Scottish Re hit by put worries; Cephalon swings; SanDisk flat, M-Systems gains on deal; Itron solid in gray

By Kenneth Lim

July 31 - Monday was a bumpy session for a couple of names in the convertible bond market, with Scottish Re Group Ltd.'s convertible bond riding a roller coaster after the company reported poor results and the resignation of its chief executive.

Meanwhile, Cephalon Inc. tumbled early in the day only to recover most of its early losses as concerns about other drug makers' patent settlements cast doubt about the company's own drug agreements.

SanDisk Corp. stayed mostly flat after the company announced a $1.55 billion acquisition of M-Systems Flash Disk Pioneers Ltd., whose convertible soared with the stock following the news.

The gray market was also active on Monday, with a new deal by Itron Inc. trading above par ahead of its pricing as investors saw a relatively cheap deal with a short put structure.

Scottish Re put in question

Scottish Re's 4.5% convertible due 2022 and putable in December this year tumbled by as much as about 25 points outright on Monday after the company warned of a second-quarter loss and said its chief executive had resigned.

The convertible, which had been trading to put at about 99 the previous week, changed hands at 74 early Monday before bouncing back to 90 later in the day. Scottish Re stock (NYSE: SCT) collapsed by 75.06% or $12.01 to close at $3.99.

"Losing three quarters of the stock price is huge," a sellside analyst said.

Scottish Re on Monday warned that it expects a loss of $130 million from continuing operations in the second quarter, and said earnings in the third and fourth quarter will fall below earlier forecasts. The company suspended its dividend, and hired Goldman Sachs and Bear Stearns to help evaluate "strategic alternatives and potential sources of capital."

The Bermuda-headquartered reinsurance company also said Scott E. Willkomm resigned as chief executive. Paul Goldean, Scottish Re's executive vice president and general counsel, was named interim chief executive.

The news prompted credit ratings agency Fitch Ratings to cut its assessment of the group by two notches to BBB. The rating could be cut further, Fitch said. Standard and Poor's also said it may reduce its BBB- rating for the company.

"The credit is kind of a moving target, but I think the market really overreacted this morning," a Connecticut-based convertible bond analyst said.

The analyst said the market's harsh reaction was a combination of the "fairly big loss" the company announced and the resignation of the chief executive.

"Just to put it in context, it's a company that's difficult to analyze to begin with, and that's had reporting issues the past couple of years," the analyst said. "The insurance business is a pretty difficult one to understand, and all that makes people really uneasy. The fact that there's another life reinsurance company that had a meltdown maybe two years ago, there may be people who remember that and think this might be a similar case."

For convertible bond holders, the news raised concern over whether Scottish Re will be able to honor its debt obligations if all the convertibles are put in December. And if the company couldn't pay off convertible bond holders, the question was whether the company would offer a good-enough sweetener.

"This morning they [investors] didn't know what to think," the analyst said. "I think there were some who just didn't want to own it no matter what, because they viewed it as unanalyzable, and frankly they just didn't want to be caught with this on their books."

But later in the day rumors emerged that suggested Scottish Re may have enough resources to honor the put, the analyst said. Scottish Re representatives could not be reached for comment.

Regardless of what the rumors say, there is no reason at the moment to believe that Scottish Re will plunge into insolvency so quickly, the analyst said.

"There's a real question about how much earning power they have going forward...they've had a number of reporting issues and financial control problems...but that doesn't necessarily mean they'll be insolvent," the analyst said.

"There would have to be just a massive collapse in the company for them to be insolvent or you'd have to lose an awful lot of net worth," the analyst noted. "Unless their insurance liabilities are just severely understated it's going to be difficult for the company to be insolvent. You'd have to see a very large combination of asset write-downs."

Cephalon slips on patent concerns

Cephalon's convertibles were slightly lower outright early Monday but climbed back later in the day in line with a rocky session for the stock as investors worried about the company's patent settlements.

The company's series A zero-coupon convertible due 2033 was about 1.5 points lower outright at

120 bid, 120.5 offered versus a stock price of $65. The B series zero-coupon convertible due 2033 was about 125 bid against the same stock. The 2% paper due 2015 was 151.75 bid, 152 offered, also against a $65 stock price. Cephalon stock (Nasdaq: CEPH) closed at $65.51, down by 0.8% or 53 cents.

"A fair amount of Cephalon traded with the stock bouncing around, it was down a lot in the morning," a buyside convertible bond trader said.

Bristol-Myers Squibb Co. said last week that it is the subject of a criminal antitrust investigation related to its patent settlement with generic drug maker Apotex. That patent settlement would have seen Bristol-Myers and its partner sanofi-aventis paying Apotex $40 million to cease a patent law suit and hold off a generic version of Bristol-Myers drug Plavix until 2011.

Frazer, Pa.-based Cephalon also has patent settlements with generic drug makers related to its drug Provigil, and the market was worried that the investigation could affect the ability of drug makers to pursue such settlements.

"People thought that Cephalon might have the same issue with Provigil," the trader said.

SanDisk flat, M-Systems leaps

SanDisk's 1% convertible due 2013 was mostly unchanged Monday after the flash memory chip maker said it was buying M-Systems for about $1.55 billion in a share swap. The deal pushed M-System's 1% convertible due 2035 up 15 points outright.

SanDisk's convertible was marked at 87.125 bid, 87.438 offered against the previous closing price of $47.14 early Monday. SanDisk stock (Nasdaq: SNDK) closed at $46.66, down by 1.02% or 48 cents.

M-Systems' convertible was marked at 137.125 against a stock price of $36. M-Systems stock (Nasdaq: FLSH) rose 13.24% or $4.21 and finished at $36.

SanDisk said early Monday that it would buy M-Systems in an all-stock deal that would exchange 0.76368 SanDisk shares for each M-Systems share, which valued M-Systems shares at about $36 apiece.

"It's obviously good for M-Systems," a sellside convertible bond trader said. "It's going to be SanDisk credit now. But it doesn't change that much for SanDisk."

Equity analysts were positive about the deal.

"We remain positive on SanDisk's long-term prospects as we believe NAND flash memory is one of the best growth opportunities in the semiconductor industry for the longer term," wrote Merrill Lynch analyst Sidney Ho in a note.

Itron gains in the gray

Itron's proposed $300 million of 20-year convertible senior subordinated notes traded above par in the gray market on Monday ahead of pricing expected after the market closed.

The convertible, which was talked at a coupon of 2% to 2.5% and an initial conversion premium of 35% to 40%, was seen 100.75 bid, 101.75 offered in the gray market.

"I think it was decent," a buyside convertible bond trader said. "Not super but not horrible. I think it'll probably price at the rich end, though. In the gray market it's up about a point, so people like it, obviously."

The convertibles were offered at par, and the over-allotment option is for a further $45 million.

UBS Investment Bank is the bookrunner of the registered off-the-shelf deal.

The convertibles are non-callable for the first five years, and the first put is in the fifth year.

Itron is a Spokane, Wash.-based provider of measurement equipment and software for utilities. The company said the proceeds of the deal will be used for acquisitions and investments and for general purposes.

A buyside convertible bond analyst said the paper modeled cheap on a "statistical" level, and the short structure was "pretty attractive."

"But I don't know...it's got a pretty high premium," the buysider said.

Otherwise the company's credit was decent, the analyst said. Itron has been active on the acquisition front, and given that they are likely to use the proceeds of the deal for further investments, the company's leverage will probably increase, the analyst said.

"But they're generating a significant amount of cashflow," the analyst added.

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