Fresh paper flutters in lower session; Sirius rebounds; Continental, airlines easier

By Ronda Fears

Nashville, Nov. 19 - New paper was mostly in a down session Friday as oil prices spooked the stock market. GenCorp Inc. was the only new issue from this week's healthy calendar continuing to gain.

On the spike in oil that rocked stocks, airline paper took a particularly hard hit. But some convertible arbitrageurs were finding interesting trades in the regional airlines, and in fact see the airlines as the best way to play the oil situation. Also, some arbs were picking up Continental Airlines Inc. as the company began seeking another $500 million in salary cuts, although it weakened alongside other airlines.

Traders also mentioned that a Merrill Lynch report on high gamma convertibles sparked some inquiries, particularly Computer Associates International Inc. and Xcel Energy Corp., as players search for equity exposure plus some downside buffer.

Holders of UnumProvident Corp. were gloating about recent buys on weakness in the insurance name, as it shot up Friday on news that the company had reached a settlement with federal and state investigators regarding its disability claims handling policy.

New issues waver off highs

Fresh paper, while eagerly welcomed, faltered a bit on the weak session Friday, but GenCorp's deal bucked the downdraft to gain another 1.25 points.

GenCorp's new 2.25% convert, which was nearly derailed last week by a protest from a big holder of the aircraft parts maker's stock, shot up to 108.75 bid, 109.75 offered. GenCorp shares gained 6 cents on the day, or 0.35%, to $17.26.

The GenCorp issue was upsized to $80 million plus the greenshoe was bumped up to $80 million from original plans for $50 million with a $25 million shoe - an unusual event insofar as having a greenshoe equal to the deal size. But a sellside market source pointed to Apex Silver Ltd.'s deal last month that was pitched as a $75 million deal with a $75 million shoe, which turned out to get boosted to $100 million while cutting the shoe to $50 million.

Overstock.com Inc.'s new 3.75% convert was cropped by 2.5 points to 103 bid, 103.5 offered, while the underlying stock fell $2.97, or 5.11%, to $55.13 on widespread weakness in the retail sector.

Level 3 Communications Inc.'s new 5.25% convert, a laggard among new issues right out of the gate, was softer by a quarter-point to 100.75 bid, 101.75 offered, while the internet access provider's stock was unchanged at $3.45.

Charter Communications Inc.'s new 5.875% convert slipped by 2 .5 points to 103.4 bid, 104.5 offered with the cable company's stock down a nickel, or 2.3%, to $2.12.

Six Flags Inc.'s new 4.5% convertible bonds were unchanged at 104.25 bid, 105 offered while the theme park operator shares edged up 2 cents, or 0.41%, to $4.85.

XM hits static, Sirius zooms

XM Satellite Radio's new $300 million 1.75% convert, which was re-offered at 99, hit a patch of static, remaining Friday at 98.75 bid, a buyside trader said, while the stock added 36 cents, or 1.04%, to $35.01. Sirius Satellite Radio Inc., however, chalked up a sharp rebound.

"There may have been some lookers [for XM's new convert] because of the price, but Sirius pretty much stole the spotlight," the trader said.

Washington, D.C.-based XM and New York-based Sirius have been in heated competition for the rapidly growing satellite radio broadcasting space, and both are old-timers to the convertible market. XM, with some 2.5 million subscribers, is ahead of Sirius with its estimated 600,000 but Sirius is seen making great headway with recent hires such as shock jock Howard Stern and new CEO Mel Karmazin, a former president of Viacom Inc. Sirius is targeting 1 million subscribers by the end of 2004.

Sirius took a hit Thursday on a downgrade to the stock as analysts pointed to its cash burn rate, but it rebounded Friday on the Karmazin news.

The new Sirius 3.25% convert due 2011, issued last month, added back 7.25 points to 131.5 bid and its 2.5% convert climbed 8.5 points to 142 bid. Sirius shares, which rose as much as $1.12, or 23.75%, in after-hours trading Thursday, closed Friday up 45 cents, or 9.45%, to $5.17.

Continental seeks labor cuts

Continental Airlines announced late Thursday that it would seek another $500 million in wage concessions from employees in an ongoing effort to return to profitability.

"The fact that top executives are taking pay cuts helps their cause greatly," said a hedge fund trader, who added that there were convert arbs taking longer positions in Continental's converts, particularly its convertible preferred.

Continental's 6% convertible preferred gained about 1.5 points to 22.25 bid, he said, while the 4.5% and 5% convertible bonds lost 1.5 to 2 points. Continental shares on Friday dropped 70 cents, or 6.17%, to $10.65 - one of the deepest declines among airline stocks, which were all lower on the rise in oil futures.

Incoming CEO Larry Kellner will cut his base salary and performance compensation by 25 % and Jeff Smisek, who is replacing Kellner as president, will reduce his base salary and long-term compensation by 20%, according to Continental.

Continental said the $500 million is a minimum target, adding to $1.1 billion in annual savings already announced. The company wants to wrap up the wage matter by the end of February.

Standard & Poor's noted that Continental is the last of the six major airlines to go for wage cuts, but it has a better operating and costs structure than its peers.

Airlines make good oil play

Beyond the majors, regional airlines also were hit Friday by the $2 a barrel spike in oil futures to over $48. Buyside traders said there was some repositioning in those stocks by convert arbs, too, and credit analysts were talking about that sort of trade as well. There was not a lot of activity in the convertibles in that space, however.

Beyond the hedging activity, a convertible fund manager in New York said, "The best way to play oil is to short airlines if you're bullish and buy airlines if you're bearish. We see huge opportunities in airlines - if one understands the fundamentals."

And some of the best ways to play airlines is to hedge the regional airline sector.

The trader mentioned arbs shorting Flyi Inc., which has been hit hard due to its link to troubled Delta Air Lines Inc. as well as bankrupt United Air Lines parent UAL Corp., while going long in ExpressJet Holdings Inc., which is associated with Continental.

CreditSights analysts Roger King and Glenn Reynolds in a report Friday wrote that the regional carriers may be up for a fresh round of noise as United put its Air Wisconsin contract out for competitive bid, which they see as a turning point for the industry, likely to lead to other majors repricing regional airline contracts.

"Risks in the regionals [airlines] started to markedly increase with the United bankruptcy and it keeps getting worse in a period characterized by a mix of opportunity and turmoil," the analysts said in the report.

Regional airline stocks in flux

The wide range in regional airline stock valuations should compress, the CreditSights analysts said, thus creating some interesting hedging opportunities.

"In a watershed event for the regional airline industry, United is putting its Air Wisconsin contract out for bid. The cozy symbiotic relationships are over as the financially challenged major carriers begin squeezing their regional affiliates and pitting them against each other for business," King and Reynolds said in the report.

"Without stand-alone operations to fall back on, the regionals have little power to maintain altitude. Wide ranges in valuation offer arbitrage opportunities."

The analysts suggested a long equity position in ExpressJet and several other regionals that do not have convertibles in play, against short positions of a couple of names also without a presence in the convertible market. Mentioned for long positions were Pinnacle and Mesaba, both captives for Northwest Airlines Corp., and for short positions independent regional airlines SkyWest and Republic/Chautauqua.

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