Sybase higher in active trade on takeout; PMI regaining ground; Nortel Networks weaker

By Rebecca Melvin

New York, May 13 - Sybase Inc.'s 3.5% convertibles gained in active trading Thursday, the day after word that the California-based software company has agreed to be acquired by German software giant SAP AG for $5.8 billion.

Hedge players should have made out OK or even made a little money on the $400 million issue of Sybase 3.5% convertibles, which will be made whole via a table, adding about 2.1 shares per bond, assuming a $65 closing price and July deal close, market sources said.

"I think it was good enough if you were on a 70% hedge. You might not be too happy about it if you were on an 85% hedge," a New York-based sellside trader said.

But since this company was a potential takeout target for some time, convertibles players were unlikely to have been set up wrong, he said.

PMI Group Inc. extended gains for much of Thursday, moving up with its underlying shares and financial stocks in general, which are recovering after a drop last week. Late in the session, however, financial shares weakened some on selling into the market close.

Nortel Networks' 1.75% convertibles due 2012 were active in trade for the last two sessions, trading at about 75 to 76 and in a point in the last week or so, sources said.

Other than that, it was "the usual suspects," a New York-based sellside trader said, and trading in the convertible bond secondary market was rather subdued as the broader markets took a breather for much of the session.

"After a couple of sessions of volatility, the market is taking a breather today," a New York-based sellside trader said in early afternoon.

Sybase moves up

Sybase's 3.5% convertibles due 2029 traded at 147.25 versus a share price of $64.50 on Thursday in very active trade. That compared to the convertibles trading at 138 versus a share price of $58.00 on Wednesday.

Germany's SAP has made a cash tender of $5.8 billion, or $65 per share, for all of Sybase's outstanding shares, which represents a 44% premium over Sybase's three-month average price.

The convertibles' make-whole table would add about 2.1 shares to the bonds at conversion, boosting value for investors who held that paper.

"I think people made out OK. If you hear differently let me know," a New York-based sellside trader said.

Sybase shares were downgraded by Raymond James to "market perform" from "strong buy."

Dublin, Calif.-based Sybase makes database software that competes with SAP and Oracle. Its programs make it easy for workers to access business software via smartphones and other mobile devices. Sybase also sells a powerful database that large companies, such as banks, use to store sensitive information.

Because the acquisition price was relatively high, hedge players did OK on the takeover news. "If the deal price was lower, you might not have done so well," a sellsider said.

On Wednesday, when word of the deal initially came out, there was talk of a $60-per-share purchase price, not the $65 that was announced.

Any software company is liable to be taken over, except for Microsoft, the sellsider said, indicating that convertibles players were most likely ready for the news.

If the bonds had been trading below par, they would have been taken up to par on the takeover news.

PMI regaining ground

PMI Group's 4.5% convertibles due 2029 have been strengthening in the last couple of sessions, trading up to nearly 94, which was up 1.6 points on the day, according to Trace data, and extending a 2-point gain from Wednesday.

PMI priced $261 million of convertible senior notes on April 26 via Credit Suisse and Bank of America Merrill Lynch. On April 28, the PMI 4.5% convertibles traded at 101 versus a share price of $5.75, and then they started tracking lower with their underlying shares on an 85% delta. The convertibles' low point was 84.5, a sellsider said.

Walnut Creek, Calif.-based PMI is a mortgage insurer.

The recent stabilization in delinquency trends, as well as an improved capital buffer from recent capital raises, has improved the outlook for PMI and MGIC Investment Corp. as well, which also priced a convertible recently, according to Barclays Capital equity linked strategies analysts.

However, the sector remains exposed to substantial macro uncertainty regarding their future business model, litigation and lower production volumes, the Barclays analysts Kannan Venkateshwa and Venu Krishna, wrote in a recent report.

"We are bullish on the company and recommend this risk controlled way that you gain upside exposure and minimize downside risk," a Barclays analyst confirmed Thursday.

The new PMI bonds are "basically moving with the market. The financial sector as a whole was down last week," the analyst said.

Initial pricing on the PMI bond jumped because it came at pretty attractive terms, like the MGIC convertibles, but later the stock price sank, the analyst said.

PMI, MGIC recommended

The Barclays Capital analysts recommend going long PMI and MGIC convertibles, using a delta hedged position given macro uncertainties that still remain in the mortgage insurance sector.

At present levels, the PMI convertibles are trading about 10% cheap, assuming a credit spread on PMI of 685 basis points over, based on five-year credit default swaps.

"While we expect these trends to continue supporting the capital structure going forward, the sector still faces meaningful risks on account of the following factors," the analysts said.

The U.S. Treasury launched the Home Affordable Modification Program in early 2009 with the intention of reducing the monthly mortgage payment burden for struggling borrowers. Under this program, mortgage servicers would offer a three-month trial modification to borrowers who fit the program eligibility criteria at the end of which the loan would be modified permanently based on the borrower not re-defaulting during the trial period and submitting relevant documentation.

The implication of loan modifications for mortgage insurers is that it reduces the number of delinquent loans and therefore losses on account of these. The recent changes to the HAMP program in March should further help this cause by increasing the number of eligible borrowers who can receive modifications under HAMP as it also calls for haircuts to the principal.

Risk rises in the slowdown in HAMP modifications over the last few months. Moreover, prior to the recent amendment to HAMP, which also added principal forgiveness, the total eligible pool under HAMP was 1.8 million borrowers, out of which two-thirds have already been offered trial modifications. As a result, modifications under HAMP are expected to slow down over the rest of this year.

While the recent change in HAMP may increase the eligible pool and delay this slowdown in the short term, the movement will still be lower in the long term and fundamentals of the mortgage market will have to improve without the support of government programs. Alternatively, the government will have to expand its programs further.

Mentioned in this article:

CA Inc. NYSE: CA

Nortel Networks NYSE: NT

PMI Group Inc. NYSE: PMI

Sybase Inc. NYSE: SY

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