Convertibles see record week with 16 deals totaling $4.47 billion; Cephalon, Continental climb

By Ronda Fears

Nashville, June 6 - It was a record week for convertible issuance with 16 separate issues totaling $4.47 billion, market sources seemed to agree. And it's likely to be a hot summer in terms of the pace of new issues.

Outside of new issues, traders said activity was very stilted.

The 16 deals tallied by Prospect News for this week separates the two-tranche deals from Schlumberger Ltd. and Cephalon Inc. The number includes a small $25 million but no investment bank-issued synthetic deals.

The $4.47 billion figure does not include any of the greenshoes that may be exercised. The week of April 7 had $4.57 billion in 4 deals and the week of May 12 had $4.48 billion in 13 deals, but both totals include exercised greenshoes.

Excluding consideration of greenshoes, it was the biggest week in terms of dollar volume as well as number of deals, according to Prospect News' analysis of convertible issuance.

"It's a record week, I believe, after May set a record in terms of number of deals with 48," said Jeff Seidel, head of U.S. convertible research at Credit Suisse First Boston.

"I think it's healthy. The convert market has shifted back to financing growth companies, small-cap companies, which will be good when the economy turns around. Of course, there have been a few trophy deals mixed in there too.

"I don't see anything knocking the wheels off this. The unusual part is there's just so many of them [deals]. It's amazing, and it's in a low volatility environment."

Indeed, other sellside analysts and sources on capital markets desks as well as buyside sources don't see a big slowdown for convertible issuance, even during the typical slow period that summer usually brings.

"People didn't really believe this rally [in issuance] when it began around mid-April, where we started seeing multiple deals every day," said Stuart Novick, convertible analyst at Citigroup.

"This could last a while," though, he added.

Issuers are motivated by getting favorable terms, he commented, as underwriters are still willing to reprice bought deals. Citigroup has counted 12 deals that were repriced below par by the underwriters.

"At some point that's probably going to come to an end, because it means basically you're doing the work for free," Novick said.

But, he said the benefits to the banking firm are getting or maintaining placement on league tables, which can be important during the slow times, and secondary trading that a deal can generate.

Issuers also have been lured to the market by bankers pitching structures that highlight the benefits of a convertible, particularly the call spread hedging strategy that can curtail potential stock dilution from the offering without seriously impacting the terms of a deal to buyers.

Cephalon Inc.'s deal was one of the best examples of the call spread strategy.

The two-part 0% converts were sold at par with 23.8% and 17.6% initial conversion premiums - which was a huge draw for buyers - but the company boosted the effective conversion premium, from its perspective, to 50% with a call spread transaction.

Both tranches of the new Cephalon converts were closed by lead bank CSFB at 100.5 bid, 101 offer.

Cephalon shares lost $2.09, or 4.34%, to $46.05 on very heavy volume.

The other high-profile home run of the week came from Continental Airlines Inc. - and its new issue continued to climb on Friday.

Continental's new 5% convert gained about 2 points to 109.375 bid, 108.875 offer as the stock slipped 2c, or 0.14%, to $14.60.

Other airline paper - namely Delta Air Lines Inc., Northwest Airlines Inc. and Alaska Air Lines Inc. - had rallied earlier in the week, but traders said those issues were flat Friday.

There is still buzz in the convertible market that American Airlines Inc., or parent AMR Corp., will look at tapping the convertible market, also.

Certainly, terms are very favorable to issuers.

Many deals of late have been refinancings with vastly more appealing terms to the issuers.

Getty Images Inc.'s deal this week was one of the most dramatic examples of that.

The company, which creates and produces photography and contemporary imagery for a variety of media, refinanced its 5% convertible due 2007 with a 0.5% convertible due 2023 and - the clincher - with the same strike price of $61.08.

"It's almost as good as it gets," said a capital markets source about the terms issuers are getting in the convertible market these days.

"I won't say it's as good as sliced bread, but it's just about as good as it gets."

"Free money" is the phrase most frequently used by salesmen and buyside traders.

Salesmen have commented about some difficulty in pitching deals with the aggressive terms seen in recent months but for the most part buyers have not entirely balked although some resistance is noted with deals that are reoffered below par.

With U.S. Treasury and reference rates at about 1%, most convertible pitchmen say it's not so difficult to get beyond the complaints from coupon-clippers given the equity component of a convertible - a feature not available widely in other debt markets, although a good number of junk bonds have equity kickers attached.

Moreover, money just keeps pouring into convertibles, even as stocks have begun to rally back, due to strong convertible returns that were propelled by the incredible rally in the credit markets.

CSFB's convertible index at the end of first quarter showed a gain of 3.81% for convert versus a 2.45% drop in the underlying stocks, Seidel noted. That began to level off in April with the massive stock rally, he said, with converts gaining about even with the underlying stocks. Still, he said year-to-date, through the end of May, converts are doing better than their underlying stocks.

Volatility and credits remain very tight, though, so the broad secondary market of convertibles is fairly valued, if not still a bit rich.

"Some of the premium compression is starting to happen but the only way to get any delta is with the new issues," Seidel said. He said conversion premiums topped out in the 90% area in March, dropped to the 80% range in April and for May was about 68%.

That also has helped convertible performance, he said.

"The credit rally is pretty much done. It can't get any tighter, I don't think," Seidel said.

But the anticipated underperformance of converts in the face of a strong stock rally, due to the huge conversion premiums, has not been dramatic.

Thus, new money keeps getting pledged to the convertible strategy and bankers say they still have a very healthy shadow calendar of deals coming to market.

Omnicare Inc.'s $250 million convertible trust preferred is the only firm deal sitting on the calendar for next week, though.

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