New deal train chugs slowly along with string of small deals; dividend risk still high profile

By Ronda Fears

Nashville, Aug. 13 - Convertibles were flagging as stocks floundered in response to falling bond prices Wednesday, but cheapening is expected to continue and in fact pick up in pace as bonds continue to decline and there is no corresponding rise in stocks.

Meanwhile, the new deal party was rocking on, albeit at a much slower rhythm with a trio of small deals in the wings. AtheroGenics Inc., InVision Technologies Inc. and Serologicals Corp. are marketing deals that together total just $275 million.

While convertible market watchers still see the market cheapening, some expect valuations to drop sharply over the next month and throughout the remainder of the year.

A major culprit is money being taken off the table as hedge fund returns lag now for the third consecutive month.

"Some funds of funds are liquidating or in the process of sending out redemption notices," said one market observer.

"With two months of negative returns, the interest rate curve widening and no corresponding risk in equities, money will be taken off the table.

"Valuations will definitely cheapen. It can spiral quickly. No one's saying meltdown spiral yet, but there's going to be some pain probably through December."

It's part of the cycle of a mature market, though, the observer added, and a healthy one as the cheapening will bring in new money to the convertible asset class.

Indeed, in the past month at least two large convertible strategies have been launched, one with an arbitrage and the other with a multi-strategy approach. Both are in the start-up phase, so asset totals or targets were not available. But they follow at least two outright fund launches totaling nearly $1 billion together since April.

Dividend risk remains a factor in the market cheapening, too, and that has been a focal point since Mandalay Resort Group sparked the scare in May.

The latest "fiasco," as one dealer put it, was Triarc Cos. Inc.'s announcement earlier this week.

Triarc's 5% convertible due 2023, issued just in mid-May, leveled off Wednesday to 100 bid, 101 offered, traders said. It dropped around 4 points Monday when the restaurant chain initiated a dividend.

The company announced an initial cash dividend to class A stockholders of 6.5c a share, plus a special dividend of 2 shares of new class B common stock. Also, the company initiated a cash dividend of 7.5c a share for the class B stock.

"People were upset at Triarc initiating a large dividend, [it] cost quite a bit of money for arbs," said a buyside market source.

The big contention, he said, hinged on the class B stock. When the convertible issue was being marketed, he said, it was understood that the company would not be paying a dividend on class B stock.

But, Triarc said in a filing with the Securities and Exchange Commission regarding the stock dividends that it will be adjusting the conversion rate on the convertible notes to account for the class B stock.

Radian Group Inc. is another name circulated in relation to dividend risk. The company last week declared its regular quarterly dividend of 2c a share, but a market source said there is some anxiety that the company might boost the dividend as it has "lots of cash."

The Radian 2.25% convert due 2022 closed Wednesday up slightly, about 0.125 point, to 102.5 bid, 103 offered. The stock added 4c to $44.50.

Elsewhere in secondary dealings, energy and power names continued to crumble under selling pressure. The most noteworthy drops were in Dynegy Inc. as it lowered its 2003 guidance and further declines in Reliant Resources Inc. on the heels of its big loss and lowered outlook.

Dynegy slashed its earnings expectations for 2003 financial, citing costs related to the $1.5 billion restructuring that included its new convertible notes earlier this month. The company now expects net income of $780 million to $835 million, or $2.10 to $2.24 per share.

Also, Dynegy noted in earnings statements that it had less cash on hand and bank credit than a month ago, also due to the refinancings.

Dynegy's new 4.75% convert due 2023 was about 2.5 points lower, a trader said. The stock closed off 13c, or 4%, to $3.04. Dynegy's junk bonds were down about 2.5 points, the trader said.

Reliant continued to drift southward too. The 5% converts lost another 3.5 points to 68.5 bid, 69.5 offered and the 9.25% junk bonds due 2010 fell 3.25 points to 83.25. Reliant shares, though, gained 12c, or 3%, to $4.

In the primary market, there was only a trickle of tiny deals to look at.

AtheroGenics was at bat with a small $75 million deal. The five-year Rule 144A notes were talked to yield 4.0% to 4.5% with a 22.5% to 27.5% initial conversion premium. A market source said after the close that it looked like the deal priced at 4.25%, up 25%, but that had not been confirmed with the bookrunner.

AtheroGenics shares ended down $1.75, or 12.26%, to $12.52.

InVision's $100 million of 20-year convertible senior notes talked to yield 2.25% to 2.75% with a 27.5% to 32.5% initial conversion premium was described as a bit rich by sellside analysts, and a repricing or reoffer below par was speculated. The deal won't price until after Thursday's close.

Lehman Brothers analysts put the InVision deal, at the midpoint of guidance, 1.88% rich, using a credit spread of 650 basis points over Treasuries and a 35% stock volatility, plus noting a difficult stock borrow.

Late Wednesday, Serologicals launched $100 million of 30-year convertible notes talked to yield 4.25% to 4.75% with a 25% to 30% initial conversion premium, also for pricing after the close Thursday.

Cadence Design Systems Inc.'s new 0%, up 17% convert, which was reoffered at 98 by bookrunner JPMorgan, dropped 0.8125 point to 97.5625 bid, 97.6875 offered.

QLT Inc.'s new 3% issue gained 0.75 point to 104 bid, 105 offered. And, the new GATX Corp. convert was quoted at 102 bid, 103 offered.

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