Molson Coors convertibles may have run dry, Lehman Brothers report says

By Evan Weinberger

New York, Sept. 12 - As anxiety in the broader markets heated up over the summer, investors looking for a cool, refreshing convertible looked to Molson Coors Brewing Co.

Maybe it's time for those investors to think about closing their tab on the Montreal-based beverage producer's 2.5% convertible senior notes due July 30, 2013. The reason, according to a Lehman Brothers report released Wednesday, is that with an increasing implied and real volatility, and a relatively high vega of 0.72, investors are exposed to significant volatility risk.

"While we acknowledge the technical bid on these bonds given the non-cyclical, defensive nature of TAP [Molson Coors's New York stock exchange ticker symbol] and the investment grade rating, we believe the bonds are trading rich on an implied volatility basis," the analysts wrote.

The Lehman Brothers report quoted a closing price on the TAP bonds Tuesday at 106.625 versus $90.99.The report also said that the bonds have a current yield of 2.34%, call protection for 5.9 years - the convertibles priced in June - and a delta of 60.9%. They also have a Libor plus 40 basis points credit assumption.

The key stats in their calculations are the 0.72 vega, and an implied volatility of 27.1%. The spread between convert implied volatility and the [24-month at-the-money] listed implied volatility now stands at 4.2 points, which the analysts said was at the higher end. "Given the downward sloping term structure and the skew, one could argue that the true spread between the convert implied vol and a comparable like-strike, longer-dated listed options vol would be even higher," the analysts wrote.

The analysts summed up by saying that, given the relatively high vega, "bond holders are exposed to a fair deal of vol risk at current levels and we recommend that holders (especially arbitrage investors) sell into strength."

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