Further cheapening noted, but many buyers waiting in wings; new deal slate remains active

By Ronda Fears

Nashville, Aug. 5 - Dealers said the convertible market continues to cheapen, but buying interest still seems to be hanging in the wings. Meanwhile, there was a small deal pricing after the close and a $700 million issue launched for Wednesday's business.

Jitters over rising interest rates continue to pressure the markets and convertible investors are trying to get a grip on how to tackle the situation, traders said. A buyside trader said hedge funds are looking for rate risk protection but are "greatly encouraged" by a spike in volatility.

"The market is getting cheaper but we're not seeing a lot of buyers yet; we saw more sellers today," said a dealer.

Buying "interest is building at some of the levels we're seeing, though," the trader added.

Most of the market lost ground, with sharp markdowns in biotech paper - Alexion, Cephalon, Gilead and Baxter. Tech issues also softened considerably on lackluster guidance out of Cisco.

Of course, Costco was the big talk of the day - getting slammed on all sides after it cut its guidance.

"Just as the back-to-school season hits, all the retail names are getting slammed," said a dealer.

Costco's converts plummeted 14 points on the day to 70 bid, 70.5 offered while the stock fell $6.09, or 18.67%, to $30.06. Convert traders said Costco's straight bonds were hit, as well.

The Costco news hurt other retailers, like Gap Inc., also. Gap's convertibles dropped 2.25 points to 127.5 bid, 127.625 offered while the stock ended off 38c, or 2.13% to $17.48.

School Specialty also was active, with the new 3.75% convertibles losing 1.625 points to 95.125 bid and the 6s dropping 2.75 points to 103.625 bid. The stock fell $1.03, or 3.78%, to $26.25.

Shaw Group and Tyco also were lower.

Shaw's convertible was quoted down 2.25 points to 58.75 bid, 59.75 asked. The stock dropped 99c, or 12.12%, to $7.18.

Tyco's 2.75s were quoted off 1.25 points to 101.5 bid, 102 offered and the 3.125s down 1.5 points to 101.75 bid, 102 offered. The stock lost 45c, or 2.45%, to $17.95.

Cheapness also has extended into most of the new issues of late, but several sellside analysts didn't find the Church & Dwight Co. Inc. deal so cheap.

Church & Dwight marketed the $110 million of 30-year convertible notes throughout the day, aiming to price it after the closing bell. It was talked to yield 4.75% to 5.25% with a 42.5% to 47.5% initial conversion premium.

At the midpoint of talk, Lehman Brothers analysts put it 2.7% rich, using a credit spread of 450 basis points over Treasuries and a 20% stock volatility. Merrill Lynch & Co. analysts put it 0.12% cheap, using a credit spread of 380 bps and an 18% stock volatility. Deutsche Bank Securities put it 2.45% rich to 0.75% cheap, using a credit spread of 375 bps over Libor and a 21% stock volatility.

Lehman analysts noted that the new deals on average were 3.52% cheap in July.

After the close, DST Systems Inc. also trotted out a deal, with pricing slated after Wednesday's close. The two-part cash-to-zero convert will be for up to $700 million with the initial conversion premium on both tranches talked in a range of 43% to 48%. (See story on page 1 for full details.)

Series A is talked to yield 3.375% to 3.875%, paying a cash coupon for seven years. Series B is talked to yield 2.875% to 3.375%, paying a cash coupon for five years.

Traders noted that most of the activity in the secondary market is still concentrated in the new issues put into play recently.

Yellow Corp.'s new 5% convertible continued to climb right out of the gate. Bookrunner Deutsche closed it with an offer of 102.5 while the stock ended off 60c, or 2.34%, to $25.05. The deal was upsized to $200 million from $150 million, and priced at the middle of guidance.

Andrew Corp. sold $200 million of 10-year convertible notes at par to yield 3.25% with a 38% initial conversion premium - at the cheap end of guidance. Citigroup, one of the lead managers, closed it at 100.5 bid, 101 offered. The stock closed off 1c to $9.97.

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