Kmart falls after downgrade back to junk; Granite climbs on asset sale

By Paul Deckelman and Paul A. Harris

New York, Dec. 17 - Kmart Corp. bondholders reacted badly Monday to the news that the giant retailer is once again squarely in junk bond territory, its debt falling about five points across the board. On the upside, Granite Broadcasting firmed smartly after the company agreed to sell its San Francisco-area TV station to NBC

In primary market activity, meanwhile, talk was of buyer exhaustion after last week's heavy issuance. Terms on the session's only scheduled new deal, from Cott Beverages, Inc., had not emerged late in the day and are now expected Tuesday morning.

Kmart used to be a straight junk issuer, and then managed to claw its way to some semblance of split-rated respectability last year, when Moody's Investor's Service raised it to Baa3. But what Moody's giveth, Moody's taketh away, announcing Friday after the day's trading activity had wound down that it was lowering the Troy, Mich.-based discount department store chain operator's bonds two notches to Ba2. It also cautioned that in light of the company's recent weakness (Kmart reported a $224 million third-quarter net loss two weeks ago), Kmart faces "a continuing challenge" to improve operations, and cautioned that it may be "some time" before this can be achieved.

Standard & Poor's, meantime, recently lowered Kmart's bonds to BB from BB+ previously.

In Monday's dealings, Kmart's bonds were "down pretty big," a market observer said, "at least five or six points." Kmart "was more active today than we have seen in a while," a trader agreed, "although at much lower levels."

Kmart's 9 3/8% notes due 2006, which had finished Friday's trading at bid levels around 87-89, but had pushed down to 82.25 bid/84.5 offered. Its 8¾% notes due 2004 retreated to 82.75 bid/84.75 offered from 88-89 Friday.

The 8 1/8% notes due 2006 dipped to 77 bid from 82 on Friday. The trader said that among Kmart's longer-dated paper, such as its 7.95% bonds due 2023, which had previously been quoted offered in the mid-to-upper 60s, but with no bids heard, "some people showed interest" and the bonds traded at 61 bid/64 offered. "The long end was getting pushed down anyway prior to this news, so it didn't drop as dramatically as you'd think."

He added that "we'll see if these bids are here just to cover shorts and then it all disappears. That's the thing you've got to be careful of - they'll throw out bids just to cover shorts, and then those bids will disappear and the next bid down is five points, which can happen."

Kmart was also down on the equity side Monday, its shares losing 63 cents, or 10.90% in New York Stock Exchange trading, to close at $5.15. Volume of more than 16 million shares was about four times the usual turnover.

Kmart temporarily took the spotlight off another issuer whom Moody's dropped into the junk category late Friday, Calpine Corp. Moody's - which had only raised Calpine to a split-rated credit in October - reversed that earlier decision and on Friday lowered its bond ratings to Ba1 from Baa3 previously, just a day after it had warned that it might strip the San Jose, Calif.-based power producer and energy trader of its coveted investment-grade rating. The Moody's move brings its rating on the credit in line with S&P, which last week affirmed the bonds at BB+.

Calpine, for its part, publicly appeared to shrug off the downgrade, issuing a statement Monday in which it declared that its operations "are not significantly affected" by the downgrade to Ba1 and noting that the downgrade "does not trigger any defaults under the company's credit agreements and will have no material impact on credit requirements in its power sales agreements."

The financial markets appeared to agree; Calpine "gets downgraded going out Friday and they trade up this morning," the trader said. "You tell me what it means." He quoted the company's senior debt as having finished Friday around 75 bid/77 offered; while the bonds opened around 68 bid Monday, the retreat did not last very long, with levels having been lifted to around 77.5 bid/79 offered by the end of Monday's trading. At another desk, Calpine debt was seen essentially unchanged on the session. Calpine stock, meanwhile, lost just 30 cents on the session (2.27%), to close at $12.90, although its NYSE price level had dipped as low as $11.81 before rebounding off its lows. The volume of 22 million shares was nearly three times the usual turnover.

Calpine, of course, has recently struggled after having been lumped in with the failed Enron Corp. in the minds of some investors - they note that both companies were once high fliers, playing in the volatile energy markets to rack up heavy profits, but now both are affected by the slide in the oil and gas markets. And just as Houston-based Enron was laid low by apparent accounting irregularities now under government scrutiny, questions have been raised about some of Calpine's unorthodox strategies (Calpine has made strenuous efforts to distance itself from Enron and to deny that there are any serious similarities between the two companies).

Another company now getting hit by some of the fallout from the Enron debacle is Dynegy Inc., the rival Houston-based energy trader which was going to buy Enron at the bargain-basement price of $9 billion, plus the assumption of $13 billion of debt, until new questions about Enron's finances caused it to back out of the deal. Moody's cut Dynegy's bond ratings to BBB- - just one step above junk - citing the uncertainties surrounding its nasty legal battle with the bankrupt Enron over just who owns the Northern Natural Gas pipeline, a key Enron asset which Dynegy claims it bought the rights to acquire.

Dynegy sought to stay on the good side of investors by responding with a $1.25 billion restructuring plan, which includes the issuance of $500 million of new common stock over the next 10 months, thus lowering the company's debt-to-equity ratio. Dynegy also plans to cut capital expenditures and sell off non-strategic assets - moves which it hopes will put $750 million back on its balance sheet.

Bond investors were impressed, taking its (still investment-grade) 7 5/8% bonds due 2026 up to 78 bid and its 7.27% notes due 2010 to 80 bid, both up two points on session. However, stockholders were dismayed by the prospects that their holdings will be diluted when the new common stock is issued and they took Dynegy's shares down $3.24 on the NYSE, or 12.99%, to $21.70. Volume of 15.2 million shares was almost three times the normal daily handle.

Besides the worries over the stock dilution, the shares may have also fallen in response to the company's guidance, as Dynegy lowered its 2002 earnings estimate $2.30 to $2.35 a share from the $2.50- to-$2.60 range previously, reflecting overall economic sluggishness and the restructuring plan. It also said it would take $125 million of Enron-related charges in the fourth quarter, when the company expects to earn 41 cents a share.

Outside of the energy sphere, Granite Broadcasting Corp. bonds were quoted rock-solidly higher Monday, after the New York-based television station group owner announced the sale of its San Francisco-area TV station KNTV, San Jose, Calif., to NBC for $230 million. Granite's 10 3/8% notes jumped six points to 80 bid; its 9 3/8% notes went from 68 bid to 75, and its 8 7/8% notes also closed at 75 bid, up four points.

Another TV station operator, Young Broadcasting Inc., however, was down on both the stock and the debt side, its 10% notes due 2011 quoted down almost three points on the session at 95.5 bid, and its shares down 82 cents (4.72%) to $16.55 on the Nasdaq.

Separately, Young announced that it had retained Credit Suisse First Boston as its exclusive financial advisor, to assist the New York-based company in the evaluation of its business options. It said that its recent sale of $250 million 8½% senior notes due 2008 "has provided us with greater financial flexibility and has enhanced our ability to negotiate deals from a stronger position."

U.K. cable-televison operator NTL Inc.'s bonds "were down a little," an observer said, quoting its 11½% notes due 2006 and 2008, as well as its 11 7/8% notes at 30 bid, all down from prior levels at 31.75. The news was all bad for the company, with Reuters reporting that the prospect that NTL - struggling with a massive debt load of over $11 billion - might announce a debt-for-equity swap would likely result in a even lower prices for its bonds. Those investor fears translated into prices under 30 cents on the dollar for its euro-denominated debt in London trading. Meanwhile, Bloomberg reported Monday that a number of fund managers and other NTL debt holders believe that a bankruptcy filing might be the only way out of its debt dilemma, following recent ratings downgrades by the major agencies to weak credit levels not far removed from default.

Those calls come despite the company's announcement last week that it could make its interest payments.

The word going around the high yield primary Monday was that the buy-side was "shopped out" from the junk bond smorgasbord that the investment banks served up during the week of Dec. 10.

"People are getting close to calling it a year," contended Margaret Patel, high yield fund manager of Pioneer Capital Management, who told Prospect News that she declined to play any of the deals that priced during the Dec. 10 week.

"I was able to resist them all," Patel said. "My last new deal was the Tesoro. I'm pretty selective."

One rumor that has circulated on the high yield primary market for nearly a month is that state and local pension funds are taking a particularly close look at the high yield asset class, presently. Patel said she has seen evidence of such activity.

"I think it's true," she said. "We've had some inquiries from institutional clients who are interested in looking at high yield, and wanted to discuss our outlook and our approach. We've seen that directly.

"I think it just reflects the fact that the absolute yield in Treasuries is so low. If you're looking for income at these yield spreads you have to take a hard look at high yield.

"And I think once we start to see bankruptcies go down, which will happen next year, then I think you will be able to see yield spreads between Treasuries and high yield narrow. And I think high yield will be pretty attractive next year. I think that's what advisors are seeing."

"And at a time when the outlook for earnings, for equities, is still a little clouded, and people are thinking that the ramp-up in earnings growth might be pretty slow, a high yield bond that has a yield of 8% of 10% or 12% looks very competitive with what you might get from equities over the next year."

One syndicate official explained to Prospect News that pension funds do not always play high yield to the maximum allocations their charters allow but this year may be different.

"Normally they don't have to, because if Treasury rates are 6% or 7% area and investment grade stuff is yielding 8% they can fund their payments with that type of coupon," the source said.

"They can fund their payables when they are receiving that type of coupon on a quarterly or semi-annual basis. But when rates get down into the 4% range all of the sudden they run into a funding gap. So they need to invest in higher yield securities."

Terms on Cott Beverages, Inc.'s offering of $275 million of 10-year notes were expected Monday but had not emerged by late in the session.

In addition to those Cott terms, Tuesday could see price talk emerge on EchoStar $700 million, via bookrunners Deutsche Banc Alex. Brown and Credit Suisse First Boston. The deal is scheduled to price Wednesday or Thursday.

However, the sell-side source quoted above does not expect to see very much business come into the high yield primary during the week of Dec. 17.

"Based on the reception that a couple of those deals got last Friday I think that people realize that investors don't have that much appetite right now and they're getting a little tired," the source said.

End

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