Citigroup adds Maxtor's new 6.8% convertible to recommended portfolio

By Ronda Fears

Nashville, May 7 - Citigroup is adding the new Maxtor Corp. 6.8% convertible to its recommended portfolio, as it is a good yield play that also offers some potential upside equity participation, according to analyst Lynn S. Hambright.

Also, at 105 with the stock at $5.86, the bond is roughly 2.45% cheap, using a credit spread of 550 basis points over Treasuries, she said in an investment note Wednesday. At that trading level, the implied spread is 610 bps, putting the yield to maturity at 6.2%.

The risk/reward profile is positive given the yield and the opportunity for positive equity sensitivity, Hambright said, noting the bonds trade at roughly a 60% delta.

Fundamentally, Hambright said the credit is stable and Maxtor's sheet looks fairly solid. Also, she said the company is profitable and generating cash with a nice revenue stream of about $4 billion annually, plus has growth potential in market share. In the first quarter, she noted, there was positive cash flow from operations of over $44.2 million.

"Total liabilities of $1.7 billion, which are greater than tangible assets of $1.4 billion, may initially give some investors pause as the details aren't readily apparent," Hambright said.

"Digging, we find roughly $613 million of 'soft' liabilities [such as taxes and accrued warranties], which makes us more comfortable with the credit picture."

She said investors should be aware that a stable or improving credit profile is contingent upon rational pricing in the hard disk drive market, however.

"We believe the stable case has a high probability given industry consolidation over the last few years leaving three key players with roughly 85% of the market," Hambright said.

"Currently, Maxtor has roughly 4.6% market share in the server drive market; going forward, this division could provide for a growth opportunity."

Apparently, Maxtor is seeing traction due to new products and customer concerns regarding Fujitsu's long-term strategy for this market, she said, noting that Seagate is the market share leader with roughly 50%, Fujitsu is second and IBM/Hitachi is third. Excluding internal drives, Maxtor is third.

"In summary, going forward - barring irrational pricing from competitors (Seagate and Western Digital) - we would expect continued improvement as NAS restructuring costs roll off and from the potential growth in the server drive market," Hambright said.

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