SanDisk dragged lower by guidance; Kyphon deal seen as fair; XM attracts buyers; four deals launched

By Kenneth Lim

Boston, Jan. 31 - SanDisk Corp. dropped outright on Wednesday after the company announced disappointing first-quarter guidance.

Kyphon Inc. was quiet in the gray market early in the day, with observers describing its offering as slightly cheap with potential for credit improvement.

XM Satellite Radio Holdings Inc. saw some buying interest, but traded unchanged from week-ago levels as the convertible found technical support following a recent slump.

The XM 1.75% convertible due 2009 traded at 85 versus a stock price of $14.25, while XM stock (Nasdaq: XMSR) closed at $14.21, up by 2.23% or 31 cents.

"We've seen some buyers come in on the XMSRs," a sellsider said. "It's been weak the past week or so with all the consolidation rumors, but I think you'll start to see support at this levels. At the 84 level it'll cross into high-yield territory at that level."

Shares of XM, a Washington-based satellite radio provider, lost some of its upward momentum mid-January after speculation of a merger with rival Sirius Satellite Radio Inc. lost steam following a regulatory official's comments that current rules do not allow for a merger. The shares came under pressure again just over a week ago after a judge allowed a suit against XM's "XM+MP3" players to proceed.

For the general convertible market, news on Wednesday that the U.S. Federal Reserve was leaving short-term interest rates unchanged failed to cause a stir.

"It's pretty benign," a sellside convertible trader said.

"We need a good shake-up here. If they moved interest rates up or down it would have been better. In the convertible universe, we thrive on dislocation, things going unexpectedly right or wrong, but in some direction. The VIX [CBOE Volatility Index] is at 10.45 right now, it's near five-to-10 year lows...Convertibles are just kind of languishing here."

Meanwhile, convertible issuance fell into a slump in January, with proceeds raised falling year-on-year despite an increase in the number of deals. But the primary market is set for a burst of activity, with $4 billion of new deals by U.S. Bancorp, Boston Properties Inc., Newport Corp. and Trico Marine Services Inc. announced after the markets closed.

SanDisk falls on poor guidance

SanDisk's 1% convertible due 2013 fell about 3 points outright and was mostly in line on a dollar-neutral basis after the company issued first-quarter guidance that fell short of expectations.

The convertible was marked at 85.25 bid, 85.75 offered versus a stock price of $39.90 on Wednesday. SanDisk stock (Nasdaq: SNDK) fell 6.19% or $2.65 to close at $40.18.

"The bonds are actually trading off somewhat," a sellside convertible strategist said. "These bonds get bid up on a pretty juicy volatility anyway. The last few times, even though the stock was hit, the bonds also traded off. There's such a volatility premium built into the name."

SanDisk on Tuesday reported a fourth-quarter net loss of $35.1 million, or 17 cents per share, from $133.9 million, or 68 cents per share, in the year-ago period. But excluding charges related to SanDisk's acquisition of Msystems in November, the Milpitas, Calif.-based flash memory maker would have earned 87 cents per share.

The company guided for a sharp drop in average selling prices, and forecast first-quarter revenue of $700 million to $800 million, below Street estimates of about $930 million.

"It's a disappointment that they're looking at lower guidance for Q1 than people were expecting, but I don't think that it's that surprising an event," a sellside convertible analyst said.

The analyst said SanDisk "seemed to lay everything out in a pretty rational way" during a conference call, and the company continues to expect "big gains year over year."

"I think it's in that kind of environment where it cycles through this kind of thing fairly quickly," the analyst said. "It's fairly tough for any of them to get their forecast correct...It didn't sound troubling. I wasn't really too disturbed by it. It looks like a relatively short-term supply and balance issue. The long term fundamentals of flash memory are still very good."

The analyst agreed that a fair amount of volatility was expected in the stock.

"I was modeling them with a 40% vol, and that's pretty unusual these days even in tech, and this is the kind of stock where you will get that type of volatility once a quarter or even more than that," the analyst said.

"But by the same token, though, when it gets to the point where once it's all priced in, then it's questionable whether you're going to extract that kind of a return you were expecting. If it's all priced in and then some, and then the bonds get to the point where they're actually rich, then you'll be like running fast just to stay in place."

Kyphon seen as fair

Kyphon's planned $350 million offering of five- and seven-year convertible senior notes were quiet in the gray market early Wednesday, but analyst described the deal as slightly cheap with potential for credit improvement.

Kyphon's deal was expected to price after the market closed.

The $175 million five-year series is talked at a coupon of 0.75% to 1.25%, while the $175 million seven-year series is talked at a coupon of 1% to 1.5%. The initial conversion premium will be 20% to 25% for both tranches. Kyphon stock (Nasdaq: KYPH) closed at $46.90, higher by 4.11% or $1.85.

Each tranche has an over-allotment option for a further $25 million.

Goldman Sachs, JP Morgan and Banc of America are the bookrunners of the Rule 144A offering.

Kyphon, a Sunnyvale, Calif.-based maker of spinal medical devices, said it will use the proceeds of the offering to retire part of a $425 million senior syndicated bank term loan that it used to buy St. Francis Medical Technologies. It will also use the proceeds to fund convertible hedge and warrant transactions.

"It doesn't look bad, actually," a sellsider said, adding that both tranches modeled "101-ish" at the midpoint of price talk. "There's definitely room for credit tightening."

The sellsider was using credit spreads in the mid- to high-200 basis points region, and a volatility in the mid-30% range.

Another convertible analyst also had the convertibles just below 1% cheap using similar assumptions, but thought that the deal was only fair.

"It's fairly attractive, but it doesn't set up well with these tiny coupons," the analyst said. "It's OK. It's not great."

The analyst agreed that the company's credit had potential to improve, but thought that there was still a lot of risk involved. The company could continue to seek acquisitions, which might increase the risk while lowering the volatility as the company's market capitalization increases, the analyst said.

"There's still a lot of risk with all the acquisitions that they're making," the analyst said. "I think it'll probably do better if they reprice it so that it prices a little cheaper. At the midpoint it's not all that attractive."

Slow start for issuance

January saw issuers create $1.872 billion of new convertibles through nine deals, excluding Kyphon's, about 37.3% less than the $2.987 billion raised through seven convertibles in the year-ago period.

Lehman Brothers took an early lead in the convertible league tables, bringing about $376 million of new convertibles to the market through three offerings. Morgan Stanley, which did not make it to the top 10 underwriters in January, nevertheless was the most prolific underwriter when synthetics were counted. Including investment bank exchangeables, Morgan Stanley's eight deals raised about $430 million in proceeds. In second spot is Lehman, followed by Citigroup.

But the primary market came back to life on Wednesday, with the announcement of four deals that could raise about $4 billion over the next few days.

U.S. Bancorp's $3 billion overnighter will be the largest deal so far this year. Its planned 30-year convertible senior debentures were set at a coupon of Libor minus 175 basis points and an initial conversion premium of 15%, and reoffered between 99 and 99.125.

There is an over-allotment option for an additional $450 million.

Deutsche Bank is the bookrunner of the overnight Rule 144A offering.

U.S. Bancorp, a Minneapolis-based bank, said it will use the proceeds of the deal to concurrently buy back up to 14 million shares of its common stock and for general purposes.

Boston Properties' $750 million of 30-year exchangeable senior notes will also price before the market opens on Thursday. Its notes were set at a coupon of 2.875% and an initial conversion premium of 20%, and reoffered between 97.75 and 98.

The notes will be issued by Boston Properties LP, a subsidiary of the listed company. They will be exchangeable into Boston Properties Inc. common stock.

There is an over-allotment option for a further $112.5 million.

JP Morgan and Morgan Stanley are the bookrunners of the overnight Rule 144A offering.

Boston Properties, a Boston-based real estate investment trust focusing on office properties, said the proceeds will be used for general purposes, including repayment of debt, development opportunities, asset acquisition and other future investment opportunities.

Trico Marine's $125 million of 20-year convertible senior debentures is talked at a coupon of 2.75% to 3.25% and an initial conversion premium of 35% to 40%, and pricing is slated for Thursday after the close.

There is an over-allotment option for a further $25 million.

Lehman Brothers is the bookrunner of the Rule 144A offering.

Trico, a Houston-based provider of marine support vessels for the oil and gas industry, said the proceeds of the deal will be used for general purposes, which may include pursuing opportunities in emerging markets, increasing its fleet renewal program and making strategic acquisitions.

Newport's planned $150 million of five-year convertible subordinated notes will price on Monday, Feb. 5, after the market closes. Those notes are talked at a coupon of 2.5% to 3% and an initial conversion premium of 22.5% to 27.5%.

There is an over-allotment option for a further $25 million.

Merrill Lynch is the bookrunner of the Rule 144A offering.

Newport, an Irvine, Calif.-based maker of lasers, photonics and precision products, said $48.2 million of the proceeds will be used to pay off debts owed to Thermo Electron Corp. and $40 million will be used to concurrently buy back its common stock. The remaining proceeds will be used for working capital and general purposes.

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