Toys R Us off on break-up plan; Brinker drops after company cuts guidance; GM slides

By Ronda Fears

Nashville, Aug. 11 - Technology issues in the convertibles market were hit as the underlying stocks suffered en masse from a warning from computer giant Cisco Systems Inc. that spending by corporations as well as consumers is slow and inventories are rising. Outside of that group, similar pressures were being felt.

Toys R Us Inc.'s convertible dropped alongside the stock after the struggling retailer - butting heads with rising competition from discounters like Wal-Mart and Target - announced a decision to pursue a break-up plan, although the details are yet to be fully known.

Brinker International Inc. posted solid results for its fiscal fourth quarter and fiscal year but lowered its guidance for the upcoming year's performance based on recent weak sales trends. The zero-coupon convertibles were hit hard, which a trader said also strongly reflected concern about the contingent conversion feature on those bonds.

General Motors Corp.'s convertibles were down by about a quarter-point to a half-point, although the stock edged higher, seemingly shrugging off concerns expressed by Standard & Poor's about the company's weak sales, rising inventories and other matters like pension fundings.

"After the interest rate hike, and these [earnings] warnings, it's like the Fed is a whistling in the dark," a buyside trader at a hedge fund in New York said. "We're seeing stuff for sale and not a lot of buying, well a little but it's name-specific and there has to be some compelling force to act on."

For example, he said the Delta Air Lines Inc. convertibles continued to get sold off, with each dropping another 2 points Wednesday. The 8% convertible was at 32.5 bid, 33.5 offered and the 2.875% convert at 34.25 bid, 35.25 offered. Delta's junk bonds also continued to ease, with the 7.7s of 2005 at 41 bid, 42 offered.

Sellers also were seen for El Paso Corp. convertibles as the energy concern announced further revisions to past financial statements when it files them next month. The company also said it has received additional waivers on its $3 billion revolving credit facility and other financings, giving it until Sept. 30 to file its annual report and until Nov. 30 to file first and second quarter results. El Paso plans to hold a conference call to discuss the restatement and give a financial update on Aug. 23.

El Paso's convertibles dropped about a quarter-point with the zeros quoted by a sellside trader at 49 bid, 49.5 at one shop and at 48.75/49.25 at another, and the 9% mandatory lost 0.25 to 26.98 on the New York Stock Exchange. El Paso shares lost a dime, or 1.31%, to close at $7.55.

Toys R Us loses 0.5 point

Toys R Us' long-expected restructuring, underscoring growing competition from discounters Wal-Mart and Target and on the heels of closing all its Kids R Us and Imaginarium stores last year, was not exactly well met, one sellside trader said.

The Toys R Us 6.25% mandatory due 2005 dropped 0.5 point to 45.25 on the New York Stock Exchange, and dealers said volume was very heavy in the issue.

Toys R Us junk bonds were off 3 points on the news, with the 7.625% notes due 2011 at 100.5 bid, 101.5 offered.

Toys R Us shares lost 27 cents, or 1.64%, to $16.15.

"It's not clear what will be left of the company, whether there's going to be a sale and/or spinoff, or what," the sellside trader said. "They say they will cut costs and all that jazz, but a lot of people holding on just have gotten tired and decided to sell out. Remember Kmart had to file for bankruptcy, and who would want to hold on here if that's coming down the road."

Standard & Poor's put Toys R Us debt on negative watch after the news broke, he pointed out.

The company said specific alternatives are still being considered. By separating the two retail lines, the company said it expects to cut costs by $275 million, which includes liquidating $150 million in inventory and taking a $14 million charge to cover severance and other related costs.

The idea of a breakup did appeal to some, however.

"Breaking up the company would actually release value, in my opinion," said a buyside source in California. "They turn the screws and cut costs, EPS goes up, or they throw in the towel. There's a lot of risk, no doubt, but I don't think that's [bankruptcy or liquidation] going to happen."

Brinker paper 1.5 points softer

In addition to Brinker's warning, traders said the convertibles were under selling pressure from the contingent conversion feature, again. The bond initially dropped when the potential for new financial reporting rules, requiring issuers to quantify dilution, surfaced in early July, but again Wednesday when the company mentioned it in its earnings release.

It was a small footnote at the end of a table in the release, stating that for earnings per share purposes the company counted "approximately 93 million outstanding diluted shares, exclusive of any impact of the potential conversion or inclusion in the share base of the company's outstanding convertible debt."

The 0% convertible plunged 1.5 points on the day to 63.875 bid, 64.125 offered.

"Everyone is a little antsy about the CoCo issue," a buyside trader said.

A Financial Accounting Standards Board task force is scheduled to discuss the matter further in a meeting Sept. 29 and 30.

Brinker shares also were beaten down by the lowered guidance, falling $2.60 on the day, or 7.6%, to $31.60.

"Primarily due to recent sales trends that have been softer than the company's initial forecast, the company is revising its business outlook for fiscal year 2005," Brinker's earnings release stated.

Diluted EPS for fiscal 2005 was cut to $2.18 to $2.30 from $2.28 to $2.38.

Otherwise, Brinker's earnings were in line with analysts' expectations with fiscal fourth quarter net income of $64.5 million, up from $40.2 million, on sales of $1.02 billion.

GM converts sold, stock up

GM's outlook is negative now, said S&P credit analyst Scott Sprinzen in a report Wednesday, saying he now expects GM's automotive earnings to be under pressure during the second half of 2004, reflecting in part the need to cut production and/or raise incentives to reduce high dealer stocks.

GM's 6.25% convertible lost about a half-point to 27.875, and the 5.25% convert dropped about a quarter-point to 23.625, a dealer said. GM shares ended up 7 cents, or 0.17%, to $41.74.

There also was increased concern about GM credit on S&P's comments, he said. S&P held a conference call on the Big Three automakers - GM, Ford and DaimlerChrysler - on Wednesday.

Sprinzen specifically mentioned in his report, however, that he did not view the looming CoCo accounting rule as a "significant adverse development." He noted that some $8 billion of GM debt is its contingent convertibles, $4 billion of which was sold in 2003 for pension-funding purposes.

"GM has suggested that if this change in accounting treatment were required, the company could waive its right to issue shares up to the par value, committing itself to use cash instead if debtholders sought to exercise the conversion or put options," the analyst said in a report.

"We would not view this as a significant adverse development, as we had not placed any reliance on the potential for equity issuance: conversion would occur only if the share price appreciated substantially from recent levels, and we had doubted GM's willingness to suffer the dilution that would result under the scenario whereby holders were seeking to put the debt back to the company."

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