GenCorp buyout bid hurts hedged holders; CenterPoint, Penn Treaty up; InterMune off

By Ronda Fears

Nashville, Nov. 11 - Veteran convertible players said Thursday that in the wake of the Federal Reserve's quarter-point interest rate hike and despite the sharp gain in technology stocks it still seemed passions were fading.

"There is very little conviction right now," said a trader at a hedge fund. "There is reluctance to continue to bid up the market, but the pickings are slimmer and slimmer. You could see the mood in how the market traded yesterday afternoon, after the Fed."

A source at another hedge fund suggested players are having to reach outside the convertible paradigm.

"Currently, we're playing a lot of smaller names and special situations. For example, we did really well on the Foster Wheeler restructuring," he said. Along more traditional lines, perhaps, he added, "We are also playing a number of healthcare and biotech names which have had some good runs."

Meanwhile, smaller new deals are trickling along. At bat after Thursday's close was FuelCell Energy Inc. with a $75 million perpetual convertible preferred talked with a 4.5% to 5.0% dividend and 15% to 20% initial conversion premium.

GenCorp bid a surprise bullet

While the Steel Partners II LP bid for GenCorp. Inc. was at a hefty 20% premium - $17 a share, or roughly $770 million - hedged holders in the aircraft component maker's convertible were crushed as they scrambled to cover short positions in the stock. The 4% convert lost 7 to 8 points on swap, with a hedge of about 65% to 70%, while outright holders saw the issue gain about 8 points.

"We missed the GY takeover landmine, although I still don't think this shareholder takes over GY, or leads to someone else coming in," a buyside source said.

A sellside trader pegged the 4% converts at 122 bid, while the stock rose $3.35, or 23.67%, on the day to close Thursday at $17.50. GenCorp's 5.75% convertibles, which have been a redemption target by the company, were pegged at 107.

The problem with the situation is that in such a transaction, the bonds just convert into cash.

"We dodged a bullet," because of holding just $2 million of the GenCorp convertibles, said a source at a hedge fund. "I still don't think they get taken over, but I don't want to lose anything being wrong."

The company said in a statement that it is meeting with its advisers to consider its response.

Another holder said, "I agree with Steel Partners that we need to replace the BOD. This most recent restructuring proposal is stupid."

Steel Partners criticizes GenCorp

In its buyout offer, Steel Partners particularly cited GenCorp's recent announcement of a new convertible offering of up to $75 million plus 8.6 million shares of stock as "yet another example of the incorrect and misguided business decisions the [GenCorp] board has and continues to make."

GenCorp's proposed $50 million convertible issue, with a $25 million greenshoe, is slated to price next week via bookrunner Wachovia Securities. Price talk has not emerged on the deal. GenCorp had said the proceeds would be used to repurchase part of its 5.75% convertible subordinated notes and repay or repurchase other debt.

Steel Partners, describing itself as a "long-term and patient shareholder of GenCorp," said it has given GenCorp "the benefit of the doubt despite the many mistakes it has made in allocating the company's capital and the poor job it has done managing the day-to-day operations" of the company.

Another criticism of GenCorp was the sale of its GDX Automotive unit to Cerebus Capital Management LP for $147 million in cash. GDX accounted for 60% of consolidated revenues for GenCorp, according to analysts.

Penn Treaty up 12 points

Over the past week, Penn Treaty American Corp.'s convertibles have gained 12 points, a market source said. And with its third quarter results coming in ahead of expectations, he said buying continued Thursday.

Along with the gain in the convertibles, Penn Treaty shares saw a nice gain Thursday as well. The stock gained a nickel, or 2.66%, to end at $1.93.

Penn Treaty's third quarter results signal a turnaround, said JGiordano Securities Group analyst Ed Cabrera, who on Thursday recommended the name as a buy on the quarterly upside surprise. Moreover, he said the small cap insurance stock is a bargain compared to its big cap peers but should head north on improving performance.

The stock closed Thursday up 5 cents, or 2.66%, to $1.93, and Cabrera expects it could trade between $3 and $4 over the next six to 12 months.

Penn Treaty reported net income of $41.8 million, or $0.48 per fully diluted share, which accounts for the anticipated conversion of its convertibles and in-the-money options. That compares to a year-ago net loss of $25.4 million, or $1.20 per share. Total revenues came to $150.2 million, versus $59.5 million.

"This solid performance occurred despite higher than expected persistence that forced a $2 million increase in reserves," Cabrera said in the report. "We expect the persistency rate to trend down to our annual projection, which will cause GAAP to release the reserves and improve EPS results in subsequent quarters."

Persistency is the renewal of in-force policies that require higher reserves, but the analyst said higher persistency is actually a positive factor since it means more premiums in the long term.

Penn Treaty's new annualized premiums reached $5.1 million in third quarter, which was a 36% gain from third quarter 2003. Cabrera sees the company on track to reach $20 million in new premiums for 2004 and $30 million for 2005, despite a delay in getting approval to engage in "the lucrative California market."

CenterPoint convertibles tick up

CenterPoint Energy Inc.'s converts ticked up a bit Thursday, with the 2.875s gaining 0.75 point to 104.75 bid and the 3.75s adding 1.25 points to 112.5 bid. The stock was up 19 cents, or 1.77%, to $10.95.

Late Wednesday, the Houston-based power company said the Texas Public Utility Commission ruled to allow $2.3 billion of stranded cost recovery, in line with amounts estimated earlier but $1.4 billion short of what the company had been seeking.

"This is just another step toward closing the overhang gap in this name," a sellside trader said. "And, really, the PUC ruling is probably pretty reasonable. At least it was not something unexpected."

On Tuesday, CenterPoint reported a net loss of $1.1 billion, or $3.66 a share, compared with net income of $182 million, or 59 cents per diluted share, a year ago - largely because of an $894 million writedown related generation assets. Revenues edged up to $1.7 billion from $1.6 billion.

Originally, CenterPoint requested $3.7 billion in rate hikes to cover the so-called stranded costs, but in September the Texas regulators ruled that the power company could only recoup about half, or $1.9 billion, of the expenses associated with electric generation assets sold as part of the deregulation process. The regulators now are allowing CenterPoint to recoup interest on the amount, which pushed the total up.

CenterPoint to finance balance

"Although the commission's final order is essentially in line with what we have been expecting based on their earlier deliberations, we nevertheless are extremely disappointed in the decision today," said David M. McClanahan, chief executive of CenterPoint.

Scott Rozzell, general counsel for CenterPoint, said the company will ask for a re-hearing before Texas regulators and if unsuccessful there, will appeal the ruling.

Meantime, Rozzell said, the company is working to get securitization bonds issued for the balance of the company's requested amount "while current bond market interest rates are favorable. Securitizing quickly should save customers hundreds of millions of dollars in interest costs."

Not getting the full amount requested could jeopardize CenterPoint's investment-grade standing, as Standard & Poor's is watching the development with a negative outlook. S&P said the drastic reduction in the judgment would be negative for the credit quality of CenterPoint as its BBB rating is predicated on deleveraging to the tune of about $5 billion from asset sales related to the deregulation process.

InterMune slide deepens

InterMune Inc. continued to slide in the aftermath of revealing a federal investigation into its drug marketing practices, with the 0.25% convertibles off about 1.25 points to 82.5 bid while the stock lost 3.42%, or 44 cents, to close Thursday at $12.39.

On Tuesday, InterMune said it had received a subpoena from the U.S. Department of Justice requiring the company to provide information about the promotion and marketing of Actimmune interferon gamma-1b, which is approved to treat chronic granulomatous disease and severe malignant osteoporosis.

The company has a broad and deep late-stage product portfolio, including treatments for the hepatitis C virus.

"There could be days and weeks of dumping here," said an InterMune holder. "If you truly are a believer in the confidence that's been building over the last few months, then this is a buying opportunity."

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