Aquila climbs 1.5 to 2 points; Delta steadies; Calpine lower; Red Hat seen as volatility play

By Ronda Fears

Nashville, Aug. 19 - After a string of bought deals that were remarketed below par, Aquila Inc. - a utility still struggling in the wake of the shakeout in the energy sector after Enron Corp. collapsed three years ago - priced a good sized $300 million mandatory at the tight end of guidance. The Aquila paper shot up right out of the chute.

"It [Aquila] was a decent pricing. It's a turnaround story and if you are into that sort of thing, or can handle the risk, now is when you want to get involved, you know, not after they have made the comeback," said a convertible trader at a hedge fund in Chicago.

At bat after Thursday's close was a small $70 million deal from aQuative Inc. talked to yield 2.0% to 2.5% with a 42.5% to 47.5% initial conversion premium.

Otherwise, oil prices remained at the forefront of players' considerations as they looked for opportunities in the secondary market. Crude oil futures hit another record close Thursday, gaining $1.43 to settle at $48.70 a barrel.

"Oil prices are at least relieving fears of too quick an interest rate hike regimen," said a convertible fund manager in California. "So, you hide in big investment-grade names with decent coupons and with decent beta stocks where you can trade a little easier ye olde gamma, or unwind bonds to the yield-hungry masses."

Volatility was another particular source of betting among convertible players, but with volatility still as low levels, it's a risky and sporadic gamble. The Nasdaq volatility index Thursday dropped 1% to 23.91, and the market volatility index rose 4.5% but was still at a low spot of 16.96.

Red Hat Inc. saw heavy activity as a "cheap" volatility play, a sellside trader said. A convertible trader at a hedge fund in New York also mentioned a couple of oil drilling names, BJ Services Co. and Transocean Inc.

"You have to get ready for the great unwind of oil, but I feel we need total fear or panic and pain to get there first," said the West Coast convertible fund manager.

Hedges against oil prices was a draw to several airlines, although Delta Air Lines Inc. was certainly not in that loop since it went "naked," selling its oil hedges in February.

Delta's bonds, however, were steady Thursday as the stock slipped on restructuring developments and a Standard & Poor's downgrade to the credit. After gaining Wednesday, traders said bondholders were leaning more toward a view that the company would have to file bankruptcy despite the out-of-court restructuring under way.

Calpine Corp. convertible holders also are nervous, and a sellside trader said there was selling in the 4.75s to buy secured paper of the independent power producer. The convertibles dropped a point to 74.625.

Aquila deal climbs to 26.5 bid

Aquila sold $300 million of three-year non-callable mandatory convertibles in the PIES, or Premium Income Equity Securities, structure at par of 25 with a 6.75% dividend and 22% initial conversion premium. The issue priced at the aggressive end of price talk for a 6.75% to 7.25% dividend and 18% to 22% initial conversion premium.

The issue closed by bookrunner Lehman Brothers at 26.5 bid, 27 offered. That was where the issue was seen in the gray market before the opening bell Thursday, having already risen from the late Wednesday gray market bid of 0.5 point over issue price.

Buyside sources said support for buying into the turnaround utility story was aided by the S&P upgrade to Aquila credit ahead of the pricing and a similar Fitch Ratings action on Thursday. Fitch revised Aquila's outlook to stable on the convertible and stock offering (40 million shares).

"With the prepaid gas supply contracts behind them pretty much and this infusion of capital, the risk of default is diminishing as we speak," said the Chicago fund manager.

"Fundamentally, you have to remember that behind all the merchant energy shenanigans and prepaid contracts, they are a utility and that's still a pretty safe bet. [It's] not as safe as it used to be, as we've learned the hard way, but safer than a lot of stuff that is out there."

Aquila shares closed up a penny Thursday, or 0.39%, to $2.56.

Delta bonds steady on anxiety

After initially getting a lift from Delta's restructuring progress, the convertibles and straight bonds leveled off Thursday as bankruptcy buzz continued to linger.

Delta's 8% convertibles were steady at 35.5 bid, although the offer widened to 37.5 from 36. The 2.875% convertibles also were unchanged at 40 bid, and the offer on that issue widened, too, to 42 from 41. Delta's junk bonds shot up 6 points on the news with the 7.7% notes due 2005 at 44 bid, 46 offered.

On Wednesday, the Delta paper gained on reports of progress in union pilot talks and the airline hiring Weil Gotshal & Manges.

On Thursday, airline management and union pilots were meeting to discuss wage concessions, which also may include giving the pilots an equity stake in the company. The company was also talking about reducing its fleet and workforce.

Despite the developments, CreditSights analysts Roger King and Glenn Reynolds said in a report Thursday that it looks like the Delta events are following the game plan of American's restructuring but could be more of a Hail Mary.

"The first salvo was aimed at the older ETC [equipment trust ceritificate] bondholders, who are in serious danger of getting their planes back. Management is trying to show a little backbone in front of the labor negotiations, but the big 2000-2003 EETC holders will be hard to budge," the analysts said.

Delta has a much higher hill to climb than American, for one thing, they pointed out. Besides, Delta is going into winter with a low cash position; an unfunded pension hole that is $4 billion deeper and then there is still significantly stronger low-cost-carrier competition.

"American had to go to the bankruptcy courthouse steps to get all the factions in line; Delta will likely have to go into the courthouse just to stay alive," the analysts said in the report. "Management will make an attempt to negotiate a consensual restructuring out of bankruptcy. But at the end of the day, it is too late in the season and it is too deep in the hole to climb out."

Buying airlines outside Delta

For those liking airlines, many of the other major carriers offer opportunity, and traders pointed out that the others have hedged themselves somewhat against oil prices.

Delta went "naked" in February and now is suffering more as oil prices continue to climb.

"They needed the money, because you know it wasn't something smart," said a sellside trader, referring to Delta's decision to sell the oil hedges.

That is not a fundamental reason to switch into the other airlines, though, a convertible fund manager, who is involved in both outright and hedged convertible strategies, said.

"Of course, no one will want those 'hedges' if and when the oil price tumbles. Hedges aren't hedges. 'Hedges' are bets, even bets, unlike at the casino, but bets nonetheless," he said.

"The oil price is much more likely to go down than up from here. What's left to boost the price? China has boomed. India has grown. The U.S. economy has done OK and Americans have bought trucks instead of cars. Iraq, Russia and Venezuela have threatened to reduce oil supplies. NIMBYs [not in my back yard - environmentalists] in America have prevented refineries from being built. The dollar has weakened. Most everything has favored a higher oil price.

"Delta is too risky for us. There's plenty of potential return in stronger companies like Continental and AMR."

Red Hat seen as cheap vol play

"Volatility, volatility, volatility" - it sounds like the realtors' incantation: Location, location, location. But it's actually the mantra of hedgies these days looking for something to boost returns and to stay busy.

Some were selling puts on oil names. Specifically mentioned were BJ Service and Transocean.

But Red Hat was the "red hot" volatility play of the day, a sellside trader said.

"There was a huge volume, a huge spike in volatility on the stock - it dropped something like 10%," he said. "A lot of people are short the stock and they see it as cheap volatility. The bonds are 3s [yield to put] up 75%."

Red Hat's 0.5% convertible was quoted at 89.375 bid, 89.875 offered at one sellside shop. At another, it was quoted at 88 bid, 88.5 offered. The stock fell $1.64, or 11.21%, $12.99.

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