Williams $1 billion mandatory convertible talked at 8.75-9.25% yield, capped upside at 60-70%

By Ronda Fears

Nashville, Tenn., Jan. 3 - Williams Cos. Inc. launched $1 billion of three-year mandatory convertibles with price talk of an 8.75% to 9.25% yield with the upside participation capped between 60% and 70%. The registered deal, via joint book-running lead managers Merrill Lynch & Co. and Salomon Smith Barney, is scheduled to price after the market close Wednesday.

The $25 par units consist of a three-year forward stock purchase contract and a five-year senior note. The issue is expected to be rated Baa2 by Moody's Investors Service and BBB by Standard & Poor's. There is a $150 million greenshoe.

The convertible deal is part of Williams' plan to strengthen its balance sheet and thereby maintain its investment-grade credit status, which the company announced about three weeks ago. Williams said the proceeds would be used to fund its capital program, repay commercial paper and other short-term debt, and for general corporate purposes.

Mandatory convertibles have been on a tear in recent weeks, which has stimulated interest in that type of convertible, market sources said. Part of the appeal is the higher yield that issuers generally pony up for mandatory converts to entice buyers because the upside participation is usually less than with plain convertible bonds. Buyers hungry for yield particularly like the structure and are willing to give up some of the upside potential.

The Williams structure is really a return to the original structure for mandatories, which have been scarce in recent years as DECS (debt exchangeable for common securities) became more popular as arbitrage players took a larger role in the convertible market. Under the DECS structure, the issuers retained the first 20% of the upside participation potential, according to a syndicate source. Under the Williams deal structure, all the initial upside goes to the buyers, but is capped between 60% and 70%.

In terms of the dilution factor to common stock, the Williams structure is more appealing to issuers because it caps the value of the shares that will have to be issued.

"If the stock goes up to the exercise price or above that, it doesn't do you any good. Instead of getting the option premium up front, you get it over time but it's capping the upside potential, too," said a convertible trader at a hedge fund in New York.

"What a lot of people, buyers may not realize is that they are fully exposed to the downside. There is no downside protection except for the yield, and only the difference between the dividend and the stock dividend. This was the original mandatory structure, when everyone was a yield hog. If people really want yield, they are willing to give up some upside," the trader added, saying that the deal will likely appeal more to outright convertible investors than artibrageurs.

"There is decent upside to this, though, and right now, there are a lot of people looking for yield to bring up the average on their portfolio."

It makes for a tricky trading situation for arbitrageurs, but there is expected to be fairly healthy interest from the hedge funds in the Williams deal.

"I don't think people are too concerned that they will hit the cap. It's just not that good on a quantitative model from an arbitrage standpoint," said a hedge fund manager in Connecticut. "There is just not enough yield, because you have to shave off 3% or so from the common dividend."

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