Deutsche sees SPX convert undervalued in wake of Tyco fallout

By Ronda Fears

Nashville, Tenn., Feb. 14 - SPX Corp., which shares the multi-industry space occupied by Tyco, has been handed a beating along with Tyco - and Deutsche Banc Alex. Brown convertible analysts said in a report Thursday that SPX looks undervalued as the Tyco contagion subsides. But the analysts prefer SPX's 0% due February 2021 over the 0% due May 2021 and recommend switching for investors who hold the latter.

"Now one year old, we feel that the SPX #1 0% 2021 bond has been somewhat forgotten by investors amongst the Tyco furor. But we feel there are a number of reasons for considering it at this time," said analysts Jeremy Howard and Jonathan Cohen in the report. The analysts noted, too: "We caution investors that both SPX #1 and SPX #2 were issued with contingent conversion and contingent payment features."

There is a real balanced opportunity, the analysts said, with the 0% due February 2021 trading on a 19% premium with only 28.75% downside to the bond floor at 52.65. It offers inexpensive volatility, they added, with an implied volatility of 38%, based on a credit analysis using Libor plus 550 basis points. The analysts also noted that hard call protection extends to February 2006 and there is a put in February 2004, which give the bond a highly attractive investment profile.

The analysts noted they prefer SPX's first convertible to the second because the 0% due February 2021 has a lower premium than the second issue's 25% premium on a 58% delta and provides more upside participation with the underlying stock, although both have a reasonably high gamma. Also, the 0% due February 2021 has a lower implied volatility than the second issue's 41%. The first convertible also provides more call protection since the second issue is callable in May 2005.

Deutsche does not formally cover SPX in equity or fixed income research, the convertible analysts said, noting that the company produced "solid financial results for 4Q 2001 in a difficult operating environment" and the stock is trading at only 13.5 times the 2002 consensus estimates. SPX management has indicated it is happy with guidance of $8.76 for 2002. The company reported $720 million EBITDA for 2001 and total debt of $2.6 billion, for a debt-to-EBITDA ratio of 3.6 times. Net interest expense was $133 million for an EBITDA-to-interest expense ratio of 5.4 times coverage. Cash flow from operations, net of capital expenditures and restructuring cash charges, was $397 million and there was $460 million cash on the balance sheet.

"On the 4Q conference call, management expressed confidence that there is no need for external financing to cover the $160 million of short-term debt due in 2002. Furthermore, there is no immediate need to go into the market for anything. With $600 million available on their credit facilities plus the cash on the balance sheet, SPW has liquidity greater than $1 billion," the Deutsche analysts said.

"Management stated that the company is more liquid now than any point in their history and stated their goal of an investment grade rating. Relative to its peers, management believes its credit quality is improving."

Regarding guidance for 2002, the analysts noted that SPX management stated that from their point of view, they have been operating in an economic recession for 18 months, and they don't anticipate any significant improvement in 2002. Targets include flat internal growth, a 200 basis points margin improvement to 13.8% and EBITDA of $940 million, or up 20% from $780 million.

"Management went on to state that there are is a lot of unsubstantiated and inaccurate information regarding asbestos exposure at SPX circulating in the market," the analysts said. "SPW acquired UDI last year and was comfortable with the potential exposure to asbestos then, and they still are now. Management stated that the lending group and rating agencies are comfortable as well. No claims have been filed against SPW and no claims have been paid by SPW. "

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