Convertibles weaken; Herbalife's planned $1 billion offering in focus; InterMune sinks

By Rebecca Melvin

New York, Feb. 3 - U.S. convertibles were weaker on Monday but trading was on the quiet side amid a combination of sharply lower stock markets and weaker credit markets.

"Everything is a little weaker on a dollar-neutral basis by about 0.25 point to 0.5 point," a New York-based analyst said of convertibles, citing widening credit spreads.

"There were no huge moves, and not everything is down. But marginally, stuff is weaker, with not a lot of news items out," the analyst said.

Credit spreads will be a key feature of the trading week. The yield on the 10-year Treasury fell 3.26% to 2.58% on Monday.

"There isn't any panic, but if there are a couple more days of this, there might be," the analyst said.

Volumes were light, but perhaps not as light as they might have been given a combination of factors, including that fact that it was Monday, which is generally a lighter day for the convertible market; that it was the first trading day of February, which meant there was little pressure to trade; and a wet snow accumulated in many regions of the northeast during the session, which sent some market players home early or kept them home altogether.

Herbalife Ltd.'s planned $1 billion of 5.5-year convertible senior notes, which launched before the market open and which were seen pricing after the market close, were a focus. Market players said the stock borrow was tight outside of a borrow facility provided by banks associated with the deal.

After the market close, Cepheid launched an offering of $250 million of seven-year convertible senior notes that were talked to yield 1.5% to 2% with an initial conversion premium of 27.5% to 32.5%. Pricing was seen occurring after the market close Tuesday.

Elsewhere, there was continued action in InterMune Inc.'s 2.5% convertibles, which extended outright losses from Friday when competition concerns surrounding the Brisbane, Calif.-based biotechnology company's Esbriet drug reared up.

DFC Global Corp.'s two convertible bond issues also remained active after trading significantly on Friday. Shares of the Berwyn, Pa.-based provider of financial services fell another 6% after sliding 29% on Friday on a disappointing earnings miss and lowered guidance for fiscal 2014 earnings.

The DFC Global 3.25% convertibles due 2017 fell another few points to about 76 after tumbling more than 10 points on Friday, while the shorter-dated DFC 3% convertibles due 2028 held steady at around 90 to 91.

Equities plunged on the first trading day of the new month.

The Nasdaq stock market slid 106.05 points, or 2.6%, to 3,996.96, putting in the worst performance of the day, and extending its 0.5% loss on Friday, when it was the best performer. The S&P 500 stock index slid 40.70 points, or 2.3%, to 1,741.89, extending a 0.7% decline Friday. And the Dow Jones industrial average sank 326.05 points, or 2.1%, to 15,372.80, after losing 150 points, or nearly 0.9%, on Friday.

Herbalife is borrow dependent

Herbalife's $1 billion offering of 5.5-year convertibles was seen as attractive for investors, or cheap, if stock borrow wasn't too expensive, but unattractive, or rich, if borrow was expensive.

Assuming a borrow cost of 1%, and valuation inputs, including a credit spread of 450 basis points over Libor and a 40% borrow at the midpoint of talk, the deal was worth 104, according to one analyst.

But a second source said that using a credit spread of 500 bps over Libor and a 35% vol. made the deal worth 98.8 at the midpoint of talk, or rich. The midpoint of talk is for a coupon of 1.75% with an initial conversion premium of 27.5%.

This second source said that using a tighter credit spread seemed unadvisable given that the company has a senior secured term loan maturing in March 2016 that was being quoted at about 96, which equates to a spread of 414 bps over Libor.

"While the deal lacks borrow, it's cheap assuming a 1% borrow; but, the market borrow rate is way higher," the analyst said.

'There are some high-profile hedge funds that are short the stock, and if you can't borrow it, that will impact the economics," the analyst explained.

Perhaps the most vocal hedge fund involved with Herbalife is Bill Ackman's Pershing Square, which has alleged that the company engages in deceptive practices and recruitment systems.

Herbalife's convertible offering has a $150 million greenshoe and was being sold via joint bookrunners BofA Merrill Lynch, Credit Suisse Securities (USA) LLC, HSBC Securities (USA) Inc. and Morgan Stanley & Co. LLC.

Proceeds will be used for working capital and general corporate purposes, including repurchase of outstanding common shares.

In addition to the new convertible deal, Herbalife also preannounced earnings that were better-than-expected for the most recent quarter. But guidance for the current period was weak.

For the just-ended period, adjusted earnings per share are expected to be in the range of $1.26 per share to $1.30 per share, which is better than the $1.17 analysts' estimate. Full-year earnings were seen in line with prior guidance.

For the current quarter, the company expects earnings of $1.24 per share to $1.28 per share. That was below the analysts' estimate for $1.40 per share.

The company also increased its existing share repurchasing program to $1.5 billion from $1 billion. The previous program had a balance of $653 million.

Herbalife shares were volatile, starting the day higher and then moving lower, before rallying into the close for a $4.65, or 7%, climb to $69.02.

The Cayman Islands-based nutrition company plans to use the proceeds of the convertible bonds to buy back shares, for general corporate purposes and for a call spread.

Cepheid offering on tap

Cepheid's Rule 144A offering of $250 million of seven-year convertible senior notes was launched after the market close on Monday and talked at a coupon of 1.5% to 2% with an initial conversion premium of 27.5% to 32.5%.

The deal was being sold via joint bookrunners Morgan Stanley and Jefferies LLC.

There is a $37.5 million of over-allotment option.

Proceeds of the seven-year bullet paper will be used for general corporate purposes, including potential acquisitions and strategic transactions, and to pay the cost of the capped call transactions.

Cepheid expects to enter into capped call transactions with one or more of the initial purchasers of the notes or their respective affiliates.

Sunnyvale, Calif.-based Cepheid is a molecular diagnostics company.

InterMune extends losses

InterMune's 2.5% convertibles dropped another 4 points on an outright basis to 85.5 bid, 86 offered at the end of the session versus an underlying share price about $12.00.

The bonds had slipped 2 or 3 points on an outright basis on Friday to 89 bid, 90 offered from about 92. Friday's move was on an 18% slide in the underlying shares of the Brisbane, Calif.-based biotechnology company. On Monday, shares were down another 11%.

During the session, the bonds were seen at 85.75 bid, 86.25 offered versus an underlying share price of $12.85, a trader said.

The downdraft was sparked by competition concerns surrounding its Esbriet pulmonary fibrosis drug after German drugmaker Boehringer Ingelheim GmbH said that it is starting a registry to collect data on patients with idiopathic pulmonary fibrosis. The German company is also conducting a late-stage study in the disease.

Esbriet is approved in Europe to treat pulmonary fibrosis there, but it was rejected in the United States in 2010 when regulators asked for further data. The additional study results are expected to be reported in March or April.

Mentioned in this article:

Cepheid Nasdaq: CPHD

DFC Global Corp. Nasdaq: DLLR

Herbalife Ltd. NYSE: HLF

InterMune Inc. Nasdaq: ITMN

Take-Two Interactive Software Inc. Nasdaq: TTWO

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