Kmart relatively quiet and stable after slide into bankruptcy; Gaylord up as merger deal lives again

By Paul Deckelman and Paul Harris

New York, Jan. 23 - With the storm now over - for the moment - and their company in the relatively safe harbor of the bankruptcy courts following Tuesday's Chapter 11 , Kmart Corp. bond investors spent Wednesday assessing the damage. Meanwhile, two big nominally investment-grade names took big hits Wednesday that knocked their bonds down to junk bond-like trading levels, while Gaylord Container Corp. debt was quoted higher on news that the previously derailed merger with Temple-Inland Inc. was back on the tracks.

In primary market activity Wednesday, terms emerged late in the session on Pathmark Stores, Inc.'s $200 million of 10-year notes late in the session. A new, although long-anticipated deal from Solectron Corp. was formally announced. And price talk was heard on PanAmSat Corp.'s $500 million offering.

However, Compton Petroleum did not price its $150 million offering and word came from syndicate sources late in the session that the deal had been postponed.

"I'm puzzled that there's not more volume coming here," one sell-side official commented late Wednesday, noting a less-than-anticipated amount of business on the forward calendar.

"For some reason there's just this cautious tone. It's weird, because if you ask me it's the right time to bring the deals."

Before lunch, news circulated around the market that price talk of 8½% - 8¾% had emerged on PanAmSat's $500 million of 10-year senior notes (Ba3/B) via joint bookrunners Credit Suisse First Boston and Deutsche Banc Alex. Brown. Although some market sources are expecting the deal to price as early as Thursday afternoon, a syndicate source told Prospect that PanAmSat would not price until Friday morning.

Diane Keefe, portfolio manager of the Pax World High Yield Fund, told Prospect News on Wednesday that she had taken a good look at PanAmSat.

"It looks interesting," Keefe said. "In the Q&A one buy-side guy mentioned how loose the covenants are. And the management was trying to tell him that the bank debt covenants were going to be a lot tighter than the bond covenants. People would always prefer to see the bond covenants tighter.

"But it's a good company," she continued. "There's good assets there, with the satellites. And they've got a good market position. And I'm sure Charlie Ergen (CEO of EchoStar) is going to be thrilled to manage the consolidated entity when it finally comes under his control.

"That's probably going to be a very good deal."

Keefe, whose two-year old Pax World fund posted an 5.85% total return for 2001, also told Prospect News that she was interested in Coventry Health Care's offering of $175 million of 10-year notes (Ba3/BB+) via Salomon Smith Barney, which is expected to price early in the week of Jan. 28.

"I think they have room to improve their margins going forward," she said. "Their margins are in the middle of the group, and they seem like they're pros in terms of the way they've operated in the past with improving the margins with the acquisitions.

"And we really like the health care sector because it's recession-resistant. And we are continuing to tilt our portfolio in a conservative mode.

"We are not as sanguine about the economy as most folks are."

Keefe, whose "socially-screened high yield fund" zeros in on environmentally-friendly credits with diverse managements, and refrains from alcohol, gaming and big military contractors, told Prospect News that she expects 2002's trend of significant inflows of cash into high yield to continue.

"I think that people are looking for a port in the storm," she said. "We were up last year on average as a market, which is not something you can say for the stock market. And the Fed doesn't have that much more flexibility to ease from here.

"That doesn't leave the fixed income markets a lot of room to rally if they are interest rate-dependent. And the high yield market is the only fixed income market that isn't as interest rate-dependent as the rest of them are."

The only new announcement Wednesday came from Solectron, which will launch $500 million of seven-year notes (Ba1/BB+) Thursday via Goldman Sachs & Co. The deal, which had been mentioned by the company before the holidays, is expected price late in the week of Jan. 28 or early in the week of Feb. 4.

And late Wednesday Pathmark's $200 million of 10-year notes priced at par to yield 8¾%, "at the low end" of the 8 ¾%-9% price talk.

In secondary activity, a day after having sought protection from the holders of more than $2.7 billion of junk bonds and other creditors via a Chapter 11 filing with the U.S. Bankruptcy Court for the Northern District of Illinois in Chicago, Kmart's bonds were seen "pretty much bouncing around" within a range, a trader said, adding that "if you traded during the morning and then went out and came back in the afternoon, it would look as though nothing had happened."

The Kmart paper "runs (upward) a little bit in the morning, as people cover some shorts and then get finished and as retail (non-institutional investors) looks at some of the stuff, and then it softens up, to end pretty much flat (unchanged) on the day," he said.

He quoted Kmart's benchmark 9 3/8% notes due 2006 opening the day around the same 47 bid/49 offered levels at which they had finished Tuesday; then the bonds firmed to bid levels in the 49-50 area before dropping back to close out the day around the same 47 bid/49 offered area where they had started. Kmart's 7.95% notes due 2023 got as high as 49 before retreating back to around their opening levels at 45 bid/48 offered. "There was a lot of volatility - but not much change by the time the day was over," he said.

A trader specializing in distressed issues agreed that Kmart had done "not much" during the session, "basically floundering around in the high 40s. It didn't go up much or go down much, staying mostly unchanged from yesterday's levels."

Volume, he said was "not a lot for a name like that, for the cap(ital) structure and the situation it has, not a lot."

He opined that this might be because "a lot of guys got out of it earlier," as the troubled Troy, Mich.-based discount retailing giant's house of cards began to totter and fall. In the three weeks since Prudential Securities equity analyst Wayne Hood warned in early January that the company might have to flee to the bankruptcy courts if it didn't improve its cash-flow generation, the bonds have gone from about the high 80s into upper 40s.

Also, he said, despite the fact that "many people think the bonds are cheap at current levels," given the company's substantial and well-documented problems, "this is not a name that inspires a great deal of passion in a lot of people. Even if they scrap a few hundred stores (a move analysts say the company must undertake if it is to have any chance of surviving and emerging from restructuring), how long is it going to be before they have to do it again?"

In contrast to the lack of enthusiasm which Kmart's slide into his territory has produced, the distressed-debt trader said, is the sense of anticipation with distressed-debt players feel regarding a name like Georgia Pacific Corp. - even though the Atlanta, Ga.-based forest products producer is still nominally investment-grade rated, its bonds clinging precariously to high-grade respectability at Baa3/BBB- - but with Moody's Investors Service having warned earlier in the month that it might cut its rating on the bonds to junk. In that Jan. 7 announcement, the ratings agency cited the prospect of weaker profits, a high debt level and uncertainty over asbestos liability - all music to the ears of distressed-debt investors, the trader rhapsodized. "We love to see names like that sashaying into our world.

"They're going to be here" sooner or later, he continued. "They're pretty leveraged to begin with, they've had kind of a lousy year and the asbestos problem. Liquidity is now going to be tight. And for the wild card, you've got Moody's out there. I definitely think they're coming to the high yield sector. It will be interesting to see if they come to the distressed sector."

If that were to happen, it would be the third such quick passage of a big investment-grade bond issuer down into the high-yield world and from there to distressed-debt territory, following the record-speed collapse of Enron's bonds over the course of less than a week in late November and early December and the slide in the debt of Kmart. The latter quickly went from being a split-rated 5-B credit to default and bankruptcy within a matter of several weeks. Ideally, the trader said, "these things should happen about once every two months to let us chew on it for a while," but he said Georgia Pacific might accelerate that timetable.

On Tuesday, the almost-junker's debt - still quoted on a spread-over-Treasuries basis, like other investment grade credits - had widened out anywhere from 85 to 127 basis points, depending on the bonds' maturity, on the news that Willamette Industries Inc. had walked away from its proposed purchase of Georgia Pacific's building products unit and had instead opted to be acquired by paper products rival Weyerhaeuser Co. Georgia Pacific had been counting on the sale of the building products unit to pay down much of the $11 billion of debt it took on to finance the 2000 purchase of tissue maker Fort James Corp. The building products unit, like many other companies in that industry, also represented a source of potential asbestos liability problems which Georgia Pacific was hoping to get away from.

After that slide, the bonds "took a ride" Wednesday and continued to move down, a secondary market source said, noting that they were now being quoted in dollar-price terms, like junk bonds, even though their rating - for the moment - remains on the investment-grade side of the dividing line. He quoted Georgia Pacific's 8 7/8% bonds due 2031 dipping to 79 bid from 81.5 bid previously.

A trader elsewhere said it was "tough to find any bids" on the Georgia Pacific bonds. He noted that it really is "not a name that we traffic in; we're very leery about their possible asbestos problems."

Another nominally high grade name finding itself being eyed by junk bond denizens - with asbestos problems again the key - is Haliburton Co., after Moody's downgraded its bond debt two notches, to Baa2 from A3. The ratings agency cited its worries about the current pressure on the Dallas-based oilfield services and construction giant's share price and the reduction in its financial flexibility as a result of recent adverse asbestos-related jury verdicts.

"The rating downgrade also reflects Moody's concern that the rating triggers in the company's bank credit agreements will increase its reliance on alternative financing arrangements as part of its liquidity risk insurance. Moody's is maintaining a negative outlook on Haliburton's ratings in light of the risk that the company's asbestos-related costs could rise in the future," the downgrade message added.

Haliburton's bonds were down as much as 10 points in response Wednesday, the secondary market-watcher said. While its most actively traded issue, its 6% notes due 2006, had lost five points to close at 86 bid, he noted, its longer-dated paper was down even further. The bonds were already being quoted in dollar terms at some high yield desks, he said, despite their investment grade rating - "and we don't know how long those kind of ratings will hold up."

Haliburton's Dresser Industries unit recently was on the wrong end of a $30 million asbestos liability verdict in Maryland - which could serve as a precedent for a number of similar cases filed against Dresser and another subsidiary, Kellogg Brown & Root.

Moody's cautioned that "the number of open claims pending against these entities has risen substantially over the past year." On top of that, it noted, Haliburton recently took over the defense of claims previously defended by Harbison-Walker, a former subsidiary - and pointed out the risk that such outstanding claims might "turn out to be materially higher than expected."

Even beyond that, the ratings agency's screed declared, "recent bankruptcy filings have reduced the number of companies that law firms active in asbestos litigation can target, which could make law firms more aggressive in looking for plaintiffs against other companies. This could potentially result in a substantial rise in the number of asbestos claims filed against Haliburton and others."

A number of large companies - including such high yield issuers as building products makers Owens Corning, USG, and Armstrong World Industries, chemical maker W.R. Grace and auto parts company Federal Mogul Corp. have been forced into the bankruptcy courts under a flood of asbestos claims - leaving other firms not in bankruptcy, such as Haliburton, as more conspicuous targets.

A newly-minted split-rated credit, Goodyear Tire - due to Standard& Poor's downgrade of its bonds on Friday to BB+ from BBB - was also trading on the downside Wednesday, its 7 7/8% notes due 2011 quoted at 86 bid, down 10 full points from recent pre-downgrade levels. S&P said Akron, Ohio-based Goodyear - the largest U.S. tire maker - had posted "very disappointing" financial results over the last few years, and cautioned that its cost-cutting efforts will not be do enough to help boost earnings as demand for its products weakens in its major markets and as price competition and product shortages cut further into its profit margins.

Back among the pure junk bonds, Gaylord Container's 9 7/8% notes due 2008 were heard by a trader to be "up significantly," on the news that rival packaging maker Temple-Inland had offered "more advantageous terms" in an effort to revive their stalled merger deal. At another desk, the bonds were quoted up two points on the session and nine points on the week so far, in light of the revised Temple-Inland offer. Temple-Inland had backed out on Jan. 8, citing lack of sufficient support for the deal among Gaylord bondholders, who were asked to tender their notes as a prerequisite to the acquisition; the newly revived - and revised - deal, including a new tender offer, holds out better terms to the bondholders

Also on the upside, American Tower Corp.'s 9 3/8% notes due 2009 were seen up more than three points, to 72.5 bid, although no significant new news was heard. Also in the telecom sphere, a trader heard that telecommunications in general was up during the session, "smoking today," with Nextel Communications Inc.'s senior notes, such as its 9 3/8% notes due 2009 up about two points, to 74.5 bid/75.5 offered.

The trader also heard that Conseco Inc. 2002 paper was "really moving," quoting it bid around 82-83, well up from recent levels in the lower 70s - and even at one point in the 60s - "not too long ago. They've kind of grinded their way back up," he said, on the news, released early last week, that the Carmel, Ind.-based insurer had bought back $34 million of additional 2002 maturity paper. The latest purchase brings the amount of 2002 paper it has bought back since last June 30 to $266 million - fully 30% of the approximately $864 million of public debt of Conseco itself and its Conseco Finance unit scheduled to mature this year. Longer-dated Conseco paper, such as its 9% notes due 2006 remained "pretty much where they were," he said, pegging the 9s at bid levels in the 46-48 region.

At another desk, Conseco's 10¼% notes due 2002 pushed up to 94 bid from prior levels around 90, while its 6.40% notes due 2003 were up three points to 66.

On the downside, Rite-Aid Corp. debt - which was down solidly on Tuesday - was "down a bunch again," a market observer said. He quoted the drugstore chain's 6 7/8% notes as having fallen to 48 bid from 52 previously, while its 7.70% notes likewise dropped four points on the day to end at 46 bid.

End

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