KKR credit concerns; Intel active again; Encysive looking up; investors on hold for earnings

By Evan Weinberger

New York, July 17 - With earnings season kicking into full swing and a slowdown in new issues, the convertibles market saw some action in the secondary market, particularly Intel Corp. convertibles, and talk swirled around an issue set to price Tuesday night from KKR Financial Holdings LLC.

But other than that, convertibles were for the most part staying where they started Tuesday. Meanwhile, the equity markets were up. The Dow Jones Industrial Average hit another new record, closing at 13,971.55, a gain of 20.57 points, or 0.15%. The Nasdaq also finished higher, gaining 14.96 points, or 0.55%, to close at 2,712.29.

"There's somewhat of a lull prior to earnings," said one sellside analyst who held out hope that some new issues would spark investors to overcome quarterly earnings and the predictable summer lull.

"It just seems to kind of slow down right before the earnings announcements. June was pretty active on the new issues front and the secondary front. We've had two deals announced this week."

Four new issues hit the street Tuesday, but three of them hit the streets of Ottawa, New Delhi and Almaty, Kazakhstan.

Domestically, Health Care REIT, Inc. led the charge with its $400 million in convertible senior notes due 2027. The deal was upsized from its originally announced $350 million and came in right at talk with a 4.75% coupon, a 23.76% initial conversion premium and a 98.25 reoffer price. There is also a $60 million greenshoe.

The Toledo, Ohio-based self-administered equity real estate trust that specializes in senior housing and hospitals plans to use the proceeds to invest in more health care and senior housing properties. The company also plans to repay debt under its unsecured line of credit arrangements.

Canadian technology firm Zarlink Semiconductor Inc. priced C$55 million in subscription receipts that will change into C$55 million in convertible debentures, depending on Zarlink's planned acquisition of Texas-based Legerity Holdings, Inc., another semiconductor maker. Once the receipts blossom into debentures, they will carry a 6% coupon and a 35% initial conversion premium and will mature Sept. 30, 2012. There's also a C$8.25 greenshoe.

Late in the day, Zarlink increased the deal to C$75 million.

The transformation from receipts will occur upon Ottawa, Ont.-based Zarlink's acquisition of Legerity is complete.

India's largest dam builder, Jaiprakash Associates Ltd., priced $300 million in zero-coupon foreign currency convertible bonds due Sept. 12, 2012. The bonds will yield 7.95% and have an initial conversion premium of 45%. The convertible offering is less than half of Jaiprakash's plan to raise $1 billion in two tranches. The company plans to use the proceeds to build a thermal power plant and for capital expenditures.

And from Kazakhstan, BMB Munai, Inc., an oil and gas drilling concern, priced $60 million in convertibles due 2012. The bonds carry a 5% coupon and a 6.25% yield. The Almaty-based company plans to use the proceeds from the transaction to fund more exploration and drilling in western Kazakhstan. The company's stock is traded on the American Stock Exchange.

Credit concerns dull KKR's appeal

One deal that was set to price Tuesday night may not be setting the world on fire when it hits the market Wednesday morning.

Like many real estate investment trusts, KKR Financial of San Francisco is being hounded by credit concerns springing from the subprime mortgage crunch. Already this week, Health Care REIT was forced to reoffer its $400 million in convertible senior notes due 2027 at 98.25 when no one bit at par.

Traders and analysts weren't predicting a similar fate for KKR Financial's $300 million in convertible senior notes, but said concerns over the REIT's credit could keep down demand. The bonds are being talked at a coupon of 6.5% to 7% with an initial conversion premium of 30% to 35%.

One sellside trader said that he had seen credit at Libor plus 250 basis points, which seemed high to him. Other banks, the trader mentioned, had KKR at Libor plus 50 bps and Libor plus 75 bps for two-year tenors.

"This one is five years so it seems that if people are using 250 bps for just three more years, they must have credit questions," he said.

The trader went on to say that the company is rumored to be trying to "de-REIT" itself.

"The implication here is that a dividend cut may occur," he said. "But another reason people were/are unhappy with this is that, apparently, there is not favorable 'dividend protection' language (again, I've not seen or read anything on this). Based on this I might speculate that the dividend protection/conversion ratio adjustment is 'two-way' instead of the favorable 'one-way' ratchet often seen in REITs."

A buyside outright fund manager said that there was one potential sweetener in the deal.

"My analyst says to pass on that," the fund manager said, citing concerns over credit. "I'm not sure if I'm going to pass because I always like a 6½% coupon."

Another sellside trader expressed skepticism about REITs in general when assessing KKR.

"The model has it 6½% rich," the trader said. "To me a [REIT convertible] is just a vehicle to be able to be short the stock without having to pay out the high common dividend over time."

KKR stock (NYSE: KFN) closed down 31 cents, or 1.24%, Tuesday, finishing at $24.65.

Encysive makes decisive move

Encysive Pharmaceuticals Inc. announced Tuesday that it would enlist Morgan Stanley to help it evaluate its options following the Food and Drug Administration's June rejection of the company's hypertension drug Thelin. In plain English, Encysive is looking for a white knight to come and save it from its troubles, although the company did say that it wouldn't necessarily take any of those alternatives.

Don't believe them, according to traders and analysts. "$5 is a minimum sale price when you factor in assets, tax benefits and debt. It could go higher, but a buyout will happen," said a special situations analyst at a shop in Boston. "I'm thinking Glaxo [GlaxoSmithKline plc]. But don't expect to see results in two weeks. This deal could take three to six months to work out. Folks are going to have to be patient."

Investors responded well to the news that Encysive was exploring its options.

The Houston-based drug maker has one outstanding convertible, although to most investors outstanding was not meant to indicate its superlative stature. But even the 2.5% convertible senior notes due 2016 were able to gain some traction. The convertibles finished at 68.875 according to traders after starting the day at 68, for a gain of 5.125 points from the previous close. A few large lots moved over the course of the day. The stock (Nasdaq: ENCY) gained 33 cents, or 19.41%, to $2.03.

One buyside fund manager was unimpressed by the Encysive news.

"It's been years of waiting for consolidation in the biotech area," the fund manager said. "They all think they're Amgen."

Intel active again

Whatever is inside Intel is certainly making convertibles investors sit up and take notice. After an active trading day Monday, the day before its second-quarter earnings announcement, the Santa Clara, Calif.-chip maker's convertible again was among the most active movers on the day.

The company announced earnings were up 44% over the similar quarter last year, helped mainly by a smaller workforce and strong chip shipments. The announcement fell within Wall Street's expectations.

Intel stock (Nasdaq: INTC) gained 38 cents, or 1.46%, to close at $26.33.

The company's 2.95% subordinated notes due 2035 finished the day 100.875, although it had been as high as 101.22, according to one sellside trader and over 102 according to Nasdaq's trading tracer. The convertibles started the day at 100.625.

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