New Century, Fremont freefall; TXU tumbles; Palm pulls back; Pathmark, A&P higher on deal

By Ronda Fears

Memphis, March 5 - With less than a handful of rather small deals on the wires and further gyrations in the broader markets, traders said activity was rather stilted Monday.

Ongoing doubt lingers over the record TXU Corp. buyout, and bankruptcy jitters over subprime mortgage lenders such as New Century Financial Corp. and Fremont General Corp. were big overhangs, traders said. Furthermore, deal premiums appear to be getting tighter in the face of the run-up in the markets since the first of the year, so many stocks with buyout speculation circulating are getting taken down, such as Palm Inc.

"Everyone is a little hesitant," remarked one trader.

Distressed players, for example, were on the sidelines licking their chops as they carefully watch the cataclysm in the subprime mortgage sector. But they are not yet ready to jump in. Meanwhile, some distressed players are eyeing the collateralized debt obligations and asset-backed securities in the subprime mortgage sector but, again, are not yet ready to be buyers.

"I think the subprime mortgage stocks have a little ways to go yet," before distressed funds specifically become interested, said a fund manager in Connecticut. "But we are looking at those" ABS and that could lead to an equity investment.

One deal on the tape that was a disappointment, a trader said, was SafeNet Inc.'s acquisition by an investor group led by San Francisco private equity boutique Vector Capital for roughly $634 million, or $28.75 a share. The price is a 12% premium over the 30-day average stock price ending Friday but a discount to the $28.30 close on Friday. Baltimore-based SafeNet is a provider of information security. The stock (Nasdaq: SFNT) edged up by a nickel to $28.35, which the trader attributed primarily to short covering.

There were a couple of deals that pleased, however, such as The Great Atlantic & Pacific Tea Co.'s final terms to buy Pathmark Stores Inc. for $1.98 billion - including $1.3 billion of debt and capital leases - in cash and stock, up from $1.72 billion estimated by A&P last week.

Players also liked the acquisition of defense electronics contractor Aeroflex Inc. by private equity firms General Atlantic and Francisco Partners in a deal valued at $1 billion, or $13.50 in cash - a 23% premium to Friday's market. Under the deal, the company can solicit a better deal through April 18. The stock (Nasdaq: ARXX) advanced $2.05, or 18.62%, to $13.06.

Another trader remarked that Ligand Pharmaceuticals Inc. was one example of how the wild swings in the broader market may be affecting special situation equities by keeping investors on the sidelines. Last week, when the biotech announced a set of changes on its board of directors, onlookers thought that it signaled the end of its reorganization efforts and, more specifically, that the turnaround was all but complete. The measures were largely ushered in by activist stockholders Third Point LLC and Knott Partners, which have been active on the board. Yet, the stock has drifted lower ever since, and on Monday the Ligand shares (Nasdaq: LGND) lost another 31 cents, or 2.74%, to close at $11.

"It's just come in kind of slowly," a trader in Ligand shares remarked Monday, saying he had expected the stock to get a bounce from last week's news. "We haven't seen a lot of buyers, or sellers."

New Century in freefall

Several analysts joined a host of equity traders Monday in the consensus that New Century Financial, one of the largest domestic subprime mortgage lenders, faces liquidation or bankruptcy. The stock has been trading on that thesis for weeks, according to traders, but analysts have joined that line of thinking after the company revealed a criminal investigation and technical defaults with several lenders.

New Century (NYSE: NEW) plummeted $6.17 on the session, or a whopping 68.87%, to close Monday at $4.56, and in after-hours trading was heading further south. The stock is down more than 90% off the 52-week high of $51.97.

"Everyone is getting nervous," one trader said. "The banks could force them in to folding, or they could buy out the portfolios, but none of the possible scenarios look good."

The Irvine, Calif.-based company, the second-largest player in the subprime industry, said it is in technical default with several warehouse lenders and is under criminal investigation regarding securities activity. The company said it has received waivers from six of its 11 warehouse lenders and without a full slate of waivers its auditors would likely voice anxiety about it as a going concern.

Bear Stearns analyst Scott Coren was one of the analysts warning of impending bankruptcy, saying the likelihood has risen immensely with the criminal investigation as it may cripple the company's efforts to get waivers from its warehouse lenders on the defaults in question.

"New Century's disclosure about additional shareholder lawsuits and a criminal investigation by the U.S. Attorney's Office likely reduces the likelihood that a rescue-buyer/liquidity provider will step in to bail the company out," Coren said in a report. It "could hurt negotiations with lenders, too."

New Century said it had received waivers for being out of compliance with debt covenants from six of 11 lenders. Some waivers will take effect when New Century gets similar waivers from the other lenders that have the two-quarter net income covenant, according to the company.

Fremont, big banks stung

Another subprime lender speculated to be on the threshold of serious calamity is Fremont General, which extended losses from Friday as fears mount following a cease-and-desist order from the Federal Deposit Insurance Corp.

On Monday, Fremont (NYSE: FMT) fell $2.82 on the day, or 32.38%, to settle at $5.89.

Santa Monica, Calif.-based Fremont said Monday that it has retained Credit Suisse as a financial adviser as it evaluates alternatives for it subprime mortgage operations. Management and the board of directors have entered into discussions with various parties regarding the sale of this business, the company said.

"It's hard to imagine that a buyer will step up with a great price," a sellside desk analyst commented.

"Could they get 50 cents on the dollar for these loans? What is the origination business worth? Well, I don't think anyone has put a pencil to that and got an answer, not today. But you can bet it is a fraction of what they were worth a year ago, and if they can't get a buyer, in a bankruptcy scenario you are probably looking at the 20s or 30s in terms of recovery percentage rates on these mortgages."

Thus, he said the market is leery, as big banks with subprime mortgage exposure, like HSBC Holdings plc, and wholesale lenders of the subprime mortgage firms, like Merrill Lynch as well as Credit Suisse, also came under extreme pressure again.

Big banks with equity stakes in these subprime lenders also are getting hit hard, like Morgan Stanley and Citigroup as well as State Street Corp.

Traders said players in the big banks were heavily hedging their positions with options and credit default swaps, but as those are getting evermore expensive some are just "taking their losses."

TXU turmoil overshadows

The uproar over options trading ahead of the TXU buyout continued to curtail trading in the stock and keep it well below the buyout offer of $69.25 per share, traders said. Lingering uncertainty about regulatory approval for the record $45 billion transaction also has kept a lid on the stock.

TXU (NYSE: TXU) on Monday lost $1.10 on the day, or 1.65%, to end at $65.40 with 7.8 million shares traded versus the norm of 4.9 million shares.

"This [options scandal] just further sullies the deal," said one equity trader.

"There is a greater fear now that it could be hi-jacked by this trading scandal, as if the regulatory angle was not enough pressure."

Meanwhile, TXU said on Monday that it is unlikely anyone linked to the company was involved in suspected illegal insider trading before the buyout was announced. A federal judge on Friday granted an emergency order sought by the Securities and Exchange Commission to freeze as much as $5.4 million in investor assets for alleged insider trading on TXU call options ahead of the Feb. 26 buyout announcement, which was rumored the Friday beforehand.

TXU said it took a number of steps to prevent premature disclosure of the deal with an investor group led by private equity firms Kohlberg Kravis Roberts & Co. and Texas Pacific Group and has no reason to believe those measures were not effective in preventing leaks.

The court called upon the unknown investors to identify themselves and their financial accounts.

The case is scheduled for a status hearing on March 7 in Chicago.

Palm pulls back

Reversing an 11% gain on Friday on buyout rumors, Palm was pulling back Monday amid an analyst downgrade on its aging product line and new market chatter that the handheld computer and mobile phone maker has hired Morgan Stanley to evaluate options such as a sale of the company.

Palm (Nasdaq: PALM) dropped $1.80, or 9.83%, to $16.50.

Palm spokeswoman Marlene Somsak gave the standard "no comment" to a Wall Street Journal report Monday that the company is working with Morgan Stanley to evaluate its options.

A trader on the West Coast said that Palm players are optimistic of a buyout transaction, but with the technology sector pulling back in recent sessions, the run-up in Palm over the past few weeks seems out of line with a reasonable offer.

Market chatter has pegged Sunnyvale, Calif.-based Palm as a takeover target of mobile phone giants Nokia Corp. and Motorola Inc., as well as private equity; such talk has been in circulation for years but has caused a spike of more than 30% in the stock in the past month. Last week, the web site Unstrung reported a possible price tag of $20 per share.

The trader said there also is a negative perception to a company putting itself on the auction block rather than getting a buyout offer. The former is seen as an act of desperation, to some extent, he said, and perceived as a situation where perhaps a big premium will not be achieved.

Palm is slated to report fiscal third-quarter results March 22, and the trader said many expect lackluster results, which he said also contributed to heavy short selling in the stock.

Research In Motion roiled

BlackBerry maker Research In Motion Ltd. is one of the thorns in Palm's side, but that stock also was taken down Monday after saying it will restate financial statements as far back as fiscal 2004 because of past stock option reporting errors. The company said it anticipates a $250 million reduction in previous earnings, and said co-chief executive Jim Balsillie is stepping down as chairman.

Research In Motion shares (Nasdaq: RIMM) declined $1.45, or 1.06%, to end Monday at $134.52.

A trader noted light volume in the stock, but said it traded in a fairly wide band with good two-way action. He said buyers liked the dip as well as volatility in the stock, while there were some profit takers selling out as well as naysayers on the technology sector given the negative trend in some of the bigger tech stocks.

Waterloo, Ont.-based Research In Motion said a special committee determined that all options granted prior to Feb. 27, 2002 were accounted for incorrectly due to not applying variable accounting.

The company also said Balsillie has voluntarily stepped down as chairman, and Dennis Kavelman will be moving from chief financial officer to become the chief operating officer of administration and operations. Balsillie will remain co-CEO with Michael Laziridis and will also stay on as a director.

John Richardson was named lead director of the board, which will now have two additional directors, or a total of nine members. Brian Bidulka was named chief accounting officer. He is currently corporate controller.

Pathmark price pleases

A&P's sweetened price for Pathmark at an equivalent of $13 per share was not altogether a surprise but it was a pleasant one as the markets tumbled Monday, one trader said. He had noted a big buyer in the stock after Friday's close, saying there was hope of a bigger offer than last Tuesday's discussions of a price at the equivalent of $12.50 per share.

Under the deal, Pathmark shareholders will receive $9 in cash and 0.12963 share of A&P stock for each Pathmark share. Off Friday's market, it would amount to $13 per share - a 15.5% premium. Last week, A&P said it was discussing a price tag of $652.5 million, or the equivalent of $12.50 per share.

Pathmark (Nasdaq: PTMK) gained $1.21 on the day, or 10.76%, to close at $12.46.

A&P (NYSE: GAP) advanced $1.64, or 5.31%, to $32.50, which the trader attributed largely to short covering, noting the stock was moving lower in after-hours trade.

The deal will create a 550-store supermarket chain operating in the New York, New Jersey and Philadelphia metropolitan areas as well as in the states of Michigan, Louisiana and the Baltimore-Washington, D.C., region.

After the deal closes, 86% of the company will be held by Great Atlantic shareholders and 14% will be held by former Pathmark shareholders. The company will have about 49 million shares outstanding.

The Tengelmann Group, Great Atlantic's majority shareholder, will remain the largest shareholder.

Bank of America and Lehman Brothers have committed to provide financing. But A&P said it will raise some cash for the deal by selling shares in Metro Inc. or, if needed, A&P capital stock.

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