Carnival, AAR, AGCO convertibles ripe for swapping, J. Giordano's Berkman says

By Evan Weinberger

New York, Oct. 3 - When a stock is going great guns, it can often work a corresponding convertible so far into the money that the convertible ceases to exist. That's when swaps come in, and Paul Berkman, a senior vice president at J. Giordano Securities Group, has found several profitable swap opportunities.

In a research note released Wednesday, Berkman highlights convertibles issued by Miami-based cruise line Carnival Corp., Wood Dale, Ill.-based defense and aerospace contractor AAR Corp. and Duluth, Ga.-based agricultural equipment maker AGCO Corp. as prime for swapping.

Carnival stock soared in September, the report said, based on better-than-expected earnings and an increased number of people wanting to get away from it all in Europe and Alaska. Carnival stock (NYSE: CCL) closed at $50.01 Tuesday. The company has three outstanding convertibles: 1.132% convertible senior notes due April 29, 2033, zero-coupon convertible notes due Oct. 24, 2021 and 2% convertible senior debentures due April 15, 2021.

Berkman says that of the three outstanding issues, only the 1.132% convertible senior notes - the 1.75% monthly coupon is only valid through April 29, 2008 and then reverts into a 1.132% payment - are worth holding.

"The other two are now so deep in the money that they are likely to be called - and converted out of existence - on their respective call dates in 2008," Berkman said. "Most importantly, the degree of downside protection vis-à-vis the common is minuscule."

The 1.132% convertibles have a call on April 29, 2008. The zero-coupon convertibles have a call on Oct. 24, 2008. And the 2% convertible debentures are callable on April 15, 2008.

The 1.132% convertibles also have a relatively low premium of 15.8% and a put at the end of April 2008, thus lowering risk. They also have a gamma of 4, so the theoretical delta, now at about 60% will go up over 4% for each 1% change in the common stock.

And when the other two Carnival convertibles are likely called in 2008, Berkman added, "at least some holders of the other two bonds will likely become, at that time, buyers of this one."

AAR 1.75s favored

The low point for AAR stock over the last year came at the beginning of the 12-month period. Since then, the stock has gone from $23 to a high of around $35. AAR stock (NYSE: AIR) closed at $31.20 Wednesday.

AAR has two outstanding convertibles: 1.75% convertible senior notes due Feb. 1, 2026 and 2.875% convertible senior notes due Feb. 1, 2024. The 2.875% convertibles have a call on Feb. 1 2008, while the 1.75% convertibles don't have a call until February 2013.

Assuming the stock doesn't tank between now and Feb. 1, 2008, Berkman expects the 2.875% convertibles to be called on that date. "This will leave convertible players no place to go but into the 1.75% bond. I'd make the switch now," Berkman said.

The 1.75% convertibles, Berkman noted, also provide the benefit of having the most upside potential while providing significant downside protection as well as both takeover and dividend protection. The 2.875% convertibles provide protection against dividend hikes but not cash takeovers.

AGCO's rising stock

New highs are being set in AGCO stock nearly every day, Berkman said, and the low point in the last 12 months was set at the beginning of the period. The low for the period was $24.61 while the high was $52.02. AGCO stock (NYSE: AG) closed Tuesday at $51.20.

AGCO has two outstanding convertibles, the 1.25% convertible senior subordinated notes due Dec. 15, 2036 and the 1.75% convertible senior subordinated notes due Dec. 15, 2033.

The 1.75% convertibles are too far in the money to provide downside protection, according to Berkman, and could be called at any time. That is, unless the stock has a sudden fall. The 1.25% convertibles, he said, aren't too far in the money to have lost their value.

"This isn't a very high-gamma convertible, but the comparison between both bonds seems to be an easy one. The 1.25% bond moves here on a high delta (around 90%) but will lose delta on the downside as parity approaches par," he wrote.

In other words, swap into the 1.25% convertibles, Berkman said.

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