Default notice spurs Mercury Interactive; Hutchinson Tech plunges; airline convertibles slump

By Rebecca Melvin

Princeton, N.J., Aug. 30 - Convertibles players actively traded the bonds of Mercury Interactive Corp. on Tuesday after the business technology optimization software company said it received a default notice on its two convertible bond issues.

Also, Hutchinson Technology Inc. convertibles plunged after the maker of components for hard disk drives lowered guidance for the fourth quarter.

Airline convertible paper slumped along with their underlying stocks as oil prices rose to another record high in the aftermath of Hurricane Katrina, and flight cancellations to and from storm-devastated areas dealt a new blow to the carriers.

Overall the convertible market picked up and was "moderately active" Tuesday, one source said, after several somnolent sessions typical of late August.

Mercury Interactive trade mixed

The convertibles of Mercury Interactive traded actively Tuesday amid uncertainty about what would happen following a notice of default received on its $500 million of 0% coupon convertibles due 2008 and its $300 million of 4.75% convertibles due in 2007.

"The question is: are they going to pull another Brocade and waive the indenture?" a sellside trader asked Tuesday of the company's next move, following news of the default notice late Monday.

The New York-based trader was referring to a loophole Brocade Communications Systems Inc. found in the indenture of its 2% convertibles following a default notice on that issue.

The loophole allowed the San Jose, Calif.-based networked storage company to call the issue, but not for a year until Aug. 22, 2006. In the meantime, it deposited $276.1 million in interest-bearing U.S. Treasury securities into an account of the trustee to cover interest, principal and call premium related on the notes until the redemption. Those funds will remain on the company's balance sheet as restricted securities.

The move circumvented a declaration of default on the notes because it wouldn't have been able to meet the Aug. 23 deadline to file its fiscal second-quarter 10-Q. The trustee for the holders gave notice on June 24 of a potential default.

In the new case of Mercury Interactive, the company's 0% convertibles traded up about 3 points on Tuesday, as some convertibles players bet that a similar Brocade-like move couldn't happen and the bonds would likely be put back at par in two months.

The Mercury Interactive indenture doesn't have wording similar to Brocade's, which says the company has "within a year" to discharge the indenture, a New York-based sellside analyst said.

That wording allowed Brocade essentially to carry the present value of the bonds instead of having them put, he said. But Mercury Interactive has no ability to discharge the indenture like that, he added.

Nevertheless, the Mercury 0s' upward move wasn't completely wholehearted, as it stopped at 97, half way to par from 94, and right in the middle of the value of a potential par put and the bond's value based on holding it for life.

"It was right in the middle due to the uncertainty," said another sellside trader.

The 4.75% convertible wasn't traded as actively as its sister issue, but it came in a little, trading at 99.75 from a previous level slightly higher than par.

Since Mountain View, Calif.-based Mercury said it has available cash and securities to redeem the bonds, a default is unlikely. But a sweetener for holders is possible because the company also said it doesn't expect to be able to complete the required filings by the deadline of Oct. 25.

It received the default notice for failure to file its financial report for the quarter ended June 30. It also said it will restate previously reported financial statements for 2002, 2003 and 2004 following an investigation in response to an inquiry by the Securities and Exchange Commission.

Hutchinson convertibles sink

Hutchinson Technology's 2.25% convertibles slumped by more than 14 points on an outright basis after the company cut its fourth-quarter earnings guidance.

The Hutchinson, Minn.-based company reported it now expects earnings of five cents to 20 cents per share on revenue of $150 million to $165 million in the fourth quarter. The company had previously forecast a profit of 55 cents to 65 cents per share on sales of $165 million to $180 million.

The company blamed lower guidance on weak demand early in the quarter and a shift toward advanced products that produce a lower yield and productivity levels.

"I had expected it to pick up really," a sellside trader said of Hutchinson's performance. "The [company's] last problem was not enough capacity to meet demand, and at this point we are seeing more capacity online, and not expecting shipments to decline."

The trader said competition may be eating into Hutchinson's market share, which had been about 50% of the market for suspension assemblies that hold magnetic read-write heads in position above the spinning magnetic disks in hard disk drives.

The 2.25% convertibles due 2010 traded at 102.5 late Tuesday, compared to 117.5 bid, 118.5 offered on Monday. Shares of Hutchinson dropped $5.35, or 17%, to $26.16.

Airlines slump on higher oil

The 3.75% convertibles of JetBlue Airways Corp. traded down about 3.5 points on Tuesday and other paper in the group, including Continental Airlines Inc., AMR Corp. and Alaska Air Group, were indicated 2 to 3 points lower as crude oil and gasoline rose to another record high after Katrina shut down production in the Gulf of Mexico.

Additionally, cancelled flights to the storm-affected areas were viewed as another straw on the carriers' back. The Associated Press reported that Continental had 111 cancellations on Monday, the most of any major airline.

Forest Hills, N.Y.-based JetBlue's 3.75% convertible traded early at 99.875 versus a stock price of $18.90. Later it traded at 97. Its shares closed down 24 cents, or 1.2%, to $18.87.

Continental's 5% convertible due 2023 was seen down nearly 3 points at 86.85 bid, 87.35 offered. Its 4.5% convertible was down 1 point at 86 bid, 86.5 offered.

Alaska Air's convertible due 2023 was also seen down nearly 3 points at about 132.5, while the two convertible issues of AMR Corp., the parent of American Airlines, were down between 2.5 and 3.5 points.

Downgrade pressures Advanced Medical Optics

The 2.50% convertibles of Advanced Medical Optics Inc. dropped about 4 points Tuesday after Citigroup downgraded the shares to "sell" from "hold."

The 2.5s traded early at 99.625, versus a stock price of $39.60, down from about 103. Shares of the Santa Ana, Calif.-based maker of ophthalmic surgical and eye care products lost 64 cents, or 1.6%, to $39.91.

GM mixed after analysts' meeting

The $25 convertible bonds of General Motors Corp. traded mixed for another session. This time after an analysts' meeting in which the world's largest automaker reiterated it was on track with its turnaround plan but failed to provide updates on negotiations with the United Auto Workers or Delphi Corp.

The UAW talks are aimed at cutting union health-care benefits, which GM blames for hurting its ability to compete with foreign rivals. The Delphi negotiations are for relief of that auto parts supplier's cost structure woes.

The UAW talks, which have been held since April, are a vital part of GM's turnaround plan and its efforts to cut spending on health care that it expects to total nearly $6 billion this year.

"A lot of the pieces on the recovery plan, certainly around the structural costs area, are very sensitive and very difficult," GM chief financial officer John Devine told the analysts.

Discussions with the former subsidiary of Delphi are ongoing, but the outcome is uncertain, Devine said.

GM's 4.50% convertible bond edged up 0.02 point to 24.15, and its 6.25% convertible added 0.01 point to 21.65. But its 5.25% bond closed down 0.06 point to 18.85. The credit default swaps for GM and GMAC were seen wide after the meeting. "It was pretty quiet," a derivatives trader said.

GM shares jumped 41 cents, or 1.2%, to $34.45.

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