Microsoft plans to price $1.15 billion convertibles; Transocean paper weaker; Intel quiet

By Rebecca Melvin

New York, June 8 - The convertible bond market saw another strong credit - this one very strong - come to the primary market as Microsoft Corp. launched Tuesday a $1.15 billion offering of three-year convertible senior notes that was seen pricing after the market close.

The Microsoft deal, which was 100.25 bid, 100.5 offered in the gray market, followed swiftly on the heals of the Xilinx Inc. $520 million of 2.625% convertibles, which priced last Thursday.

Both deals are so-called "happy meals," which refers to a convertible bond with a corresponding set of transactions with which the issuer finances a chunk of share repurchases.

Traders began to wonder if the two deals signaled the beginning of a trend.

Both issuers are better credits in the technology sector, which have seen their share prices come off of late, and which will use a chunk of proceeds for buybacks, a New York-based sellside trader said, adding that we may see more of the same in the market given weakness in equities.

Other than the Microsoft issue, which looked slightly rich at the midpoint of price talk, there was a lot of Transocean Ltd. paper trading in the secondary, and it was weaker.

Intel Corp., which is also a better credit in the technology sector, did not see much action in its two existing convertibles. Theoretically, the Intel paper could be a target of sellers looking to make room in their portfolios for the new technology paper. But there was no evidence that that will be necessary, and there wasn't a lot of trading activity in the name on Tuesday, market sources said.

Overall, the convertible bond market was fairly quiet, with market players sticking with high-grade stalwarts including Medtronic Inc., EMC Corp. and Amgen Inc. There was also some Nasdaq OMX Group Inc. and NetApp Inc. paper trading.

NetApp was called an "EMCish name," that is well in the money, "with not a lot of value, but you don't get hurt with them," a trader said.

Market skittish after May

The market was described as "scared off," after losses notched in May and given uncertainty going forward.

In particular, investors are uncertain about the Gulf of Mexico oil crisis and commentary from the Obama Administration about potentially harsh repercussions for companies attached to the oil drilling sector.

May was a bad month, and this month is not getting off to a very good start, a New York-based trader said.

"It looks like there are people down by as much as 5% for the month, with the average loss being 1.5% to 2%. It was definitely not a good month. Some people gave back most of their gains for the year to date, and that's going to make you gun shy and protective of what gains you do have," the trader explained.

Equities were volatile with the major averages trading mixed for most of the session.

AAA-rated supply

Market sources were chagrined by the terms of the new Microsoft deal but glad for a new convertibles benchmark.

The three-year deal was talked to yield 0% with an initial conversion premium of 30% to 35%.

The Rule 144A offering has a greenshoe of $100 million and was being sold via joint bookrunners Citigroup Global Markets Inc. and Bank of America Merrill Lynch, with co-managers Barclays Capital Inc. and UBS Securities LLC.

"We need product, but not with these kinds of terms. We need something better," a Connecticut-based trader said.

Nevertheless, the deal was expected to do well and was getting pretty good "buy in" from investors. A syndicate source said "guys liked it."

While its terms were not very generous, it is a large deal, from a rare AAA-rated company, and "it will probably trade up a little bit and do OK," a trader said.

Another trader said that with a gray market at 100.25 to 100.5, the pricing seemed about right. "You don't want it to trade right up. With a deal of this size, you want pricing to be right," a sellsider said.

Valuing the deal, considering that its underlying stock is not very volatile, and with credit default swaps at 30 basis points over Libor, it models about 1% rich at the middle of price talk, using that credit spread and a 23% vol., a sellsider said.

"People are interested at the mids and better," the sellsider said.

Others observed that such a benchmark will be an asset.

"There's a place in the universe for it, given its ratings and size. If it was AAA and only $50 million, who would care," the sellsider said.

Microsoft 'happy meal'

The deal is particularly attractive from Microsoft's perspective as the call spread allows it to buy stock now and sell it forward. The effective premium will probably be in the 60% range, a sellsider suggested. Syndicate sources would not comment on the call spread.

"You get to buy your stock back here. It's not at a 52-week low, but it's definitely down," a sellsider said.

Given the weakness in the market, it may start a trend among issuers that may want to take advantage of the opportunity to monetize their higher implied vols.," a Connecticut-based sellside trader said.

Companies can buy back in an efficient, low-cost way without disrupting the market or dipping into their cash reserves.

By buying back stock from short sellers, the selling pressure on the stock and the dilutive impact of the convertible are removed.

On the other hand, given the concurrent buyback with the pricing of the convert, there isn't a very high delta on the model. Maybe 30% delta, a sellsider said.

"You are basically putting hedge on with the underwriter at issue. You don't have to hedge it up on your own, and everything is packaged together," a trader said.

The bonds are non-callable for life with no puts. There is net share settlement, which will be par cash settled, with the residual in cash or stock at Microsoft's option prior to March 15, 2013.

Microsoft is a Redmond, Wash.-based maker of computer software and hardware.

Intel steady to lower

Intel's 3.25% convertible junior subordinated debentures due 2039 were indicated to close at 114.25 on Tuesday, compared to a close of 116.57 on Monday.

Intel's older 2.95% junior subordinated convertible notes due 2035 were indicated to close about a point lower than Monday at 95.

Shares of the Santa Clara, Calif.-based chip giant closed down 13 cents, or 0.6%, at $20.18 on Tuesday.

Sources didn't think there would be selling pressure on the name for reasons of having to make room in their portfolios.

"People have a lot of dry powder, a sellsider said.

Both Microsoft and Intel were seen as providing benchmarks for the convertible market, but different types of benchmarks.

"They are dramatically different inverses, given that the Intel paper is 30-year paper and the new Microsoft is three-year paper," a trader said.

Transocean weaker

Transocean was "taking it in the throat," amid all the uncertainty related to the ruptured well that has been spewing oil in the Gulf of Mexico since April.

The shorter-duration Transocean A paper was trading at 96.125 bid, 96.25 offered.

"In normal times, people would be crawling all over this to own it," but not amid the fear that paper even six months out from a company with plenty of cash may not make it.

"Logic would tell you that there is no possibility for litigation to work itself through by then, but when the president is involved and looking for asses to kick, and all the jawboning in the government to make someone pay, it scares people," a New York-based trader said.

The common shares of the Switzerland-based offshore drilling contractor settled $2.84, or 5.8%, lower, at $46.33 on Tuesday.

Mentioned in this article

Intel Corp. Nasdaq: INTC

Microsoft Corp. Nasdaq: MSFT

Transocean Ltd. NYSE: RIG

Xilinx Inc. Nasdaq: XLNX

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