Deutsche analysts: Switch out of i2 Tech into Manugistics

By Ronda Fears

Nashville, Tenn., Feb. 26 - To play the software sector, Deutsche Banc Alex. Brown convertible analysts suggest buying the Manugistics 5% due 2007 and selling the i2 Technologies 5.25% due 2006. Both are major players among supply chain management software names, but the analysts prefer the Manugistics issue over the i2, primarily on fundamentals - but they also note a better profile for the Manugistics issue.

Both bonds are offered at nearly the same level with similar yields, but the Manugistics bond has significantly higher equity sensitivity than i2. The i2 bond carries a B- rating from S&P and the Manugistics bond is unrated.

"We believe that the equity fundamental case is more supportive of Manugistics than i2 in the near term," said Deutsche convertible analysts Jeremy Howard and Jonathan Cohen in a report Tuesday.

"The significant cash burn rate at i2 means that this credit is likely to deteriorate versus a potentially improving situation at Manugistics. We therefore feel that the simple cash position alone is not a good guide to the relative attractiveness of the two bonds."

At first glance, i2 appears well covered with roughly $350 million of cash and equivalents (net of debt) on the balance sheet, while Manugistics is short roughly $26 million cash (net of debt), the analysts noted.

"But the current cash balance may not be a good guide to the credit going forward. Manugistics has turned the corner from an operating standpoint and we are forecasting the company to lose less than $7 million over the next three quarters, after which it should be profitable. On the other hand, we are forecasting i2 to lose $143 million in 4Q 2001 and 2002 combined, leaving the company with a net position of only $211 million by FYE 2002," the analysts said in the report.

"It is clear that if i2 is unable to turn around its sizable operating losses, it will burn through a significant portion of its cash cushion. Management may even be tempted to spend the cash acquiring additional business or software lines. This might well leave i2 a fundamentally weaker credit than it is today."

Moreover, the analysts noted that the Manugistics issue has a much greater equity sensitivity with a delta of 38%, versus the i2 issue with a delta of 7%. If Manugistics stock hits the Deutsche price target of $25, the Manugistics convert could be expected to trade up to 88.40 on a 50% implied volatility and credit spread of 750 basis points over Libor - a rise of 19.3%. However, the analysts said that if i2 rises to the Deutsche price target of $9, the convertible would show minimal participation at least theoretically, due to the much higher delta.

"In reality, both these deltas are likely to be much higher, but the significantly lower premium on the Manugistics bond still makes it much more attractive," the analysts said.

In terms of profile, the Manugistics issue is $250 million and has hard call protection out to November 2003, then provisional protection at 120% to November 2007. The i2 issue, with hard call protection only through December 2002 with no provisional protection, only has size going for it at $350 million, the analysts said.

"But given the credit concerns surrounding both bonds, it is by no means clear than in this situation bigger means better," the analysts said.

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