Tyco lower ahead of buybacks; Cephalon 0s fall, 2.5s steady; El Paso, Calpine higher; Valero firm

By Ronda Fears

Nashville, Sept. 7 - Tyco International Ltd.'s convertibles were lower before headlines on its buyback of about 10% of its 2.75% issue, traders said.

Cephalon Inc.'s 2.5% convertibles were steady in the face of an investigation into its drug marketing practices due to a possible call this December but the two-part 0% converts dropped sharply on the news. The zeros initially lost 4 to 5 points but rebounded from the lows to end the day down by 2 to 4 points.

Yellow Roadway Corp.'s accelerated outlook, despite higher fuel costs, sent its converts up by 1 to 2 points. Yellow raised its outlook for third quarter earnings per share to between $1.30 and $1.35 from previous guidance for $1.20 to $1.25. Results are scheduled to be released after market close Oct.21, with a conference call the next morning.

Healthy transport volumes, which have facilitated an increase in trucking rates, have counteracted rising fuels as trucking firms, as well as railroads, are benefiting from the economic expansion and increased imports from Asia, analysts say. Also, the Overland Park, Kan.-based trucking firm said that since purchasing rival Roadway last December it has realized significant cost efficiencies.

Valero Energy Corp., an independent refining company, warned about upcoming earnings, though, due to tighter gasoline profit margins but its stock rose on short covering while the 2% mandatory due 2006 was described by dealers as steady to slightly firmer at 34 bid.

Delta Air Lines Inc. also was steady ahead of a conference call slated for 8:30 a.m. ET Wednesday in which chief executive Gerald Grinstein is to outline the company's debt restructuring plan.

El Paso Corp. and Calpine Corp. were both "slowly grinding higher," a convert trader said. Confidence was gaining in El Paso on the company's presentation at a Lehman Brothers energy conference in New York on Tuesday, one trader said. Calpine was still finding fixed-income buyers, but a trader said that there may be a snapback in Calpine as wildfires in California threatened one of its power plants.

Tyco converts off 1-2 points

Tyco said Tuesday after the market closed that it had repurchased $350 million of its 2.75% convertible bonds due in 2018 with $511 million of cash, suggesting a price of 146 for the bonds, and, as previously disclosed, the company has repaid $350 million of its accounts receivable securitization programs in July.

The 2.75% convert, a $3 billion issue, was quoted down 1 point to 143.5 bid and the 3.125% convert, a $1.5 billion issue, down by 2 points to 153 bid. Tyco shares closed off by 42 cents, or 1.33%, to $31.14.

Tyco said it expects to retain a cash balance of at least $2 billion after the outlays.

"It was positive news, a huge vote of confidence for Tyco to pay such premium for the convertibles, and at the same time it limited dilution," said a buyside market source. "It can only mean management is highly confident."

He said it you thought of it in terms of a stock buyback of 15 million shares, at about $31 a share the company wiped out $350 million of debt.

But one trader said there could be concerns about the company's future plans for buybacks and other debt repurchases.

"There was some concern about where any future buyback levels would be, because these converts are probably still in high risk of being taken out in some form or fashion," a convert trader said.

In addition to the buyback news, the buyside trader also cheered the company immediately affirming its earnings guidance.

Tyco said its electronics segment, which has come under criticism from analysts, experienced a 5% organic increase in order rates in August and a 9.5% increase for the current quarter through August, compared to year-ago levels. The company continues to expect the unit to show organic revenue growth of 8-10% in the current quarter.

Companywide, Tyco said it still expects fiscal fourth quarter EPS of $0.41 to $0.43 and $1.61 to $1.63 for the full fiscal 2004 year, noting the EPS outlook excludes the impact from the restructuring and divestiture programs announced in November 2003 and charges related to early retirement of debt.

The company also confirmed its fiscal 2004 guidance for cash flow from operating activities of $5.2 billion and free cash flow of $4.7 billion before voluntary pension contributions.

Cephalon 0s lose 2-2.5 points

Cephalon announced early Tuesday that it received a subpoena from the U.S. Attorney's Office in Philadelphia for documents from 1998 to the present regarding the sales and promotional practices relating to its products, and said it will cooperate with the request.

The Cephalon converts opened under pressure from a downgrade to the stock by Lehman Brothers, as well.

Cephalon said the subpoena was not specific to a single drug but appeared to be casting a wide net. Sales and promotional practices of drugmakers have come under increasing scrutiny, with investigators often focusing on promotion of drugs for unapproved treatments, or so-called off-label use. The request for documents back to 1998 predates any Cephalon products on the market, which could indicate interest in clinical trials - another focus of government investigations.

West Chester, Pa.-based Cephalon now has three prescription drugs on the market - Provigil for the sleep disorder narcolepsy, the painkiller Actiq and Gabitril for epilepsy. Its first product, Provigil, hit the U.S. market in 1999.

Cephalon's 2.5s due 2006 (B-) were steady at 97 bid with an offer at 97.125, which market sources attributed to the par call coming up on Dec. 15.

"The current 97 trading level may partially reflect the probability of a December call by the issuer, given that theoretical value on the convert - assuming a 30% volatility assumption and a Libor plus 285 [basis points] spread assumption - is estimated at 94.33," said Lehman Brothers convertible analyst Venu Krishna in an email bulletin.

"Should a call not materialize, downside is likely to be limited by the relatively high bond floor [92.6] and short term to maturity."

The 2.5s are a highly defensive alternative for equity investors with conservative performance expectations over the near term, he added, as the bonds would gain 5.7% on the upside and gain 2.6% on the downside, as well, for a 25% move in the stock. In addition, he noted that current yield is 2.5% with the potential for a 13.3% yield to call if the company indeed calls the bonds in December.

Cephalon's 0% convertibles (B-), however, dropped about 2 points each on the news. Tranche A with a $375 million face amount is putable/callable on June 15, 2008, at 100.25 and tranche B with a $375 million face amount is putable/callable on June 15, 2010, at 100.25.

The Cephalon zeros dropped to around 97.75 bid, 98.25 offered on Tuesday, a trader said, from the 101 area late last week.

Valero short covering signaled

Valero, which as recently as July offered a bullish outlook, on Tuesday warned third quarter earnings would fall short of forecasts because of a drop in gasoline profit margins. But traders said the stock shot up on short covering as the San Antonio-based company said it still expects to report record earnings - in the range of $2.50 per share - for the quarter.

Valero shares gained $1.35, or 2%, on the day to $67.55. Its 2% mandatory due 2006 was described as firm but steady at 34 bid.

The company's estimate is well below its July forecast of earnings of more than $3 a share for the period. At that time, Valero said it expected gasoline margins to remain at high levels, citing low gasoline inventories. Valero said it expects strong fourth quarter earnings due to above normal turnaround activity at refineries and very wide discount for sour crude oil.

Standard & Poor's said the ratings for Valero (BBB/negative) would remain unchanged.

S&P credit analyst Bruce Schwartz said Valero's ratings and negative outlook assumed that refining margins would fall in the second half of 2004 and 2005 from exceptionally high levels in the first half of 2004. In S&P's view, he said, the two principal catalysts for any downgrade of the credit would be a collapse in refining margins as the company spends aggressively to meet new clean-fuels standards and debt-financed acquisitions.

Although gasoline margins have fallen significantly in recent weeks and merit watching, Schwartz said Valero's results are likely to be buttressed in the near term by a very wide crude oil price differential and improved sour crude discounts.

"Though somewhat lower than we had originally anticipated for the third quarter, this level of earnings would be outstanding and continues to demonstrate Valero's strong earnings power," said Bill Greehey, Valero chief executive.

"Looking forward to the remainder of the year, the market continues to look strong."

Gene Edwards, Valero's senior vice president of product supply and trading, gave a presentation at Tuesday afternoon at the Lehman conference.

El Paso up 0.5, Calpine 1 point

El Paso executives were at the Lehman energy conference Tuesday afternoon, too.

Lehman Brothers was hosting what was referred to as the largest energy investment conference of the year with El Paso among the companies kicking it off at 1 p.m. ET Tuesday. The Lehman conference is traditionally bullish for energy stocks, traders away from the firm acknowledged.

A buyside market source said El Paso chief executive Doug Foshee was upbeat at the conference, describing the company's long range plan as well underway and on the right path with as new leadership team targeting $15 billion in debt by 2006, free cash flow of $200 to $400 million and EPS of 70 cents to $1.

"El Paso is on the right course," the source said. "Foshee strongly believes, as he put it, that the clouds are parting. They are no longer a wholesale seller of assets."

Peer energy name, Calpine Corp., has seen considerable sell-offs in recent sessions because the San Jose, Calif.-based independent power producer has a massive asset sale program underway, although proceeds are earmarked to reduce debt.

Calpine is still getting interest from fixed-income investors, however, and its 4.75% convertible added 1 point on Tuesday to 77 bid. The underlying stock closed up 19 cents, or 3.5%, to $3.55 but in after-hours trading it was down a couple of pennies.

Power plant outages in northern California might hamper Calpine short-term, but a sellside trader said that will likely be offset by hot weather in southern California boosting demand.

In California, wildfires in the wine country north of San Francisco have forced operators to shut down about 400 megawatts of capacity from the massive Geysers geothermal power system, for which Calpine is the main operator. The Geysers facility has a total capacity of about 1,000 MW.

Delta holding ahead of update

Delta chief executive Grinstein will on Wednesday set out details of a strategic review, the lack of which was the primary obstacle in the Atlanta-based airline getting consents from holders of notes secured with plane assets. The conference call is scheduled for 8:30 a.m. ET.

It is expected to include thousands of job losses, pay cuts and an increase in healthcare contributions from employees.

The Delta convertibles were described as about a half-point better, with the 8% issue in the 38 area and 2.875% issue at 40.25 bid, 40.75 offered. Delta's junk bonds were up a point, maybe up 1.5 points, on the day with the long-dated 8.3s due 2029 bonds in the high 20s. Delta shares closed Tuesday up nearly 10%, gaining 38 cents on the day to $4.48.

Delta paper bounced recently on views that its pilot union would come back to the bargaining table and might be persuaded to go along with the carrier's request for a 35% wage package cut, which would produce $1 billion in annual savings for Delta.

But trouble with consents from its equipment trust securities and pass-through certificates holders let some of the air out of hopes that Delta could rise above its current troubles.

As a backdrop to the Delta situation, headlines following the three-day holiday noted a breakdown in US Airways Group Inc.'s talks with pilots, a turn of events which is threatening to send that airline into bankruptcy for a second time. U.S. Airways is seeking $295 million from its pilots as part of a plan to cut annual labor costs by $800 million and reduce annual expenses overall by $1.5 billion.

But a convertible trader said the US Airways state of affairs might work in Delta's favor.

"If the US Airways pilots force [US Airways] out of the sky, that helps Delta's argument with their pilots," the trader said. "Delta's pilots are the highest paid in the industry, so if other pilots can't get any more money then they will have to relent. On the other hand, if they don't, then they will be out of a job if Delta goes belly-up."

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