By Ronda Fears
Nashville, Tenn., Oct. 2 - Solectron Corp.'s 0% convertible due November 2020 is a defensive way to play the electronics manufacturing services sector, Morgan Stanley convertible analysts suggest. The issue offers attractive returns but the analysts note that there is some risk associated with the put.
"We continue to believe investors could earn attractive returns by investing in the SLR 0.0% convertible notes due 11/20/2020. The Ba3/BB rated security, which we refer to as the SLR #3, trades with a yield to put of 24.9% (put date 05/20/2004) and a yield to maturity of 5.1%," the analysts said in a recent report.
"However, in our view, the potential for capital market risk exists as the company could pay the security's put obligation by issuing another security (either convertible or straight debt). That said, we see the SLR #3 as a defensive way to invest in the EMS industry."
Morgan Stanley electronics manufacturing services analyst Scott Craig maintains an equal weight rating on Solectron shares, said convertible analysts Anand Iyer, Waldo Best, Anthony Cichocki, Leo Kulp and Manish Pandit in the report.
In Craig's opinion, Solectron reported a mixed quarter and outlook.
On the one hand, revenue was at the high end of guidance due to new business wins, SG&A costs were contained and inventory and account receivables were worked down.
On the other, cash flow from operations was below expectations, gross margins continue to experience significant pressure, a previously announced outsourcing agreement with Lucent may be terminated and fiscal first quarter 2003 revenue will likely be flat to slightly down in what is normally a strong quarter.
"The mixed outlook seen by Morgan Stanley EMS analyst Scott Craig for the company leads us to believe that SLR common is unlikely to trade higher anytime soon," the convertible analysts said.
"The SLR #3 trades deep out of the money, indicating no equity sensitivity and we believe it will trade solely on the credit fundamentals of the company. As investors become more comfortable with the company's credit metrics, we would expect the convertible's price to trend to 58.79% [from current price of about 40.88%], regardless of movements in the SLR common stock."
Solectron's credit shows an improving trend, the analysts said, especially when excluding the debt associated with the $1.1 billion mandatory.
Total debt including the $1.1 billion mandatory is $3.8 billion. The company's trailing 12-month interest expense is $244.1 million.
The company has $2 billion in cash and cash equivalents on its balance sheet, excluding $200 million in restricted cash.
"The fall in capital expenditures beginning in 2000 was the sharpest in the last 20 years, and if our capital spending push out thesis is correct, the recovery in corporate capital spending is unlikely until 2003," the analysts said.
"The implications for EMS companies like Solectron will be deferred revenue growth and earnings volatility for the next few quarters."
Solectron Corp. 0% convertible due Nov. 11, 2020
| Convertible price: | 40.88
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| Conversion price: | $44.53
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| Stock price: | $2.21
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| Yield to put: | 24.89%
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| Delta: | 0%
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| Yield to maturity: | 5.06%
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| Volatility: | 50%
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| Conversion premium: | 1469.30%
|
| Credit spread: | 1,400 basis points
|
| Years to put/call: | 1.65 years/now
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| Credit ratings: | Ba3/BB
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| Put/call price: | 58.75%/58.74%
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| Solectron Corp 0% convertible due May 8, 2020
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| Convertible price: | 59.00%
|
| Conversion price: | $46.97
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| Common stock price: | $2.21
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| Yield to put: | 11.19%
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| Delta: | 0%
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| Yield to maturity: | 3.04%
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| Volatility: | 50%
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| Conversion premium: | 2065.00%
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| Credit spread: | 1,100 basis points
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| Years to put/call: | 0.61 years/now
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| Credit ratings: | Ba3/BB
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| Put/call price: | 62.86%/62.85%
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| Solectron Corp. 7.25% mandatory due Nov. 15, 2004
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| PEPS Price: | $9.04
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| Upper/lower strike price: | $11.58/$9.81
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| Common stock price: | $2.21
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| Min. ratio/max. ratio: | 2.1597/2.5484
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| Current yield: | 20.03%
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| Volatility (100-day): | 96.05%
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| Conversion premium: | 89.30%
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| Delta (assumed): | 100%
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| Break even: | 2.35 years
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| Credit ratings: | B2/B+
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| Years to maturity: | 2.14 years
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