Lehman deal exchangeable into General Mills bid up in gray market; Boston Private deal emerges

By Ronda Fears

Nashville, Oct. 4 - In not exactly a copycat structure, the Lehman Brothers Inc. mandatory that is exchangeable into General Mills Inc. shares incorporates a twist on the stock loan transaction used by Deutsche Bank Securities last week on the newest Calpine Corp. convertible.

"It's highly ingenious structuring," said an origination source at a busy convertible desk, but probably thought by creators to be of use only to situations like Calpine that were nearly shut out of the convertible market as a means of raising capital because of the limited borrow on the underlying stock.

"The whole purpose was to provide Calpine access to the market that they wouldn't have otherwise had. Their access was limited due to the lack of borrow" on the stock.

Calpine's new discount 6% convertible slipped about 0.25 point on swap Monday at 90.25 bid, 91.25 offered, but a sellside source said the issue has not been stupendously active as is the case with most new issues.

It's not the first recent trend-setting structure off the Deutsche desk, either. Deutsche also came up with an answer to the confusion and concern about the fate of contingent conversion features on convertibles among issuers, which ultimately proved credible as a new accounting rule was adopted last week that requires those issuers to recalculate diluted earnings per share as if the issue were converted.

Net share settlement was devised by Deutsche whereby the issuer pays the appreciation beyond the initial conversion calculation in cash.

Elsewhere in the primary market, Boston Private Financial Holdings launched a tiny $75 million deal for Wednesday's business.

In other secondary action, Beazer Homes USA Inc. was hammered in the stock market, with its shares falling $4.44, or 4.1%, to $103.75. That put selling pressure on the 4.625% convertible, which lost 1.5 points to 106.75 bid, 107.25 offered. Traders said interest rate fears and valuation concerns were the big drivers in Beazer's tumble.

MCS Software Corp. was higher in the stock market on a buyout offer at $9 a share from ValueAct Capital Partners LP, but hedge fund players in its 2.5% convertible due 2008 were squeezed as they scrambled to cover short positions. The stock shot up 12% to $8.95 with 1.33 million shares trading, 6.5 times the average for that stock, and the convertible was closed up 1 point at 111.5 bid, 113 offered.

At the other end of the spectrum, a fund manager juggling a multi-strategy fund in New York said there has been some recent cheapening in the Medtronic Inc. and Walt Disney Co. convertibles. Many players have been eagerly watching for a downdraft in Disney over the summer, but it's just now materializing. Disney's 2.125% convertible was pegged at 103.5 and Medtronic's 1.25% convert at 102.

General Mills forward stock deal

General Mills' transaction with Lehman is a forward stock contract but rather than being designed to affect a convertible sale on swap as Calpine's was, a market source said it appears to address Lehman risk exposure.

General Mills is selling $835 million in convertible preferreds to Lehman that, in the event of a credit deterioration of General Mills, will automatically be exchanged. Those proceeds are earmarked to purchase 16.5 millions shares of the 33.4 million shares of General Mills stock being sold by Diageo plc, which were part of the 79 million shares of Diageo received when General Mills bought Pillsbury in October 2001.

Also at the time General Mills acquires its stock from Diageo, it will enter into a forward purchase agreement with Lehman Brothers to sell those shares three years hence.

Lehman is then issuing a $750 million mandatorily convertible into between 13.6 million and 16.5 million of General Mills shares, mirroring the forward purchase contract terms, which can be settled in stock or cash at Lehman's option.

Reasoning behind Lehman's offer of just $750 million of the $835 million exchangeable have not been explained by sellside sources nor have any speculations on that matter been made by buyside sources.

General Mills deal gobbled up

Before Monday's open Lehman launched the $750 million of three-year mandatory exchangeables that are convertible into General Mills with price talk of a 6.25% to 6.75% dividend and 18% to 22% initial conversion premium. The quick-sale deal was pricing after the close.

In the gray market, just before pricing, the issue was seen bid 0.17 point over issue price with an offer at 0.32 point over. General Mills stock was propped up in the market, dealers said, showing only a 4-cent drop on the news to $45.26 with a seven-fold rise in volume.

"The growth and income funds will be all over this, so I would buy it," said a buyside analyst at a hedge fund. "But since it's not immediately convertible, it may stay cheaper over its life than it otherwise would."

At another hedge fund, the portfolio manager was less enthusiastic, saying, "It's only one deal, don't get too excited. I'm looking at it. It's okay."

General Mills said any remaining proceeds will be used to repay debt and the proceeds from the forward stock sale in three years would be earmarked to repay debt.

General Mills zero steady at 70

The existing General Mills convertible, the 0% due 2022, was steady Monday on the news as the underlying General Mills stock found support and was little changed on the news of the day. The convertible was bid at 70.

General Mills sold the $1.35 billion of zero-coupon converts in October 2002, with those proceeds earmarked to partially repay $4 billion of commercial paper borrowings to help fund the $10.4 billion purchase of Pillsbury. In a separate transaction at that time, General Mills bought a three-year call option from Diageo on 26.2 million shares at $3.07 per share, or $80.4 million, with a strike price of $51.56.

While the exchangeable will be linked to Lehman's credit, Standard & Poor's along with Moody's affirmed General Mills' credit ratings on the event but both mentioned concern about the transaction weakening the foodmakers' statistics.

"The transaction initially weakens General Mills' fixed charge coverage," by EBITDA from 4 times to 3.4 times, S&P said but due the forward purchase contract in three years, if delivered would mitigate the situation. Still, S&P said it remains concerned with the deterioration in cash coverage ratios, as the preferred stock issuance will pay a dividend for the three-year term.

"In light of the operational setbacks General Mills has encountered, this transaction eliminates any financial flexibility in the near term," S&P said, "and any deviation from the firm's expected debt reduction of $2 billion by 2006 will likely result in a downgrade."

Moody's was equally concerned with General Mills' leverage, the increasing complexity of its capital structure and continuing uncertainty surrounding the impact of an SEC investigation into its sales practices and accounting.

The convertible preferred will negatively impact debt protection measures in the near term, Moody's said, and will delay upward rating momentum.

"Moody's views preferred stock as a good long term source of capital," the rating agency said. "However, for highly rated companies such as General Mills, we view preferred stock as a 'debt-like' fixed income security" and the agency was using it as a 50% equity/50% debt in the capital structure of General Mills.

Boston Private deal emerges

There is a forward stock sale agreement attached to the Boston Private deal, as well, but it predates the convertible transaction. Boston Private is pitching $75 million of 30-year convertible trust preferreds talked to price with a 4.5% to 5.0% dividend and 35% to 40% initial conversion premium via bookrunner Merrill Lynch.

On completion of the convertible transaction, Boston Private said it would adjust the terms of its forward sale agreement with Merrill Lynch, originally dated Dec. 12, 2003, to extend its expiration from December 2004 to December 2005. Under the forward contract, Boston Private will receive $36 million in proceeds for the issuance of 1.6 million shares on or before the December 2005 maturity date, unless the company elects to cash settle the forward contract.

Since the convertible is not pricing until after Wednesday's close, lots of players were focused on the General Mills deal, deferring a look at Boston Private until Tuesday.

Boston merger activity a flag

However, some players were already passing on Boston Private's deal because of its acquisition activity - the target for proceeds raised in the deal.

"I'm not looking at the Boston deal," the multi-strategy fund manager said. "People got hurt on the MNS [MCS Software] cash merger, although [it was] a small deal."

Unlike MCS Software, Boston Private is a suitor, but market sources said its levels of acquisition activity could make it a target, as well.

Walter Pressey, chief financial officer of Boston Private, said the convertible and forward stock sale transactions were especially beneficial to address the bank's need for capital related to acquisitions, as the transactions create lost-cost capital while accommodating flexibility during merger talks.

Boston Private has had news on two acquisitions in as many days. On Monday, even, the company announced an agreement to buy an 81% interest in KLS Professional Advisors Group Inc. The $30 million deal - with 90% payable in cash and the remaining in common stock - is expected to close in fourth quarter. Boston Private has agreed to acquire the remaining 19% stake within the next five years.

On Friday, Boston Private completed the purchase of Encino State Bank for $33.1 million in cash, which the company said would immediately add to its earnings.

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