Alcoa up in gray, markets expects bigger, repriced deal; Citi slips, seen cheap; Johnson Controls hold firm

By Kenneth Lim

Boston, March 17 - Alcoa, Inc.'s planned convertibles shot up in the gray market Tuesday, sparking speculation that the deal will be upsized and repriced.

Archer Daniels Midland Co. was up slightly with its stock amid reports that the company could be bidding for the assets of bankrupt ethanol producer VeraSun Energy Corp.

Cephalon, Inc.'s 2% convertible due 2015 and its zero-coupon convertible due 2033 were quiet despite a sharp gain in the common stock after the company reported positive data on a key drug.

The Cephalon 2% bonds were seen at about 139.25 on March 12, while the zero-coupon notes were at 119 on March 13. The common stock rose 9.29%, or $5.87, to close at $69.06 on Tuesday.

"Obviously from the market's reaction it was positive news," a buysider said.

Cephalon said Tuesday that its narcolepsy treatment Nuvigil showed positive results in a phase two clinical trial for treating bipolar disorder. The Frazer, Pa.-based biotech said it plans to move on to phase three trials for the new indication.

It was unclear Tuesday why the bonds were not active, market sources said.

"I'm not sure," a sellside trader said. "They're quite far in the money, maybe they're not that interesting now because they're just going to move with the stock."

The new Johnson Controls, Inc. paper held firm to its gains in what has turned out to be a strong start. The 6.5% convertible bonds due 2012 were seen at 108 against a stock price of $9.50, while the 11.5% mandatory preferred stock changed hands at 53.25 versus a $9.75 common stock.

Johnson Controls common stock closed at $9.82, up by 1.87% or $0.18.

Johnson Controls is a Milwaukee-based provider of energy optimization solutions for automotives and buildings.

Citi seen cheap

Citigroup Inc.'s 6.5% convertible preferreds slipped ½ point outright on Tuesday, as a report from Barclays Capital said holders of the common should consider switching to the preferreds.

The Citigroup convertible closed at 23.10, while Citigroup common stock rose 7.73%, or $0.18, to close at $2.51.

Citigroup is a New York-based bank holding company.

"In the last couple of days the preferreds (including the convertible) have been trading at a steep discount to the exchange value, driven by negative technicals, principally the lack of borrow on the common," wrote Barclays analysts Venu Krishna, Manoj Shivdasani and William Gioielli in a note.

"Implied borrow costs have risen from 10% to 67% in recent days. Currently, the C 6.5% convertible preferreds imply a discount of 27% (37% upside from current levels to parity). Just a couple of days ago, the discount was as low as 10%... Accordingly, we recommend that C common holders swap into the preferreds to take advantage of the recent widening in discount."

Citigroup on Feb. 27 offered to exchange its convertible preferreds for common stock at an exchange price of $3.25 per common share. The exchange would be based on 85% of the face value for the $50 convertible preferred.

"In our opinion, the lack of borrow or the prohibitively high cost of borrow in the recent past has been one of the main reasons for the steep increase in the preferred discount," the analysts wrote.

"Anecdotally, borrow is unavailable for initiating new shorts at present and borrow costs have increased from GC rates before the transaction to prohibitively high levels (high double digit range).

"Conversions (long calls and short puts) on Citi provide an estimate for the actual cost of borrowing and indicate a jump immediately after the decision to announce the exchange offer on Feb. 27. However, the spike in borrow cost yesterday [Monday] was far more substantial and appears to be the single biggest factor behind the cheapness of the preferreds."

Holders of the Citigroup common can lend their stock to take advantage of the high borrow cost. They can also swap out into the preferreds, which would be "in effect buying the common at a 27% discount."

When Citigroup provides details about the exchange offer, it could also close the discount, the analysts wrote.

"Timing on the exchange offer remains uncertain, adding to the discount, in our opinion," the analysts wrote. "Details on the timing of the transaction are expected soon. We expect this to be a catalyst for the discount to start contracting."

Alcoa seen cheap

Alcoa's planned $250 million offering of five-year convertibles was expected to be upsized and repriced after initial views that the deal was extremely cheap.

The convertibles were traded at 106 in the gray market Tuesday, and bids hovered around 105.75 to 106.25. Alcoa common stock declined by 8.66%, or $0.53, to close at $5.59.

The convertibles were talked to yield 5.75% to 6.25% and an initial conversion premium of 15% to 20%. The deal, which is being sold via joint bookrunners Morgan Stanley & Co. Inc. and Credit Suisse, was seen pricing after the close Wednesday.

Pittsburgh-based Alcoa, an aluminum producer, is also planning to sell 150 million shares of its common stock.

Proceeds are expected to be used to repay outstanding debt under the company's senior unsecured 364-day revolving credit facility, with any remainder for general corporate purposes.

A sellside convertible analyst said the deal looked more than 5% cheap at the mids, based on a volatility capped between 30% and 50%. The use of the proceeds to pay down debt was a positive aspect of the deal, the analyst said.

"They're raising equity to pay down debt," the analyst said.

A buysider said the expectation from the Street was that the deal would be enlarged and richened.

"Everybody's waiting for it to be repriced, so it's not going to be that cheap anymore," the buysider said. "I think the common expectation is that it's not only going to be upsized, but it could easily be repriced."

The buysider agreed that the credit could improve.

"All in all, if they accomplish most of what they say they want to do, you're going to get... a slight improvement in the capital structure," he said.

Archer Daniels Midland gains

Archer Daniels Midland's 0.875% convertible due 2014 gained slightly outright on Tuesday amid reports that the company could be bidding to buy VeraSun's assets.

The convertible traded at 94.75 against a stock price of $28.35, up by ¼ point. Archer Daniels Midland common stock closed at $28.57, up by 1.53% or $0.43.

Archer Daniels Midland is a Decatur, Ill.-based agricultural products processing company.

"I did see some activity in ADM," a convertible trader said. "Saw some news on them, but I don't think it's anything major."

Reports Tuesday afternoon said Archer Daniels Midland was taking part in an auction for assets of bankrupt VeraSun. Archer Daniels Midland said after the market closed that it had taken part in the auction but did not end up buying any assets.

Mentioned in this article

Alcoa, Inc. NYSE: AA

Archer Daniels Midland Co. NYSE: ADM

Cephalon, Inc. Nasdaq: CEPH

Citigroup Inc. NYSE: C

Johnson Controls, Inc. NYSE: JCI

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