Salix lower on hedge on drug setback; Newmont Mining drops in line after earnings released

By Rebecca Melvin

New York, Feb. 24 - The convertible bond market was more active and maintained a decent bid Thursday amid stronger news flow, including Salix Pharmaceuticals Ltd.'s bombshell that it expects U.S. regulators to reject its application to expand the label of its Xifaxan drug for the treatment of irritable bowel syndrome.

Salix's convertibles tumbled about 15 points outright and 'came in' about 0.5 point on a hedged basis in heavy volume, a New York-based sellsider said.

Earnings news was mixed. Gold and copper producer Newmont Mining Corp.'s 3% convertibles dropped in line with its underlying shares on an 80% hedge on an output warning that accompanied strong quarterly earnings.

Superior Energy Services Inc.'s convertibles were lower outright with a similar stock drop resulting from its fourth-quarter earnings miss.

But Omnicare Inc.'s 3.25% convertibles due 2035, of which there are $452.5 million outstanding, were higher along with a jump in the common shares after the Covington, Ky.-based provider of geriatric pharmaceuticals reported earnings that were in line with analysts' estimates.

NII Holdings Inc.'s 3.125% convertibles were active and trading in the context of 99.375 bid, 99.4375 offered, which was slightly higher, but called "in line" with a 7% jump in the common shares after the Reston, Va.-based wireless carrier's earnings report.

School Specialty Inc. initiated an exchange of its 3.75% convertible subordinated notes due 2026 for $100 million of convertibles with the same coupon and maturity, but with a lower conversion price and longer-dated put, which was pushed out to 2014 from 2011.

School Specialty was a "private deal, with the company issuing a few bonds to a few institutions in a move that issuers are definitely embracing," of late, a New York-based sellside trader said.

Overall, the convertible market "still has a bid to it," with the vol. not coming in and with "outrights still caring in the names they care in," a New York-based sellside trader said.

"Outrights aren't yet taking profits; it's pretty steady," he said.

Meanwhile, the situation in Libya - which has been driving markets this week - hung in a balance, with rumors swirling around the fate of leader Moammar Gadhafi, who has cracked down on protestors of his regime, killing some of them.

"I really don't know how the situation will end, but it's getting worse every day, and the market will react," a New York-based sellside analyst said.

Salix slips on hedge

Salix's 2.75% convertibles due 2015 traded at 105.943 versus a share price $32.27 on Thursday, which was down from 122 bid, 123 offered versus a share price of $41.45 late Wednesday.

The drop was about 15 points on an outright basis, and lower by 0.5 point to 0.75 point on a hedged basis if the bonds were held on a 75% delta.

Nevertheless, the bonds "still model out extremely rich; using Libor plus 700 basis points implies 61% vol.," a New York-based sellsider said.

Another sellsider, an analyst in Connecticut, who quoted the paper during the session at 107 versus a share price of $32.27 on a 75% hedge, said that even with a spread of 350 bps, the paper was still very rich.

Shares of the Raleigh, N.C.-based pharmaceutical company skidded $9.84, or 24%, to $31.61.

"The bonds will leak premium from these levels," the New York sellsider said, citing the paper's 2.6% current yield with 52.28% premium. "A deal could not get priced with those terms today."

There were a lot of dealers that were short and they were covering their shorts, he also said.

So far, outrights have stayed with the name, he said. But the stock, he thinks, is "probably dead money for the next 18 months."

Behind the freefall in Salix's shares and bonds was disclosure of a phone conversation with the Food and Drug Administration that it probably will be denied expanded label use of its Xifaxan drug without further study, estimated to take 18 months to 24 months.

"If that happens, the stock's fair value is $35 to $37 a share," the sellsider said.

Salix, which focuses on treatments of gastrointestinal disorders, has other drugs in the pipeline, but none with the kind of potential in the near to medium term that Xifaxan has.

Xifaxan was previously approved to treat travelers' diarrhea caused by E. coli, and hepatic encephalopathy, a brain disorder, caused by liver disease.

One positive is that the company was planning to hire on many additional people to market the drug, and now it will save those costs, the sellsider said.

The FDA wants additional treatment information before approving label expansion, however, the company said.

The company expects to receive a complete response letter on the drug, which is already approved for two other indications, by March 7.

Newmont drops in line

Newmont's 3% convertibles due 2012 traded at about 126, which was down nearly 7 points on the day.

Shares of the Greenwood Village, Colo.-based gold and copper mining company fell $4.25, or 7%, to $54.76.

Newmont reported that fourth-quarter net income rose about 46% to $812 million, or $1.61 a share, from $558 million, or $1.13 a share, a year earlier. On an adjusted basis, earnings per share were $1.16.

Sales rose about 1% to $2.55 billion from $2.52 billion.

Analysts were expecting earnings of $1.13 a share on revenue of $2.57 billion.

"The Newmont 3s nuked straight down on a 80% delta with the stock off 7%," a New York-based sellsider said, referring to the fact that the bonds didn't lose premium on a hedged basis but fell "in line" with the underlying shares.

But "people were hoping for them to expand a little bit," he said.

If the shares continue to slip on Friday, the sellsider predicted that the bonds would expand. But right now, the pricing of shares puts the bonds in a no man's land.

"It's trading with 6.5 points of premium, with only a year left of maturity. If the stock goes down to the high $30s, then they cross par there, then the put aspects of the bonds kicks in. If they went to $66, they are back to parity at that level at a 75% delta," he said.

A second sellsider said he expects outrights to step in, taking advantage of the weaker pricings, and that will push up valuation.

School Specialty trades

Greenville, Wis.-based School Specialty will issue $100 million of new 3.75% convertibles due 2026 in exchange for an equal amount of its outstanding 3.75% convertibles due 2026, but the new paper will have a lower conversion price and a longer put and call date.

School Specialty provides curriculum, supplemental learning resources and school supplies.

"Some people may have bought the old bonds [today] because they see less outstanding and they will hold on to it until the put," a New York-based sellside analyst said, citing a positive scarcity value for buy and hold investors.

The conversion price for the new convertibles is $22.62, which is a 50% premium to the company's closing stock price on Feb. 23. The conversion ratio of the existing convertibles is $51.39.

The new debentures will be convertible if the company's closing stock price is more than 130% of the conversion price for at least 20 out of the 30 consecutive trading days. For the existing convertibles, there is also contingent conversion at 130% of the conversion price.

The new convertibles are callable beginning May 30, 2014, and they are putable on Nov. 30, 2014, Nov. 30, 2018 and Nov. 30, 2022. In each case, the redemption amount will be 100% of the accreted principal amount.

The existing convertibles become callable Nov. 30, 2011, and they are putable on Nov. 30, 2011, Nov. 30, 2016 and Nov. 30, 2021.

Following the exchange, $100 million principal amount of the existing convertibles will remain outstanding.

Mentioned in this article:

Newmont Mining Corp. NYSE: NEM

NII Holdings Inc. Nasdaq: NIHD

Omnicare Inc. NYSE: OCR

Salix Pharmaceuticals Ltd. Nasdaq: SLXP

School Specialty Inc. Nasdaq: SCHS

Superior Energy Services Inc. NYSE: SPN

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