Calpine preferreds soar, notes off on new deals; McMoRan deal emerges; PMA Capital up

By Ronda Fears

Nashville, Sept. 23 - Outside of a couple of new deals, including a somewhat hefty $600 million issue from Calpine Corp., convertible players muddled through another lackluster if not dismal day of secondary trading action.

That said, a sellside market source said the PMA Capital Corp. 4.25% convertible traded up 5 points on the day Thursday, but would not elaborate yet on any developments in the story. There was no news on PMA Capital, and the stock ended the day up a quarter, or 3.5%, to $7.36.

Otherwise, most of the market was lower or, at best, trading sideways, traders said. Delta Air Lines Inc. and AMR Corp., of course, were mentioned at several shops as notable decliners, but there also were remarks about lower trades in Allied Waste Industries Inc., CenterPoint Energy Inc. and Tower Automotive Inc. with no specific news moving the bonds.

"The market is coming in, but I wouldn't really call it cheapening, except on a relative basis," said a convertible fund manager in New York. "I mean, you can't say there's a lot of cheap paper out there now just because the market has come in 2 or 3 or even 5 points."

Another fund manager on the West Coast agreed, saying that with the lack of any existing convertibles that "make sense to put on," he is expanding his reach overseas. When asked if he was finding any bargains in the U.S. market, he replied, "with the caveat that we might be catching a falling safe.

"Some items do look cheap but I get the feeling that there are too many hedge funds and the returns have stunk for approaching three years. The fees are too high for flat to negative returns and many of these startups are doing it for no fee and hoping to make expenses back in the participation. I have seen names coming in spite of a flattening yield curve. Everyone is starting a hedge fund these days, [it's] a little worrisome.

"We've had lots of requests for global opportunities," he added, "so I'm looking in Europe, Asia."

Calpine's deal was interesting in that it was a good sized chunk of new paper, but the market's reaction to it was broadly mixed. Hedge funds were eager to snap it up, or so suggests the amount of shorting on the stock taking place, even though the deal won't price until Monday. But on an outright basis, only the distressed players were taking a keen interest.

Also for next week's calendar, McMoRan Exploration Co. launched a small $75 million deal.

Calpine discount deal emerges

Calpine launched $600 million of 10-year convertible senior unsecured non-callable notes that will be printed with a 6% coupon, but are talked to price at 83.9 for a 7.15% yield, and an initial conversion premium of 40% to 45% or a premium of 17.5% to 21.7% at the discount price.

Deutsche Bank Securities Inc. is sole bookrunner of the deal, which is scheduled to price after the close Monday. Calpine also entered into a 10-year stock loan agreement with Deutsche for 89 million common shares that Deutsche will use proceeds from to buy back stock from short sellers participating in the note sale.

The unsecured convertibles will pay a cash coupon only in years one and two, and then years six through 10, with interest accreting in years three, four and five.

Concurrent with the convertible offering, Calpine said it will use cash on-hand to repurchase $266 million of its existing 4.75% unsecured convertible notes due 2023 from Deutsche Bank and call $198.5 million of its 5.75% High Tides I convertible preferreds and $285 million of its 5.5% High Tides II convertible preferreds.

Calpine preferreds up, notes off

For months, the convertible market has been widely anticipating some refinancing action from Calpine regarding its three High Tides convertible preferred issues. Standard & Poor's said Calpine still faces substantial refinancing of the $1 billion issues in 2004 and 2005.

On the news Thursday, the three issues were higher and fairly active.

The 5.5% High Tides II issue was most active with 2.25 million trading, and a dealer said the issue added 1.5 points to end the day at 50. The 5% High Tides III issue was next with 1.1 million trading, and the dealer said that issue rose 1.15 points to 47.15. The 5.75% High Tides I issue was moderately active with 328,000 trading, and it edged up about 0.125 point to 50.125.

Calpine's 4.75% convertible notes, however, dropped 1.25 points as Calpine shares lost almost 3% on short selling on the news.

Also, the San Jose, Calif.-based independent power producer is selling $785 million of straight senior notes via bookrunner Merrill Lynch. Proceeds from the junk bond sale are to be used for general corporate purposes, including redeeming or repurchasing debt.

Calpine deals seen as net debt

While some argued that the Calpine deals were positive in that they lifted the cloud of uncertainty over the independent power producer's liquidity standing, others countered that it was a net debt increase so there was nothing to suddenly trigger enthusiasm about holding Calpine paper.

A sellside market source at a boutique in New York said the sum of the Calpine transactions appear to be an addition to net debt rather than a debt reduction exercise.

"I'm not sure who the buyers are," said the sellside source, who looks at the market from an outright bias. "The preferred holders wouldn't like the new convert because of how it compares to the yield on the preferreds, plus it will have way more equity sensitivity."

The Calpine 4.75% convertible notes were hit a little bit, he pointed out, so that probably suggests there is some refinancing risk even though the company is buying back a chunk of that issue from Deutsche Bank.

"I take this flurry of refinancing activity as a signal that third quarter will be an even bigger disappointment, at least in terms of a shortfall from Street expectations," said a buyside market source.

"As S&P says, the inability of FFO [funds from operations] to cover interest expense is not only made worse by disappointing operating results, but by the additions to interest expense from the High Tides, accelerated amortization of financing costs, potential project cancellations, a number of things. All of these are piling on at a bad time."

S&P said Calpine's adjusted funds from operations interest coverage was low at 0.7 times on a 12-month rolling period ending June 30, and the rating agency expects that over the next five years it will hover near the 1.0 times area.

"I would be surprised if much of the liquidity recently raised through sales can be used for debt reduction rather than meeting due bills. I don't see a significant net debt reduction as some here have suggested."

Calpine bank paper moves up

Hedge fund players are bullish on the new Calpine converts, however, as a sevenfold boost to activity in the stock suggests heavy participation in the deal from that segment of the market. And, the bank loan market also was bullish, seeing the Calpine bond transaction as a positive to the credit.

Calpine shares ended Thursday off a dime, or 2.83%, to $3.43 with 35.5 million shares trading, versus the three-month running average of 5.9 million.

Calpine's second-lien loan was about a point better on the day as the news of the bonds issues surfaced, creating a nice amount of positive sentiment in various markets and triggering a "fair amount of activity" on the bank debt side because of swaps, a bank paper trader told Prospect News.

The second-lien bank debt was quoted at 87 bid, 87.5 offered by one trader, while a second trader quoted it a bit more conservatively at 85.75¾ bid, 87 offered.

"The bond market is reacting positively because [Calpine] can come to market with any new securities and, it's being well received. The convert is a little bigger in size than expected so that was a nice surprise. [Also] It helps liquidity," a bank loan market source said. "[Plus] now that news is out, there are no more surprises. People are relieved that they're doing what they said they were going to do."

S&P said in its rating action, however, that Calpine's overall business risks have increased, as the company has limited opportunities to reduce its debt burden and, rather, has taken on more debt to fund construction projects. Calpine's inability to access the equity markets has led to debt levels over 70%, S&P said, which the agency doesn't expect to improve over the next five years.

As of June 30, S&P said, Calpine had about $844 million of cash and short-term investments with about $100 million of borrowing capacity under its working capital facilities. Although Calpine alleviated many of it liquidity issues in 2003 and mid 2004 through successful refinancing, S&P said liquidity will remain a credit concern, given its weak and volatile cash flow generation and high level of leverage.

McMoRan old 6% issue lower

McMoRan Exploration also launched a deal for next week, with the $75 million of seven-year convertible senior notes talked to yield 5.0% to 5.5% with a 25% to 30% initial conversion premium.

A buyside trader said there wasn't a gray market in the new convertible yet, as it will not price until next week, but the existing McMoRan 6% convertible due 2008 was marked down sharply on activity in the stock. The issue dropped about 10 points, he said, to about 123 as the underlying stock was hit.

McMoRan Exploration shares closed Thursday down by $1.38, or 9.4%, to $13.30 with 495,700 shares changing hands, compared with the average 69,316.

"There's a lot of interest in this [new McMoRan convert] first because there's just such a high demand for new paper right now, and, then, too, because it's in the oil and gas area," said the buyside trader, based at a hedge fund in Connecticut.

"But I'm not sure it really makes a lot of sense to set up. McMoRan's exploration program may or may not work. It's in the Gulf of Mexico. It is clearly high risk, and that exposure may not be suitable at this time."

He said another appeal point of the new McMoRan convert is that the first three years of coupon payments will be collateralized with Treasuries.

The New Orleans-based oil and gas producer is also selling 5 million shares of common stock, with a 15% greenshoe. Proceeds are earmarked to finish drilling near-term oil and gas prospects, continuing development of the Main Pass Energy Hub project and for working capital.

Also Thursday, McMoRan Exploration issued an update to its drilling operations in the Gulf of Mexico, which includes six wells and its recent acquisition of an interest in the Blueberry Hill prospect. The company said it currently has rights to some 225,000 gross acres and continues to identify prospects to be drilled on its lease acreage position. McMoRan said it also is actively pursuing acquisitions and recently has augmented its portfolio with additional shallow-water, deep gas prospects.

Delta off another 1-1.25 points

Delta announced the sale of airplanes and spare engines to FedEx, and coming after a vendor had refused to cater food and drink on its flights without upfront cash payment, the news sent its bonds lower again Thursday.

AMR Corp.'s warning about American Airlines Inc. also impacted Delta, traders said.

Delta's two convertibles dropped another 1 to 1.25 points, traders said, while the stock plunged another 13 cents, or 3.5%, to $3.57.

Credit analysts suggested the markets are reacting to the sparse showing of restructuring details from Delta so far, including the lack of any wage concession agreement with its union pilots.

Moreover, CreditSights analysts Roger King and Glenn Reynolds said in a report Thursday that Delta management has yet to provide investors with a complete restructuring plan and steps taken thus far will not prevent a bankruptcy.

"As market forces continue to ratchet down on Delta, the suspense is killing," the analysts said in the report.

"Delta's reengineering plan announcement was long on style but short on substance. There has been little follow-up...The plan was months in the works, so there must be something there. Three data points have emerged so far. Management is either playing a tight game with short, little jabs, or has yet to draft an overall solution."

AMR issues drop 2.5-3 points

AMR's warning in a late-day Securities and Exchange Commission filing Wednesday sparked more downgrades to the stock and the credit reacted accordingly, convertible traders said.

"The credit is blowing up," a sellside trader said, referring to AMR. "A lot of the blame is on oil prices, but business in the air is just bad all the way around. Everyone is afraid that American will end up right back where they were a year ago, almost literally at the doors of the bankruptcy court."

AMR's two convertibles dropped 2.5 to 3 points each, he said, with the 4.25s at about 71 bid and the 4.5s at 66 bid. AMR shares plunged 68 cents, or 7.78%, to $8.06.

AMR said in the SEC filing that it has had to get a waiver of immediate credit facility covenants and is seeking to refinance the credit facility to lower thresholds going forward. Because of weak revenues at American, rising fuel prices, hurricanes in the southeast U.S. and other factors, AMR said the bank facility covenants have been busted it expects it third quarter revenue at American will be lower by 2.5% to 3.5% from a year ago.

AMR said American has received an amendment to the covenant requirements for the immediate time being but is going to be refinancing the bank credit facility in fourth quarter.

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