Deutsche analysts recommend Medtronic convert, saying cheapening limited

By Ronda Fears

Nashville, Tenn., Dec. 18 - Medtronic Inc.'s 1.25% convertible bond due 2021 has cheapened over the past month but further cheapening is limited, assert Deutsche Banc Alex. Brown convertible analysts Jeremy Howard and Jonathan Cohen, who are recommending the convert based on the solid fundamentals.

The Medtronics convert is one of the largest U.S. convertibles with a market cap of $2.1 billion for the $2 billion issue, the analysts noted. Deutsche has a strong positive directional view on the underlying stock, with a strong buy recommendation and a $54.00 price target. The common closed at $50.12 on Monday and the bond closed Monday at 105.34 offered with a premium of 29.8%. The bond has cheapened as the premium has come down from its early November highs of 57%, the analysts noted, while the stock has climbed steadily since early November from $40 to $50.

"The fixed income component of the bond is underpinned by solid stable A1/AA- ratings, and there is a liquid market for the credit at Libor plus 85 basis points in the asset swap market, and 50/65 bps in the credit default markets. A credit spread of Libor + 65 bps provides a theoretical bond floor of nearly 99, limiting the downside on this bond to around 6 points," the analysts said in the report.

"We also feel that the implied volatility of this bond is well underpinned at current levels. While the stock has run up, the IVol (implied volatility) of the MDT 1.25% 2021 has declined from 31% to 29%. This puts it in line with listed/OTC volatility and we believe further cheapening should be limited."

Deutsche equity research analyst Sheryl F. Zimmer, in a report last week on Medtronic said it has been relatively tough sledding for Medtronic this year overall. Issues in its vascular business and positive data out of competitors have weighed on the shares, she said, but the company's outlook numbers seem very achievable and the news flow and new product momentum should become increasingly positive.

The shares currently trade at a roughly 47% premium to the S&P 500, Zimmer said in her report, which compares to an average premium of 75% over the last 3 years. Relative to the med-tech group, she said the stock is currently at a 21% premium versus its 41% average premium over the last 3 years.

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