Medtronic, DRS fall outright on poor guidance; Transocean slides on miss; CompuCredit declines

By Kenneth Lim

Boston, Aug. 3 - Quarterly earnings dominated action in the convertible bond market on Thursday, with Medtronic Inc. falling outright after the company gave guidance that fell short of estimates.

Concern over the Medtronic warning spilled over onto St. Jude Medical Inc.'s stock, but its convertible stood firm, buoyed by its December put date.

DRS Technologies Inc. fell outright but improved slightly on a dollar-neutral basis after the defense contractor lowered its full-year forecast amid government funding delays.

Transocean Inc. retreated in line with the stock after the oil services contractor's second-quarter earnings missed Street estimates, fueling concern about the company's outlook.

Also on Thursday, CompuCredit Corp.'s 3.625% convertible due 2025 declined by about 4 points outright after the Atlanta, Ga.-based consumer credit company reported lower second-quarter earnings. The convertible was marked at 96.25 bid against a stock price of $28.75. CompuCredit stock (Nasdaq: CCRT) closed at $28.31, lower by 11.83% or $3.80.

CompuCredit said Wednesday after the market closed that it made $48.8 million, or 97 cents per share, in managed earnings during the second quarter, from $80.6 million, or $1.56 per share, in the same period a year ago.

Medtronic slide on warning

Medtronic's convertibles gave up a few points outright as the stock tumbled on Thursday after the company disappointed investors with a lackluster forecast.

The company's 1.625% convertible due 2013 was marked at 94 bid, 94.625 offered against a stock price of $44.32. Medtronic stock (NYSE: MDT) lost 12.98% or $6.61 to finish at $44.32.

"I would be surprised if those didn't get bid higher," a sellside convertible bond trader said. "They were down about five points outright, but opened up about a buck on swaps."

Minneapolis-based Medtronic said late Wednesday that it expects sales in its first fiscal quarter, which ended July 28, to be $2.9 billion, short of the $2.98 billion that analysts had forecast. Excluding one-off items, the medical devices maker expects earnings between 53 and 55 cents per share. Analysts were eyeing 57 cents per share.

Medtronic cited a slowdown in its U.S. implantable cardio-defibrillator market amid concerns over Medicare reimbursement.

JP Morgan equity analyst Michael Weinstein said Medtronic's outlook suggests that the global market for the implantable defibrillators had shrank.

"As bad as our checks have suggested the ICD market was doing, it turns out it's even worse," the analyst wrote in a note.

St. Paul, Minn.-based St. Jude Medical, which also makes the implantable defibrillators, saw its stock take a beating amid concern about the sector. But the company's 2.8% convertible due 2035 held firm with its approaching call and put options providing support. The convertible may be called and put in December this year.

The St. Jude convertible traded at 99.125 against a stock price of $33.75 on light volume. St. Jude stock (NYSE: STJ) fell 10.89% or $4.12 and closed at $33.70.

"It's trading to put, so the stock price doesn't matter here," a sellsider said.

DRS takes earnings hit

DRS Technologies' 2% convertible due 2026 fell about 4 points outright but improved slightly on a dollar-neutral basis after the company issued disappointing fiscal second-quarter guidance.

The convertible traded at 92.625 versus a stock price of $39.75. DRS stock (NYSE: DRS) dived 16.97% or $7.94 to close at $38.86 on Thursday.

"It probably got a little better [dollar-neutral]," a sellside convertible bond analyst said.

DRS on Thursday said it expects to earn $2.80 to $2.90 per share for the year ending March 2007, less than the $3.05 to $3.10 per share it previously forecast. The Street had been expecting earnings of about $3.15 per share.

The Parsippany, N.J.-based defense contractor also reported net earnings of $21.3 million, or 52 cents per share, for its first fiscal quarter, which ended in June.

"Clearly the guidance was a big disappointment," the convertible bond analyst said. "It's a lumpy business, and they seem to be more exposed than some other companies in the space to the supplemental budgets, supplemental appropriations, and the delays in spending."

"I think that kind of took people aback a little because it was pretty disturbing, but the company was insistent that it was revenue delayed, not revenue denied," the analyst added. "But it [the revenue] will get pushed out a quarter or so or, even into the next fiscal year."

DRS's newly acquired business from Engineered Support Systems Inc. was partly responsible for the missed forecast, which raised some eyebrows, the analyst said.

"It's somewhat worse because the delay is in the business that they just acquired, which they already have problems with in terms of options backdating, which they kind of dodged the bullet for."

Regulators are investigating the dating of options at Engineered Support Systems before it was bought by DRS, and DRS is not considered a subject of the investigation.

It remains to be seen whether the slowdown in government funding are delays like the company says or a more serious problem that could affect the company's credit, the analyst said.

"The jury is still out on that, whether it's just a push-out or whether there are more significant issues here," the analyst said. "I think over time that will become more apparent."

For now, DRS' credit has not suffered much.

"It's not a great credit, but it's certainly got a high quality customer in the U.S. government, some people are probably going to think that it's not going to be a credit issue here."

Transocean sinks with earnings

Transocean's 1.5% convertible due 2021 slipped about six points outright on Thursday, dragged by lower second-quarter earnings that fell short of Street estimates.

The convertible was marked at 106.625 against a stock price of $72.50. Transocean stock (NYSE: RIG) closed at $71.80, down by 8.74% or $6.88.

"The stock got hit pretty bad," a sellside convertible bond trader said.

Transocean on Thursday reported second-quarter earnings of $249.5 million, or 75 cents per share, down from year-ago earnings of $301.8 million, or 90 cents per share. The Houston-based oil drilling rig contractor said it expects revenue in the fourth quarter to exceed $1 billion for the first time in the company's history.

"There's a general sentiment developing with all these oil services names, that the earnings growth is near the peak, and it looks like it's peaking," a buyside convertible bond analyst said.

Although oil and gas prices are at a high, oil services contractors are also facing rising costs, such as employment costs as workings become harder to find.

"The utilization rates are pretty high right now, daily rates are high, and that's where the sentiment comes in," the analyst said. "You can only hike your dayrates so much. Earnings have actually declined compared to last year, because costs are rising faster than revenue."

Transocean's stock and convertibles could become bargains again if there is a sell-off in the sector, but at the moment they are still not cheap, the analyst added.

Transocean's convertible does not have enough downside protection to justify getting in at the moment, the analyst said, noting that the next put in 2011 is too far away.

"You really have to believe in the common here, in the equity, to take a plunge," the analyst said.

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