloy said the Liberty/AOL issue is trading around 2.3% cheap, using a credit spread of 204 basis points over the 5-year Treasury and a 34.3% stock volatility.
Over a one year horizon, Merrill estimates the issue will return +14.7%/-13.6% for a stock price move of 25%, assuming the discount to theoretical value remains constant. Additionally, Merrill estimates the issue would produce a total return of about 30% if AOL shares reach the $24 target, which would be a 47% gain for the stock from its current price.
The issue is quite equity sensitive, considering its low premium and parity delta of 0.719, and has five years of call protection. In addition, the convertible offers a modest yield advantage above the common stock of 67 bps.
Liberty Media sold the issue in March to monetize its $1.9 billion stake in AOL. While exchangeable into AOL shares, it is a credit obligation of Liberty.
Cohen noted in a report earlier in the week that AOL management has made impressive strides on a number of levels and has accelerated the pace at which it has addressed several key issues, including strengthening its balance sheet, right-sizing its cost structure and renewing focus on advertising.
"Although we have greater confidence in the AOL division, our constructive view is a function of cost containment rather than revenue enhancement," Cohen said in the report.
"We believe that under Don Logan, management can successfully reduce cost structure to adjust to the changing complexion/ economic contribution of AOL's sub [subscriber] base."
Key risks remain shareholder lawsuits, government investigations, the lack of a cable IPO and failure to execute balance sheet initiatives, she said.
Liberty/AOL 0.75% exchangeable due 2023
Price: 111.88
Stock price: $16.36
Parity: 93.92
| Premium: | 19.12%
|
| Payback period: | 24 years
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| Current yield: | | 0.67%
|
| Yield to maturity: | 0.14%
|
| Call: | March 30, 2008
|
| Call price: | 100
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| Yield to call: | -1.67%
|
| Put: | March 30, 2008
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| Put price: | 100
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| Yield to put: | -1.67%
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| S&P/Moody's: | BBB-/Baa3
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| Delta: | 0.604
|
| Implied volatility: | 30.40%
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| Note: Prices as of July 16.
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