AGCO plowed under on SEC inquiry; Level 3 leveled on dim outlook; three deals at bat

By Ronda Fears

Nashville, Feb. 5 - Level 3 Communications Inc. dropped sharply on a lackluster 2004 forecast plus a cutback in business from one of its biggest customers, America Online Inc. AGCO Corp. also plunged, also on a disappointing outlook, but more so on its revelation that the Securities and Exchange Commission had launched an informal inquiry into its accounting practices.

Overall, convertibles firmed slightly on Thursday, traders said, but sellers were gaining steam.

"I don't know if any of the selling really had anything to do with the new deals on the table, as they're pretty small and not anything so hot that people are scrambling, scratching to get involved, you know," said a convertible dealer.

A trio of deals just $255 million in all were at bat after the close - American Axle & Manufacturing Holdings Inc., Equinix Inc. and LTC Properties Inc. In addition, Citadel Broadcasting Corp. put a $300 million deal on next week's slate.

American Axle traded 1 point over issue price in the gray market, but no trades were seen in Equinix, buyside traders said. LTC's pricing was delayed a day from initial plans to price it after Wednesday's close.

"All of these were very quiet in the gray," a buyside trader said.

"I don't think people are all that excited."

A long march in small steps

With a couple of more small deals on the table, buyside players still are not overwhelmed.

"Underwhelmed is more like it," a convertible trader at a huge hedge fund in New York said, referring to the deals that have emerged this week.

"There is a long row to hoe and we're late getting out of the chute," he added, referring to the slow pace of issuance thus far in 2004.

American Axle's 20-year cash-to-zero convertible notes, pricing alongside a $250 million straight senior note offering, were talked to yield 2.125% to 2.615% with a 37.5% to 42.5% initial conversion premium. The issue was being sold on swap, with $40 million of proceeds going to repurchase stock.

At the middle of price talk, Deutsche Bank Securities analysts put the American Axle convertible 0.42% cheap, using a credit spread of 125 basis points over Libor and a 25% volatility.

Another buyside trader said the American Axle issue was not active in the gray market at all, although there was a bid of 1 point over issue price with an offer at 2 points over. He said the only desirable feature of the American Axle issue, in his opinion, was that it was investment-grade paper (BBB), given the valuation.

American Axle shares closed up 71 cents, or 1.83%, to $39.59.

Equinix Inc.'s $75 million of 20-year convertibles - talked to yield 1.75% to 2.25% with a 28% to 32% initial conversion premium - traded at 1 point over issue price in the gray market midmorning, and the bid was hung there with no further activity for the rest of the session. Equinix shares closed down $3.10, or 9.51%, to $29.50.

At the middle of price talk, Deutsche analysts put the Equinix convertible 3.175% cheap, using a credit spread of 750 basis points over Libor and a 50% volatility.

Citadel's $300 million of seven-year convertible notes were talked to yield 1.5% to 2.0% with a 30% to 35% initial conversion premium with pricing set after the close next Wednesday.

Air deals on downward slope

While most other airline paper stabilized or began to gain small measures of altitude, the new converts from Mesa Air Group Inc. and Delta Air Lines Inc. continued heading south. Meanwhile, there was some speculation about another troubled airline - Air Canada - tapping the convertible market.

"Mesa fell flat it seems," said one buyside trader, who did not get involved with the new deal.

Another, who also declined to participate, said, "This is a really screwed up new issue, Mesa. It's a piece of garbage. I mean, who ever heard of an airline selling something at essentially 2.115%, up 40%."

Mesa sold $100 million discount cash-to-zero convertibles, pricing the deal roughly at the middle of guidance, at 58.34, for a 3.625% yield to maturity and a 40.3% initial conversion premium - roughly at the middle of guidance for 3.25% to 3.75% yield, up 38.5% to 43.5%.

At the final terms, Deutsche analysts put the new Mesa convertible 2% rich, using a credit spread of 450 basis points over Libor and a 50% volatility, plus noting the borrow on the underlying stock is extremely tight. At the middle of guidance, Deutsche had put it 2.69% rich.

Merrill Lynch, sole bookrunner of the Mesa deal, closed it off by about 0.25 point at 57.1875 bid, 57.375 offered. But buyside sources said the Mesa issue dropped 2 to 3 points right out of the gate and ended some 7.25 points below issue price at 51.875 bid, 58.125 offered.

Mesa's old 6.25% converts lost 2 points to 52 bid, 53 offered.

Mesa shares closed down 45 cents, or 4.37%, to $9.85.

Delta's new 2.875%, up 30% convertible, which was repriced at 97, also was lower, but the slide was subsiding. It ended off by 0.5625 point to 94.0625 bid, 94.3125 offered.

Delta's old 8% convertibles dropped 1.5 points to 85.5 bid, 86 offered.

Delta shares edged 4 cents lower, or 0.41%, to close at $9.66.

Mesa and Delta were the only airline convertibles that lost ground Thursday, however, as the group tilted upward on a Wall Street Journal article that suggested JetBlue Airways Corp. and AirTrans Holdings Inc. were potential winners from Delta postponing the second phase of its low-fare, high-frills program.

But a dealer noted that a research note out early by a JPMorgan equity analyst said any lift in JetBlue or AirTrans on the article would be a mistake.

"The gist of this is that it's old news, no one should be a buyer thinking they are getting in ahead of the crowd," the trader said.

Perhaps as a result of the recent deals from Delta and Mesa, there was some buzz heard Thursday that the name speculated in recent weeks of an issuer tapping the convertible market out of bankruptcy might be Air Canada.

"This is pure speculation, but it would be interesting," one market source said.

"Air Canada probably would look pretty good right out of a bankruptcy restructuring, too. They have $585 million in [bankruptcy] exit financing from General Electric Capital Corp. There hasn't been any news of any other debt, and they are buying aircraft."

Air Canada has said it is planning to buy 90 new regional jets in the second half of this year from Bombardier Inc. and Embraer.

Level 3 leveled on outlook

Level 3 improved its net losses last year but said it expects market conditions to remain soft, or "challenging" through 2004. Indeed, Level 3, one of the largest Internet-backbone companies, also said Thursday that AOL, one of its biggest customers, has said it plans to cut back dial-up capacity purchases.

As a result, Level 3's newest convertibles, the 2.875% due 2010, fell 12 points or about 1.5 points on swap to 94.5 bid, 95.25 offered, a trader said. He said the 6% converts, both the 2009 and 2010 issues, came in about 9 points to 70 bid, 71 offered.

Level 3 stock plunged 70 cents, or 12.48%, to $4.91.

Early Thursday, Level 3 reported a fourth quarter net loss of $121 million, or 18 cents a share, versus a net loss of $313 million, or 73 cents a share, a year earlier; revenue rose 6.7% to $988 million. For 2003, the net loss was $711 million, or $1.26 a share, versus a net loss of $858 million, or $2.11 a share, for 2002; revenue rose 29% to $4.03 billion.

Chief executive James Crowe said Level 3 generated $25 million of free cash flow for the last half of 2003, better than the company had expected, and renewed several large customer contracts. However, demand and pricing for basic optical transport and Internet protocol, or IP, services remained challenging.

"We expect these market conditions to remain unchanged through 2004," Crowe said.

Level 3 expects to see pressure on revenue through the first half of 2004, primarily from its managed-modem customers like AOL. The impact from the AOL cutback, and other factors, could be a reduction of as much as $150 million in revenue, Crowe said.

If that revenue reduction comes to pass, consolidated free cash flow for the year will decline by as much as $60 million, he said.

AGCO falls 11 points, 1.5 on swap

AGCO posted a fourth quarter profit but provided guidance for first quarter earnings that was far below analysts' expectations. But the blow that sent AGCO securities reeling was the company revealing that since year-end 2003 it has received an inquiry into its accounting practices by the SEC.

AGCO's 1.75% convertible due 2033, which was issued in mid-December, dropped 10.875 points - or 1.25 points on swap - to 97.875 bid, 98.625 offered. The underlying stock plummeted $3.10, or 16%, to $16.25.

A dealer said, however, there was not a selling frenzy in reaction to the news, at least insofar as the convertibles were concerned.

"Oddly, there wasn't a lot of the convertibles traded," he said. "We got lots of calls, people checking to see where they were, that sort of thing."

The Duluth, Ga.-based agriculture equipment manufacturer said proceeds from the convertible offering would help pay part of the purchase price for its €600 million acquisition of Valtra Corp., the tractor and off-road engine manufacturer unit of Kone Corp.

AGCO said Thursday that federal regulators have launched an informal inquiry into its policies with regard to accounting for revenue recognition - particularly bill and hold transactions - sales and sales returns and allowances, plant and facility closing costs and reserves, and personal use of corporate aircraft.

In some cases, AGCO said it recognizes revenue when equipment remains on its premises after having been invoiced to the dealer, at a dealer's request. These recorded sales, before discounts and allowances, amounted to $32.8 million at Dec. 31, 2003, and $29.9 million at Dec. 31, 2002, the company said.

Otherwise, AGCO was upbeat about 2004, although it noted that first quarter results will be negatively impacted by the addition of Valtra's seasonally low first quarter results and one-time costs related to the acquisition and debt refinancing.

Current industry fundamentals are favorable entering into 2004 with relatively high commodity prices contributing to strong farm income, the company said in its earnings release.

Adjusted earnings per share are expected to grow by 20% to 30% in 2004, and reported earnings per share are seen up by 50% to 60%.

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