Mentor bucks trend, gains on takeover; Citigroup drops with stocks; energy names fall on OPEC move

By Kenneth Lim

Boston, Dec. 1 - The convertible market had another weak session on Monday to start the month as equities struggled to hold onto the previous week's gains.

Mentor Corp. was a rare gainer, climbing several points on news of a proposed cash acquisition by Johnson & Johnson.

Financials continued to struggle as weak economic data pulled active names like Citigroup Inc. lower. Market sources also noted uncertainty amid news that banks are beginning to tap a temporary debt-guarantee program run by the Federal Deposit Insurance Corp.

Energy names also had a tough session after OPEC delayed a decision on whether to cut oil production. Transocean Inc. and Chesapeake Energy Corp. fell with their stocks.

Quiet start

The convertible market was mostly quiet as stocks fell and investors were slow to come back from a long holiday.

"I really wasn't doing anything," an east coast trader said. "Just sat around watching the carnage."

Another sellside convertible trader said: "It'd kind of a slow day. It's the first of the month. People are probably still digesting their turkey and stuffing."

There was slight interest in the more stable names, but actually trading was slim, the trader said.

"I feel like what I'm seeing is bids for some of these stronger investment-type names," the trader said. "It's a flight to quality right now."

Mentor gains on takeover

Mentor Corp. saw its 2.75% convertible due 2024 gain about 7 points outright on Monday after Johnson & Johnson made a $1.07 billion cash takeover bid.

The convertible, which may be put and called on Jan. 1, 2009, was seen at 105.375 against a stock price of $30.60. Mentor common stock closed at $30.58 on Monday, up 89.35% or $14.43.

Johnson & Johnson will offer $31 for each Mentor share and assume the company's net debt of about $50 million.

Mentor is a Santa Barbara, Calif.-based maker of plastic surgery products, including breast implants, equipment and consumables used in liposuction and skin restoration products.

"Based on the $31 stock takeout price, parity will be $107.60," said Michael Knox, president of Xtract Research. "Interestingly, this will not be a change of control as defined in the indenture because parity above 105 is not a change of control. However, even though this is a contingent convertible bond and normally requires parity to be 120% before holders can convert, there is a carveout that allows holders to convert upon a merger, but they must do so within 15 days before or after the effective date of the merger. Given the yield to put and yield to maturity at $107.60, I would assume that holders will convert immediately after the transaction closes in order to get $107.60."

Holders are unlikely to worry too much about whether the transaction is a change of control, which triggers a put option, as long as they can convert, a sellside analyst said.

"It doesn't make sense to put," the analyst said. "If you put you only get par, whereas if you convert you also receive the premium that Johnson & Johnson is paying for the stock."

The deal will likely work out better for outright holders than hedged investors, the analyst said.

"If you're outright, it's great," the analyst said. "It's like getting a little bonus, because the outrights were probably thinking they'd just put this back in January and get par, but now they'll actually get a little more," the analyst said. "If you're hedged, I think it will depend on what kind of delta you're on."

Citi falls with stock

Citigroup's 6.5% convertible preferred fell about 2.5 points outright on Monday as the underlying common stock dropped amid disheartening economic news.

The convertible traded at 24 versus a stock price of $7.25 as Citigroup common stock dropped 22.2% or $1.84 to close at $6.45.

Citigroup is a New York-based bank holding company.

"Financials were getting hammered today," a convertible trader said. "Everything's down, but what's new?"

Bank stocks fell on Monday as the National Bureau of Economic Research determined that the U.S. economy has been in recession since December 2007. Federal Reserve chairman Ben Bernanke also said in a speech Monday that the economy will probably "remain weak for a time."

Reports that banks, including Bank of America Corp. and Citigroup could be issuing senior unsecured debt this week under the FDIC's temporary liquidity guarantee program - continuing a flow of new deals that started right before the holiday - had an uncertain effect on convertibles, observers said.

"There probably will be an impact, but I'm not sure what that's going to be," a buyside analyst said. "For any of these firms that are going to issue this debt it definitely eases any liquidity concerns. It allows them to take out near-term debt and replace them at a lower rate. But it pushes anything junior lower down in the capital structure, and you got a lot of supply, which could crowd other borrowers out of the market or push spreads wider."

Another buysider thought that the overall effect would be positive even if the bank-issued convertible preferreds were further down the capital rankings.

"If they issue a bond it's going to be senior to you, but it's going to improve the liquidity of the company, so it's probably a slight positive, I would think," the buysider said. "To the extent that they're not diluting their stock, that's kind of positive for converts. It probably makes them less likely to default on the preferreds."

Energy slides lower

Transocean saw its series B 1.5% convertible due 2037 fall 1 point outright as oil and gas equities fell after the Organization of the Petroleum Exporting Countries delayed a decision on cutting oil production.

The Transocean convertible was 77.25 against the closing stock price of $75.85 on Monday. Transocean common stock fell 13.5% or $9.03.

Transocean is a Houston-based offshore drilling contractor.

Oklahoma City-based Chesapeake Energy also saw its 2.25% convertible due 2038 drop three points outright to close at 47.75 versus a stock price of $15. Chesapeake common stock declined by 12.69% or $2.18 to close the day at $15.

Over the weekend, OPEC decided to delay a decision on cutting crude oil production to later in the month, disappointing investors who were hoping for action to slow the slide in oil prices.

"A cut in production could potentially mitigate the drop in oil prices, but I don't know how much of an effect it will have," a convertible trader said.

Mentioned in this article:

Cheseapeake Energy Corp. NYSE: CHK

Citigroup Inc. NYSE: C

Mentor Corp. NYSE: MNT

Transocean Inc. NYSE: RIG

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