Bear Stearns recommends Medtronic on recent sell-off

By Ronda Fears

Nashville, Tenn., June 25 - Bear Stearns & Co. convertible analysts recommend the Medtronic, Inc. convertible for moderate exposure to the stock with the security of an investment-grade credit rating.

The analysts suggest the 1.25% due 2021 with a 30% hedge for arbitrage investors.

"We are recommending the MDT 1.25% notes to outright and swap investors as they offer a modest equity exposure, good risk/reward exposure, combined with the warm fuzzy feeling only a non-tech investment grade name can provide," said analysts Rao Aisola, Sarah Gallagher, Matt Hempel and Thomas Sugiura in a report Tuesday.

There is 30% to 40% participation on the upside with negligible downside, the analysts said.

In its intra-quarter conference call, Medtronic reiterated that the 32c consensus estimate for fiscal first quarter earnings per share and $1.41 for fiscal 2003 are consistent with its EPS growth guidance of 15%, with possible upside to 17%.

"While some of this upside reflects the positive tailwind afforded by FX currency translation, they may be muted by MDT's existing hedging programs," the analysts said.

Bear Stearns medical supplies analyst Rick Wise raised his 2003 revenue estimates by $10 million to $1.71 billion but is maintaining his EPS estimates in line with consensus.

Wise believes that Medtronic's strategic relationship with Abbott is not meaningful financially in the near term. However, he thinks that recent and upcoming product launches should help sustain top-line growth over the next several quarters and rates the common attractive.

Bear Stearns has a price target in the low $50s for Medtronic stock.

The convertible affords "a modest equity exposure to an investment grade name at a reasonable option implied volatility and a favorable risk/reward profile," the analysts said.

Assuming 30% volatility in the stock and a credit spread of 125 basis points over Treasuries, the analysts said the notes are a point cheap. As a reference, 100-day volatility is 23% and 12-month volatility is 27%, with equivalent listed calls at 31% implied volatility.

"The default swaps are quoted at 44-60 bps for 5 years and much tighter for near term maturities - indicating that our 125 bps spread over Treasuries is conservative," the analysts said.

The analysts noted that the Medtronic convertible bonds are trading at or near their bond floor.

"Let us face it folks, there are not too many investment grade names out there trading at a reasonable volatility with strong growth prospects for the near term," the analysts said.

"We believe MDT is one such name."

The $2 billion (face amount) convertible is the only debt on the balance sheet with $531 million in cash, interest expense of around $25 million per year and an operating cash flow of about $430 million per quarter.

Medtronic convertible senior notes due 2021

Convertible Price: 101.25

Stock Price: $42.90

Conversion Premium: 45.87%

Conversion Price: $61.806

Current Yield: 1.23%

Yield-to-Maturity: 1.18%

Delta: 35%

100-Day Volatility: 23%

Call Price: 100.625

Spread: 125 basis points over Treasuries

Years to First Call: 4.22

Credit Ratings: AA-/A1

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