Convertible market turns south with stocks, curtails secondary gains for new issues

By Ronda Fears

Nashville, Tenn., Dec. 13 - Convertible traders said the market went south as stocks retreated on worries that hopes of an economic recovery were premature as Lucent and Ciena warned of future losses. Calpine firmed a bit more, but there was concern anew as Moody's said it was reviewing the credit for a possible downgrade. And, while there was much excitement about more than $1.5 billion in new deals, traders said the paper was hampered somewhat by the turbulent market.

"It was a very tough day. All the new issues seemed to do well but they had a rough ride in this sloppy market," said a convertible trader at a major investment bank in New York. "The Calpine situation had been seeming to quiet down during the day and then Moody's came out and said it may cut Calpine. That's a big deal and it could really sting."

Calpine's convertibles all gained ground again Thursday, as did several other power and energy names that had been dragged down with it as scares rose that Calpine and/or others could go the way of Enron into bankruptcy. Calpine's zero-coupon issue (Baa3/BB+) due 2021, which sold at par in April, added 0.5 point on the day to 93.5 bid, 94.5 offered while Calpine's 5.5% convertible preferred gained 0.25 point to 41 bid, 43 offered and the 5.75% convertible preferred rose 0.5 point to 61 bid, 61.625 offered as Calpine shares edged up 14c to $16.05,

The news from Lucent and Ciena caused many market players to reverse their strategies that had been pushing stronger into the telecom and telecom equipment sectors, thinking that the industry was on the cusp of a rebound. Lucent said its fiscal first quarter loss will probably be lower than anticipated by analysts, but speculated that will be the low point for sales in the current market downturn. Ciena Corp. said it expects sales in first quarter to fall 30-40%, which could lead to an operating loss for the year, after reporting a net loss of around $1.8 billion for fiscal fourth quarter.

"The whole gamut of telecom names was getting slammed. Everyone got punished," said a convertible trader at a hedge fund in New York. "Some of the converts held up better than others, because of the structure and terms of the deals. This is a deja vu situation where you want to have a lot of downside protection.

Lucent's 8% convertible preferreds due 2031 (B3/B-) fell 50 points on the day to 109 bid, 109.375 offered as the stock dropped $1.21 to $6.52. Ciena's 3.75% convertible notes due 2008 (Ba3/B+) dropped just 0.25 point to 66 bid, 67 offered as the stock fell $3.03 to $14.94. The Corning convertibles were also sharply lower, with the 3.5% issue due 2008 dropping 10.5 points on the day to 112.75 bid, 113.25 offered as the common stock lost $1.17 to $8.95.

As stocks reversed course to negative territory, convertible traders said there wasn't a massive sell-off but many investors wanted to unload losing issues and, in some cases, pick up a profit they couldn't have seen a month ago. The Nasdaq lost 64.87, or 3.23%, to 1946.51 and the Dow Jones Industrial Average dropped 128.36, or 1.30%, to 9766.45.

"There were more sellers today," said a convertible trader at one of the major investment banks in New York. "Some were reversing recent decisions, others were taking advantage of a getting a little more back now than they would have a month ago, or not losing as much now as they would have a month ago, whichever way you look at it. And there are still some people believing that eventually everything will turn around, and they were selectively, very selectively buying in the telecom and tech names."

Lots of buyers were around, but most were picking up new paper as over $1.5 billion was injected into the market for trade early Thursday. A couple of those, one being the high profile Prudential deal, were upsized on very strong demand. But buy-side sources noted also that terms were getting less aggressive, which has heated up demand even more.

"We're beginning to see terms get a bit more favorable, or at least not as aggressive as we'd been seeing," said a convertible trader at a hedge fund in New Jersey. "It could also be that these deals were less aggressive because of so many being preferreds rather than bonds, which means there were probably lots of dedicated convertible funds playing these deals. In any event, the pendulum seems to be swinging more back to center."

Some of the deals were very cheap, particularly the Reinsurance Group of America deal, which one analyst said was a whopping 18% cheap assuming a credit spread of 100 basis points and 35% volatility in the stock. Most of the new deals of the day were priced at the cheap end of yield guidance but the premiums were at the high end of the ranges, which market sources said was because investors are interested in a bit more downside protection.

Some of the new paper struggled a bit in the immediate aftermarket, which traders said was mostly due to the sloppy stock market rather than a lack of buyers.

Prudential's new 6.75% mandatory convertible preferred was the richest of the new deals of the day, pricing with a tighter dividend than guidance but also showed the biggest gain in the aftermarket, indicating that syndicate sources were not exaggerating about the furor to snap up this paper. Syndicate sources said the deal was oversubscribed many-fold but would not provide a specific example. In the aftermarket, as the new stock climbed so did the convert. The convert added 2.95 to 52.95 as the stock rose $1.80 to 29.30.

"There was a mad scramble to get in on this deal. It was the biggest insurance IPO in history and everyone wanted a 'piece of the rock,' so to speak," said a buy-side source, metaphorically using Prudential's advertising slogan.

GTech's 1.75% 20-year convert gained 1.5 points from par as the stock rose $1.80 to $44 and Cinergy's 9.5% mandatory convertible rose 1 point to 51 bid, 51.25 offered as the stock gained 81c to $29.96. The AT&T 6.25% exchangeables into Rainbow Media Group added 0.4 to 22.90 as the underlying stock rose 35c to $22.85 and the Evergreen Resources 4.75% convertible notes were quoted at par with the stock off 6c to $35.94.

Reinsurance Group's new 5.75% convertible trust preferred slipped 0.25 to 49.75 as the stock declined 44c to $32.06.

Interpublic's new zero-coupon convertibles due 2021, which sold at 81.914, slipped 0.75 point to 83 bid, 83.25 offered with the common stock off 83c to $28.10. It was learned late in the day that the Paris-based advertising firm Publicis SA was selling €174 million of exchangeables that convert into Interpublic stock. The five-year paper was expected to price to yield 1.625% to 2.125% with a 29% to 33% initial conversion premium, according to a market source. The issue will be non-callable for three years, then with a 130% hurdle. Dresdner Kleinwort Wasserstein is sole lead manager of the deal, which is pricing in Europe.

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