Kerzner buyout hurts hedge investors; BioMarin plans new deal; Time Warner Telecom offer seen as cheap

By Kenneth Lim

Boston, March 20 - Kerzner International Ltd. gave hedge investors a painful start to the week as plans for a leveraged buy-out sent the stock soaring, exposing arbitrageurs who were short the stock but had no takeover protection on the convertible.

Meanwhile, BioMarin Pharmaceutical Inc.'s planned $125 million offering of seven-year convertible bonds are talked to yield 2.5% to 3% with an initial conversion premium of 22.5% to 27.5% will be priced Thursday, market sources confirmed. But analysts are split over how to assess the biotech's credit risk after the company recently reported positive drug trial results.

Time Warner Telecom Inc.'s proposed $200 million issue of 20-year convertible bonds, which are also expected to price Thursday, also seems a little cheap at the mid-range of talk, says a sell-side analyst.

The convertible market on the whole was kept busy on Monday, said a sell-side source. Oil drilling contractors Diamond Offshore Drilling Inc. and Nabors Industries Ltd. were seen trading as their stocks fell on lower oil prices.

The Organization of Petroleum Exporting Countries on Friday lowered its forecast for global oil demand, while U.S. data showed crude oil inventories rose last week to 10% above year-ago levels. Oil prices fell on Monday, with light sweet crude for April delivery sliding $2.35 to $60.42 a barrel in New York.

Houston-based Diamond Offshore (NYSE: DO) saw its 1.5% convertible bonds due 2031 change hands at 170.25 versus a stock price of $83 on Monday, while its stock fell $3.22 or 3.88% to close at $79.84. Nabors' 0% convertible due 2023 traded at 109 versus a stock price of $65.90. Nabors stock (NYSE: NBR) closed at $63.84 on Monday, down $2.06 or 3.13%. Nabors is a St. Michael, Barbados-based land drilling contractor.

In the biotech sector, Amgen's 0.125% convertible due 2011 traded at 101.625 against a stock price of $73.00. Amgen (Nasdaq: AMGN), the biotech giant based in Thousand Oaks, Calif., saw its shares close at $72.85 on Monday, down slightly by 40 cents or 0.55%. Cambridge, Mass.-based Genzyme's 1.25% convertible due 2023 changed hands at 109.5 versus a stock price of $69.50. Genzyme stock (Nasdaq: GENZ) dropped $1.58, or 2.27%, to end at $67.98.

Kerzner buyout cuts hedges

Kerzner's convertible came in about nine to 10 points on a hedged basis on Monday after the company said its chairman and chief executive were leading a group of investors to buy out the resort and casino operator for about $3.6 billion.

"The hedge guys were completely annihilated," said a sell-side analyst. "It was good for the outrights, but it's a disaster for hedge funds. It [the convertible] doesn't have takeover protection."

Kerzner's 2.375% convertible due 2024 was marked at 136.75 versus a stock price of $79.25 on Monday at a major convertible shop. Another trading desk had the security marked at 137.39 bid, 138.39 offered against the closing stock price of $79.43. Kerzner stock (NYSE: KZL) jumped $9.39, or 13.35%, on Monday.

A sell-side convertible strategist said hedge funds who were holding the convertible on a market delta position would have lost about nine points, which would have been "pretty painful."

The buyers in the consortium include Kerzner chairman Sol Kerzner and chief executive Butch Kerzner, Dubai government investment vehicle Istithmar PJSC, Whitehall Street Global Real Estate LP 2005, Colony Capital LLC, Providence Equity Partners Inc. and the Related Cos. LP.

Under the agreement, the group will pay $76 per Kerzner share in cash as well as assume about $599 million of the company's net debt. Kerzner will also tender for the 2.375% convertibles and its 6.75% senior subordinated notes due 2015.

The Paradise Island, Bahamas-based company will also solicit competing bids in the next 45 days, and expects to close the deal by mid-2006, subject to regulatory and shareholder approvals. The Kerzner family and Istithmar, who control a combined 24% of the company, have agreed to cooperate with the solicitation process. JP Morgan Securities is advising the company, while Deutsche Bank and Groton Partners are advising the investor group.

The buyout did not have significant impact for investors who were not arbitraging, said a buy-side manager whose firm was exposed as an outright investor.

"I'm not short the stock," the source said. "The bonds were marked in about 10 points, they were at 131.5 on Friday...from my perspective, if it went down to $76, I lost maybe a dollar."

The main gripe the buy-side source had was that a buyout would take the convertible out of play. "I hate to have names go out of my universe...I liked their longer term prospects," the source said.

The buy-side source said hedge funds could have taken quite a substantial hit from the news because the Kerzner convertible was an attractive arbitrage play and some funds could have had significant exposure.

"It had lots of call protection," the source said, adding that the convertible was also very equity sensitive.

The one thing the convertible did not have was takeover protection.

"If you had takeover protection, it would have traded at a 20% to 30% premium," the source said.

Although this is the second time that Kerzner is seeking to privatize itself - the first time was a failed attempt almost 10 years ago - the buy-side source said the market did not suspect such a move was coming.

Kerzner's surprise buyout highlights the risks of convertibles issued around 2004 - when the Kerzner securities were launched - that do not have takeover protection, the buy-side source said.

"We've got so many companies with so much cash on their balance sheets now, the chance of a cash takeover is higher," the source said. Having said that, conversion premiums have come down so low for convertibles without takeover protection that it's "hard to get hurt."

Jefferies and Co. equity analyst Lawrence A. Klatzkin wrote in a research note that his target price for Kerzner's stock was $81. Klatzkin, who thought that the buyout was being carried out in a "fair process," also noted that White Plains, N.Y.-based Starwood Hotels and Resorts Worldwide (NYSE: HOT) could offer a competing bid.

BioMarin plans $125 million deal

BioMarin Pharmaceutical plans to offer $125 million of seven-year convertible bonds talked to yield 2.5% to 3% with an initial conversion premium of 22.5% to 27.5%, market sources confirmed.

There is a further $18.75 million greenshoe option on the deal, which will be priced at par.

Final pricing is expected on Thursday after the market closes. Merrill Lynch is the bookrunner of the off-the-shelf offering.

A sell-side analyst said the convertibles modeled at 101 points based on a "very conservative" credit spread of Libor plus 800 basis points with a volatility of 45%.

"It's a very wide spread because the financials aren't all that great," the analyst said. "They're highly levered, not profitable, but they have a new drug, so who knows?"

"Biotech is all about sentiment, and the fundamentals are half the time garbage," the analyst quipped.

But another sell-side observer said the offering looks cheap and a tighter credit spread could be justified. "I think you can definitely go with Libor plus 600 bps, or 500 bps. But it's a seven-year paper, so it would probably be a 40ish vol," the convertible strategist said.

Novato, Calif.-based BioMarin is also planning an offering of 9 million shares and possibly a further 1.35 million shares under an over-allotment option. Merrill Lynch is also the bookrunner for the stock offering.

The biotech company plans to use the proceeds of the two offerings to fund the commercialization of its products, additional clinical trials of products that include metabolic disorder drug Phenoptin, and potential acquisitions. The company may also use some of the proceeds to buy back some or all of the $125 million outstanding of its 3.5% convertible bonds due 2008, which become callable on June 20 this year.

The 3.5% convertibles were marked at 106.3 bid, 107.3 offered against the closing stock price of $14 on Monday. BioMarin stock (Nasdaq: BMRN) retreated 4.37%, or 63 cents.

BioMarin reported the week before that it had gotten positive results from phase 3 trials of Phenoptin, which increased the likelihood that its product would make it to market.

Time Warner Telecom deal could be cheap

Time Warner Telecom's planned $200 million offering of 20-year convertible bonds would be reasonably priced at the mid-range of talk, said a sell-side analyst.

The convertibles are talked at a coupon of 2.125% to 2.625% with an initial conversion premium between 25% and 30%, and are expected to price on Thursday.

Morgan Stanley, Wachovia Securities and Deutsche Bank are the bookrunners of the registered deal.

There is also a greenshoe option of $30 million.

"We're using 35% volatility and Libor plus 450 bps," the analyst said. "At the mid-point of talk, it's about 0.3% cheap with those assumptions. At the cheap end of talk it's 2.7% cheap."

The analyst highlighted that the convertible is being issued by Time Warner Telecom the parent company, and not Time Warner Telecom Holdings Inc. the operating subsidiary. Time Warner Telecom also has a couple of straight bonds outstanding that are issued by the operating subsidiary, and because the subsidiary is where the key assets are, that could make Time Warner Telecom's 9.25% senior unsecured note due 2014 and its senior unsecured floating rate note due 2011 structurally senior to the convertible.

Time Warner Telecom, a Littleton, Colo.-based IT services company that manages data and voice networks, said the proceeds of the deal will be used to call for redemption a portion of its 10.125% senior notes due 2011.

Also on Friday, Time Warner Telecom's major shareholders Time Warner Inc. and Advance/Newhouse said they would sell 17.5 million Time Warner Telecom shares in a public offering, with an over-allotment option of a further 2.6 million shares. Those shares represent about 17.2% of Time Warner Telecom's share capital. Deutsche Bank, Morgan Stanley and JP Morgan are the bookrunners for the stock offering.

Time Warner Telecom stock (Nasdaq: TWTC) closed at $14.79 on Monday, up slightly by 2 cents or 0.14%.

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