Kmart bonds take another beating; market ignores big inflows; three new deals price

By Paul Deckelman and Paul Harris

New York, Jan. 11 - Kmart Corp. bonds moved lower for a second consecutive session Friday, amid renewed investor concerns about the discount retailing giant's performance outlook and liquidity situation. In the primary sphere, three deals priced - AMC Entertainment Inc., Rural Cellular Corp. and Interface Inc.

The market gave a mixed response to good market liquidity news in the form of a huge inflows to high yield bond mutual funds.

While one secondary trader termed the $1.21 billion net inflow to high yield mutual funds in the week ended Wednesday Jan. 9 "gigantic," he and others said there was little sign of any benefit to activity.

However from the primary desks, syndicate officials told Prospect News Friday that the tidal forces of the fund inflow made themselves felt as the three deals scheduled for the last day of the week were executed.

"I think with the huge positive inflows the deals went pretty well," said one official on the syndicates of both the AMC Entertainment and the Interface deals.

"There was a lot of demand," the official added. "So in general the market felt good for both deals."

Interface Inc.'s $175 million of eight-year notes (B2/BB) priced at par to yield 10 3/8%, better than talk of 10½%-10¾%, according to one official.

Joint bookrunners for the deal were Salomon Smith Barney and Wachovia Securities.

Rural Cellular Corp.'s $300 million of eight-year notes (B3/B-) priced at par to yield 9¾%, coming "in line" with the 9½%-9¾% price talk, according to one syndicate official. Dresdner Kleinwort Wasserstein ran the books.

And AMC Entertainment Inc.'s $175 million of 10-year notes (Caa3/CCC) was upsized from $150 million and priced at a discount of 98.436 to yield 10 1/8%. Price talk had been announced as 10% area. Salomon was bookrunner.

"Everything feels very well-bid out here," one syndicate official said. "There's a lot of new deals coming down the pike."

In fact, half a dozen deals were winding their way to market for pricing during the week of Jan. 14.

Leading the pack is Xerox Corp.'s $500 million of dollar and euro seven-year notes, set to price Monday morning.

Also coming during the week are $185 million from Longview Fibre via Banc of America Securities; Owens Brockway Glass Container, Inc.'s $300 million of seven-year notes, also out of Banc of America; Compton Petroleum Corp.'s $150 million of 10-year notes via Lehman Brothers; $200 million of 10-year notes from Regal Cinemas, Inc. via Credit Suisse First Boston; and Coinmach Corp.'s $400 million of eight-year notes from Deutsche Banc Alex. Brown.

In the secondary sphere, Kmart "was the only real mover of the day," a trader said. "They got crushed pretty good today."

He quoted the Troy, Mich.-based department store operator's 8 3/8% notes due 2004 around 68 bid/70 offered, down from about the 75 bid/77 offered level at which they had finished Thursday. Kmart's 9 3/8% notes due 2006 dropped to 67 bid/69 offered, while its 9 7/8% notes due 2008 ended at 66 bid.68 offered, "all down around three-to-five points across the board."

Kmart "was the only story of the day, them heading south. A lot of people don't like them," he concluded.

At another desk, Kmart's 8.54% paper retreated seven-points to 58 bid. The 9 3/8% notes were quoted as low as 60 bid during the session.

Another trader concurred that Kmart's troubles were the dominant feature of an otherwise mostly so-so session, estimating the bonds as down anywhere from five to seven points.

He also saw Fleming Cos. debt, linked intimately to Kmart's prospects by a big contract for the Dallas-based food grocery wholesaler to supply Kmart's approximately 2,100 stores with grocery items. Fleming's 10 1/8% notes dipped to below 96 from prior levels around 98 bid.

Kmart's bonds and shares - and those of Fleming - had fallen sharply in the first trading week of the new year, after Prudential Securities equity analyst Wayne Hood predicted a sharply reduced fiscal fourth quarter net from his earlier estimates, changed his forecast of a modest full fiscal year profit to a loss and warned that unless cash-flow improves Kmart might have to consider a bankruptcy filing.

After that, the bonds went on a week-long rebound, which was joined by the shares, as investors came to the conclusion that a bankruptcy filing probably would not happen any time in the near future.

But on Thursday, the retreat resumed, after Kmart warned that its profit for the fiscal year ended Jan. 30 will be below analysts' consensus one-cent-per-share expectations, and said it is talking with its lenders about possibly lining up some supplemental financing to help it get through its hard times.

After the session had wound down late Friday, Moody's Investors Service chopped the retailer's senior unsecured debt three notches to B2 from Ba2, and likewise downgraded several other Kmart ratings, totaling about $4.7 billion of debt.

The ratings agency cited "uncertainty about the prospects of Kmart's franchise longer term and the traction of its turnaround strategy."

As its bonds sank Friday, Kmart's shares tumbled in New York Stock Exchange trading as well, falling 90 cents, or 21.43%, to $3.30, Volume of 46.5 million shares was over seven times the average daily turnover of around 6.5 million.

Besides Kmart, the trader said, the only other real market features was AT&T Canada Inc., which he said "continued to slide" for a second consecutive session, amid concerns that corporate parent AT&T Corp. might refuse to stand behind its debt, even in the event that it is successful in buying the 61% of the Canadian long-distance and Internet provider which it does not currently own.

He quoted the company's 7.65% notes due 2005 - which had already fallen about 10 points on Thursday to the 44 bid level - down at least another seven points , to 37 bid/40 offered.

Another market source saw AT&T Canada's 7 5/8% notes due 2005 down several points to 37.5 bid, and said its 10 5/8% notes due 2008, which had fallen to around the 47 level on Thursday, were also down several additional points on Friday.

Earlier in the week, Moody's announced that it was putting the Baa3 rating on some $2 billion of long-term AT&T Canada debt on review for a possible downgrade. The ratings agency warned that the action "reflects our concern that the company's weak financial status and lack of regulatory progress in Canada may cause AT&T Corp. to reevaluate its long term support of AT&T Canada."

A3-rated AT&T, which hopes to buy the unit by June 30 - assuming Ottawa eases its stringent rules limiting foreign ownership of Canadian-based companies - has "effectively guaranteed" a floor price of AT&T Canada stock, but has not extended the same protective umbrella over the bondholders.

"Corp. (i.e., AT&T) has been clear in stating that it has no legal responsibility for the debt of ATTC," Moody's continued. "Even if ATTC is fully acquired by Corp., ATTC's debt is unlikely to be refinanced or guaranteed by Corp.," Moody's declared in outlining its likely course in lowering AT&T Canada's rating "to a level that better represents ATTC's stand-alone credit quality, which is substantially lower than Baa3."

The trader said that despite the deterioration of the bonds' prices, reflecting investor angst, Moody's had not pulled the trigger yet on the downgrade. "It's all still just rumor," he noted.

With traders calling the Kmart and AT&T Canada situations clearly the biggest story of the day in the secondary market, the secondary saw notably little reaction to the $1.21 billion net inflow to high yield funds, the largest inflow seen since at least 1999.

It was the second consecutive weekly gain in the mutual fund flow numbers, which are closely watched by many market participants as a reliable barometer of overall market liquidity trends.

In the previous week, according to market participants who track the weekly fund statistics compiled and distributed by AMG Data Services, some $216.5 million more had come into the funds than had left them, making the net inflow for the fledgling new year $1.426 billion. That continued an inflow trend which had taken place for most of the final quarter of 2001, after several weeks of sizable ($1.6 billion) outflows in the wake of the Sept. 11 terrorist attacks, which roiled the financial markets. Inflows had risen for nine straight weeks after that, totaling $2.6 billion, before outflows of almost $700 million in the final two weeks of the year tempered that surge.

Neuberger Berman High Yield Fund manager Robert Franklin told Prospect News that investors are recognizing that high yield in 2001 had its best year in the last four years - and that most of the business came in 2001's final quarter.

"With the economy bottoming out, the returns to the asset class should be closer to the coupon yield, if not better," Franklin added.

"I've been touting the asset class for this year. If you look at the components of return - meaning price return versus income return - in the last four years the price return has been negative.

"If indeed the economy has bottomed, then the price component should at worst be stable. An unknown is what happens to interest rates. A really hot economy could cause them to rise, putting pressure on prices. But I don't know anybody who's looking for that."

Also encouraging interest in junk bonds are the small yields on offer elsewhere, said a trader.

"What it comes down to is you've got the high-grade funds, some of which are 12b funds that take out that extra 75 basis points and the rest take out 100 basis points for fees, and the yield that you're getting by holding those funds and the dividends that they're paying have just eroded in value as Treasuries and the high grade market have rallied so much this year," the trader pointed out. " So you have a lot of rotation out of the high grade funds and into high yield."

He also noted that there had been a lot of tax-loss selling by high yield accounts at the end of 2001, as well, due to the big losses suffered by telecommunications names. That selling left a lot of cash in the hands of investors. "You have a lot of cash on the sidelines. Couple that cash with product rotation into high yield," and you see the kind of huge surge in the week's inflow number.

"People who are depending on current income or cash-flow stream for their income - older people for instance - are willing to take a little more risk to earn some more incremental income for themselves, because they're certainly not getting it from Treasuries, or the money markets, or the high grade funds," he said.

But while all of that cash is in the market, "you didn't see a lot of it put to work today," he concluded.

Another trader concurred that he had seen no real response to the AMG numbers, adding that apart from Kmart and AT&T Canada, "it was a typical Friday session - after noon, things came to a screeching halt."

On the upside, Polymer Group Inc.'s bonds were up four points on the session, its 9% notes and its 8¾% notes both ending at 40 bid.

Among Friday's newly issued bonds, a trader said the only one which he had seen freed for secondary dealings was the Interface Inc. 8-year notes, which priced at par and then pushed as high as 103 bid when trading began, before going out at 102.5 bid/103.5 offered, investor demand for the new paper helped by "a nice fat coupon."

End

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.