Merrill sees Millennium offering sweetener for 4.5% and 5% converts in 8%-13.5% yield to put range

By Ronda Fears

Nashville, April 14 - Millennium Pharmaceuticals Inc. is likely to want to keep the 4.5% and 5% convertibles outstanding and offer a sweetener to avoid the put coming up on both issues later this month, said Merrill Lynch & Co.

If the company decides to just keep one issue outstanding, it would likely be the 4.5% as it has a smaller coupon.

"We believe that a sweetener to keep the bonds outstanding will be offered to investors, but only at a level that represents attractive financing for Millennium," said Yaw Debrah, head of U.S. convertible research at Merrill, in the report.

"There is the risk," he added, "that the 4.5% senior convert is sweetened, while the 5% subordinated security could be redeemed at the put price."

Both Millennium 4.5% and 5% convertible bonds, inherited in its acquisition of Cor Therapeutics in February 2002, are putable on April 29.

"We believe that Millennium Pharmaceuticals would like to leave the convertibles outstanding, as evidenced by the extension of the put one year ago," Debrah said in the report.

"Despite the fact that the company had high liquidity at that time (Millennium's 2001 10-K showed a cash and marketable securities position of some $1.5 billion), they decided to offer a sweetener to investors to extend the put date, in order to preserve their large liquidity cushion.

"Also, with the convertible not too far out of the money, there was a good chance that the stock could rise to between $25-$30 over the next year, from its level at that time of about $21, meaning that the put would never have to be paid."

The cost to the company was a yield to put of between 13% and 13.5%, together with offering an out-of-the-money call option to investors since the 5s were trading with a conversion premium of about 60% and the 4.5s a conversion premium of about 90%.

This time around, though, the analyst expects the company to be looking to make a cheaper sweetener, even though its cash balances are higher now, and it may just do so for one of the issues.

The 4.5% bonds were recently trading at 111.75 bid, 112.75 offered, while the 5% bonds were trading at 110.75 bid, 111.75 offered, he noted.

The midpoint pricing of 112.25 and 111.25 represents a sweetener of 2.75 points over the respective put price of 109.5 for the 4.5% convertible and 108.5 for the 5% convert. That, Debrah said, would make the present level of 112.25 represent fair value for the 4.5% bonds while the 5% bonds could be overvalued if the company decides not to offer a sweetener on these bonds.

Millennium's cash and marketable securities balance has increased to $1.8 billion at the end of 2002 from $1.5 billion at the end of 2001, bolstered by $309 million from Cor following the acquisition, together with a further $112 million from the issuance of stock and exercise of options.

Instead of rising, Millennium shares over the past year have lost over 50% to $9 from about $21, he pointed out. And, the 4.5% and 5% are trading at conversion premiums of 400% and 320% respectively.

"There is no optionality in the convertibles," Debrah said.

"If a further put was offered, there is little likelihood over the next year that the stock price could rise to the $25-$30 level, where the further put could be avoided. They are probably going to have to refinance this put again next year.

"Nonetheless, given Millennium's desire to maintain a substantial liquidity position (we note that the company used up cash at the operating level to the tune of $353 million in 2002), we believe that the company would like to leave the bonds outstanding over the next year, if they could get cheap enough financing."

While last year Millennium was prepared to endure financing costs of about 13.5% in order to keep the converts outstanding for a further year, but Debrah said, "given how deep out of the money the converts currently are, we do not believe that Millennium would be prepared to endure another year of financing at this level."

"Average short dated B2 rated paper is trading at a spread of around 600 bps, according to Merrill Lynch indices. With three-year Treasuries trading at about 2%, we believe that attractive financing for Millennium would be a yield-to-put of about 8%," he said.

"For the 4.5% convertible, this would represent a put price of about 113. For the 5% convert, the appropriate put price would be about 112%. The sweetener could end up somewhere between a yield-to-put of 8%-13.5%

Apart from a two-month period in September 2002 to October 2002, when high-yield spreads were near record highs, the two convertibles have traded in tandem near the same dollar value, since the tender offer was announced in April 2002, he noted.

"Despite that fact the 5% are subordinated to the 4.5%, carrying a CCC+ rating compared to the B2 rating on the senior notes, investors have largely treated the two convertibles as cash, due to the high level of cash and marketable securities held by the company," Debrah said.

"However, given the high liquidity level of the company and the degree to which the convertibles are out of the money, Millennium could very well decide to leave just one of the convert issues outstanding, redeeming the other, which would not seriously compromise its liquidity position.

"In such an instance, we believe that it would be the 4.5%, which would be sweetened, the seniority of the bonds and the smaller coupon making it a cheaper financing vehicle for the company."

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