Saks, Kodak and General Mills trade in a mixed convertibles market; June marks improvements

By Rebecca Melvin

Princeton, N.J., June 30 - Household names like Saks Inc., Eastman Kodak Co. and General Mills Inc. were trading in the convertibles market on Thursday as traders kept an ear opened to interest rate news and began shifting into neutral to coast into the holiday weekend.

As expected, the Federal Reserve raised a key interest rate by a quarter-point, marking the ninth such boost in 12 months and pushing the federal funds rate up to 3.25%. But the Fed also promised to keep moving rates up at a "measured" pace, disappointing stock investors but relieving the Treasuries markets.

Although convertibles often take their cues from the bond market, neither the hike nor the Fed's sentiment were seen to have a direct impact.

"Convertibles trading is very issues specific," a sellside analyst in New York said. "The gains you're going to see in June are related to improvements in credit, especially across high-yield issues. It's a technical issue: the Fed move is just noise in the background that gives people something to talk about up on the monitors on CNBC."

Another sellside analyst in New York said that the increase was already priced in. "But over the long haul the rates to borrow are also going to go up," he said. "It's going to be more expensive to borrow funds to lever up investments."

The convertibles secondary market was mixed, with "odds and ends" trading in a fairly active market early on, said one convertibles source. But another sellside trader said, "It's pretty illiquid."

"Everything in June has already happened," an analyst said. "Now, we're just coasting to the end of the second quarter, and getting ready to come in next week and begin the third."

Saks sits up

Saks Inc. stock and its convertible, which is in technical default, rose sharply as a pair of research notes from Merrill Lynch's convertibles research desk circulated in the market and raised questions.

The first note dated June 29 posited that holders of the $230 million deal (at the time of issuance) of 2% convertibles were better off accepting a consent fee of 10 basis points rather than risking par redemption if the notes are accelerated.

In a second note, dated June 30, Merrill Lynch added that the risk of a par redemption now looks irrelevant given that the Saks 2% convertible has recently been trading above par - the Merrill analysts said they had seen them at 106 bid, 106.5 offered.

In trading Thursday, Saks' 2% convertibles due 2023 traded up three points in early action to 110 bid, 110.5 offered, versus a stock price of $18.45. At the close, it was seen at 111.50. Saks shares also jumped to close up $1.22, or 6.9%, to $18.97.

In follow up by Prospect News, Tatyana Hube, a Merrill Lynch vice president and part of the convertibles research team that puts out Merrill's Convertibles Flashnotes, said: "We got a lot of feedback from clients [about the first note]."

The first note explained the worst-case scenario based on conversations with the trustee, Hube said.

In addition, the second note modeled out valuation of the default put option over a longer period of time given the possibility that Saks won't be able to file by Sept. 1 as it plans. It may be that the retailer won't remedy the default until the end of October, Hube said.

What will happen isn't clear, Hube added. The stock could tank by September or October, or the company could offer a better deal, or a potential leveraged buyout could emerge, she said.

But an analyst at another firm commented: "The put has no value. It's only a good backstop depending on the timing of when it's putable."

The Birmingham, Ala.-based retailer received a default notice June 14 from New York-based hedge fund, Highbridge Capital. Subsequently, the company announced repurchase of three issues of outstanding debt and offered consent solicitations for three others, including the convertible, as it seek more time to file financial reports with the Securities and Exchange Commission.

If Saks does not obtain the consents and the convertibles are accelerated, holders would receive par.

Underwriter nonpareil

Meanwhile Prospect News data shows that Morgan Stanley remained the top underwriter of convertibles for the year so far, bringing to market $2.74 billion of convertibles, and well ahead of number-two ranked Goldman Sachs & Co. with $2.07 billion.

However, Deutsche Bank was number one in the second quarter and for the month of June. Its heft was due in large part because it was sole bookrunner for Cephalon Inc.'s $800 million sale on June 2.

For the year-to-date, issuance totals $16.27 billion, down by almost half compared with the same period a year earlier. But while 2005 activity remains significantly off from 2004, June's strong performance has tightened the gap. At the end of May, issuance was 39% of the 2004 figure.

General Mills, Kodak trade

Eastman Kodak Co.'s convertibles traded up 0.25 point in early activity Wednesday, according to a New York sellside trader. No news could be tied to its move. Its stock also gained somewhat during the session, but settled near its low for the day at $26.85, off 11 cents, or almost 0.5%.

The 3.375s traded Thursday at 107.875, versus a stock price of $27.50.

The convertible has never really recovered from a beating it took in April when Kodak reported a first quarter loss and received a downgrade from S&P, which cited uncertainties surrounding its business profile and the transition to being a digital film and camera company. Before that, the 3.375% convertible due 2033 had been in the 115 to 120 neighborhood.

General Mills' 0% convertible was essentially flat in continued brisk trading a day after the Minneapolis, Minn.-based food company reported fourth-quarter earnings and 2006 guidance below analyst expectations.

The 0% due 2022 traded at 70.625, unchanged from Wednesday, a trader said. Its stock lost $0.42 or 0.89% to close at $46.79.

Weatherford rises with deadline

Weatherford International Inc.'s converts traded up slightly for the day - capping a three point-plus climb since Monday - to meet the Houston-based oil services company's put/call deadline Thursday.

The 0% convertible due 2030 closed at 64, just over the put/call level of 63.98, versus a stock price of $57.98, traders said. Its shares closed on the New York Stock Exchange down 64 cents, or 1.1%, to $57.98.

Fellow oil services company, Schlumberger Ltd. held its ground in trade as its stock price slipped 1%, retracing some gains notched during a multi-day oil price spike that started last week and continued into the early part of this week.

Oil prices on Thursday sank to a two-week low. But Schlumberger's 1.5% convertible tranche A traded firmly at 115.50, versus a stock price of $76.75. On Wednesday, one sellside shop had the issue go out at 115.247 bid, 115.497 offered.

Market players didn't report any activity in Pride International Inc.'s three convertible issues. Pride announced after the close Wednesday that chief executive Paul Bragg had resigned and will be replaced by current chief financial officer Louis Raspino.

Bear Sterns said in an equity report Thursday that the management change is positive for the stock and brings an end to an era of disappointing performance.

"We believe that Raspino is an excellent choice to lead the company; he has already had a positive impact as CFO," the report said.

The underwriter also said that its earnings per share estimates remain at $0.67 for 2005 and $1.40 for 2006; and it rated the stock at outperform with a price target of $33.

Pride stock closed up 65 cents, or 2.6%, at $25.70.

Medicis/Inamed wrinkle-free

In what one player described as the lack of anything else to do Thursday, the market jumped on Medicis Pharmaceutical Corp. on a new report praising its proposed merger with Inamed Corp., which actually was announced a couple of months ago and expected to be completed by year-end.

With the Inamed merger, Medicis is seen by analysts as making headway in the competition with Allergan Inc.'s Botox with their Reloxin and Restylane products.

"It was so blasted slow today, with the Fed, that just about any tidbit of news or mention from an analyst would move the market," said an equity trader at a bulge bracket firm on Wall Street, when asked about the move in Medicis and Inamed without any news on the tape about that situation.

A convertible trader, though, noted a small amount of activity in the Medicis convertible. He said the 1.5% bond traded 4 points higher at 97.125, but he too saw no real impetus for the move other than the gain in the underlying stock. Medicis shares rose 83 cents, or 2.66%, to close at $31.70 while Inamed gained 96 cents, or 1.45%, to close at $67, with both stocks seeing moderate volume.

"I suppose a 1.625% yield might look okay in this market, but I wouldn't be that keen to put position on," the trader said, panning the "paltry" yield and the fact that a new $650 million seven-year senior secured credit facility Medicis is working on to fund the acquisition will put more debt ahead of the convertible.

The only mention of the two companies on the wires Thursday was when Leerink Swann & Co. started coverage of Medicis shares with an outperform rating. Medicis, based in Scottsdale, Ariz., is a specialty pharmaceutical company focused primarily on products for the treatment of acne, eczema, rosacea and psoriasis as well fine lines and wrinkles.

Gary Nachman, Leerink Swann analyst, said his investment rating is based on the successful outcome of the proposed merger, which he believes would increase the company's exposure to the high-growth cosmetics market. He sees the merger as a strategically smart move for Medicis because it should help drive significant long-term growth at the combined company.

Connetics shrugs off bumps

Another dermatology name, Connetics Corp., was active Thursday, as well. Having largely recovered from an FDA setback in mid-June for its acne treatment Velac, Connetics saw another big bounce as analysts pointed to a "robust pipeline" of potential revenue-producing products despite the trouble with Velac.

On June 13, Connetics revised its earnings and revenue forecasts downward in response to the FDA's rejection of its experimental acne treatment, Velac gel, over concerns that the treatment could cause cancer. It came after the FDA rejected the Palo Alto, Calif.-based company's experimental treatment for fungal infections last year.

That news sent Connetics shares plunging 27% to $15.13 and its convertible bonds followed suit with the new 2% senior unsecured notes due 2015 falling to the 77.5 area and old 2.25% senior notes due 2008 in the 93 neighborhood.

By Thursday, the stock had climbed back over $17 and the Connetics convertibles had added back 5 to 6 points. Connetics shares on Thursday gained 26 cents, or 1.5%, to $17.64.

Leerink Swann's Nachman launched coverage of Connetics on Thursday, as well, with an outperform rating and said he believes Connetics' proprietary products and robust pipeline will produce solid earnings growth over the next several years. In fact, he said now is an attractive entry point after the selloff in the stock on the Velac disappointment.

The news in mid-June spurred Friedman Billings Ramsey to cut its stock rating on Connetics to market perform from outperform, and slash its price target to $18 from $30.

Ronda Fears contributed to this report

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