AES, Gap seen lower in mostly quiet pre-holiday market; little response to Halliburton developments

By Paul Deckelman and Paul Harris

New York, Feb. 15 - The high yield market mostly sleep-walked through a quiet, abbreviated pre-holiday session Friday. In the secondary, traders said quotes were scarce, with only a few issues moving around. Among them were AES Corp., haunted by its overseas exposure, and the newly junked Gap Inc.

And after a week that saw $1.455 billion of new issuance, the primary was quiet too.

AES bonds - which had begun falling Thursday - "got crushed today (Friday), a trader said. "It was the story of the day."

The Arlington, Va.-based independent global power producer's 8 3/8% notes due 2007 fell more than four points on Thursday to end trading bid around 63 and on Friday the trader saw those bonds, and all of the company's longer-dated senior paper, languishing in a 60-63 range. Late in the session, they were being quoted as low as 56.5. He pegged its subordinated paper in the 48-52 range, although he allowed that there was "not a lot of trading going on," given the overall paucity of activity Friday.

At another desk, the 8 3/8% notes and 8½% notes were being quoted late in the session as having "dropped quite a bit" to 54 bid, well down from levels in the low 60s on Thursday, while AES' 9½% paper was seen six points lower, at 64 bid. AES' 8 7/8% notes due 2011 and 9 3/8% notes due 2010, both of which had traded Thursday in the upper 60s, were seen as low as the 56-57 range.

AES shares, meanwhile, swooned $2.50 (26.32%) in New York Stock Exchange dealings, ending at $7. Volume of 29.3 million shares was nine times the usual turnover. There seemed to be brisk activity in the final half hour of trading, as the shares came off their intraday lows below $6 to reach their closing level.

The surprise decision by Venezuelan President Hugo Chavez earlier in the week to float the country's currency unit, the bolivar - the result of unsustainable capital flight from the troubled Latin American nation in recent weeks - was seen as the catalyst behind the latest tumble in AES' securities, especially given the steep fall the bolivar took against the dollar in its first week of free trading. AES has significant exposure to Venezuela's dicey economic situation through its Venezuelan unit, Caracas-based CA La Electridad de Caracas (EDC). The company is the largest private-sector utility in Venezuela and is a significant cash-flow source to AES.

Noting this, Standard & Poor's on Friday placed the debt ratings of AES, including its BB senior unsecured debt rating and B+ subordinated debt rating, on CreditWatch with negative implications, and did the same for the debt of several AES subsidiaries.

"Substantial devaluation of the bolivar, which Standard & Poor's believes to be significantly overvalued, could negatively affect distributions from EDC," S&P warned in its announcement of the CreditWatch placement. While noting that EDC benefits from a favorable tariff arrangement that allows for adjustments based upon currency devaluation, the ratings agency cautioned that "this arrangement has yet to be tested in a free floating currency environment."

It pointed out that AES has cash needs of approximately $1.75 billion, including interest and construction and equity commitments, in addition to $488 million in refinancing needs. The company is expecting to get $1.25 billion in cash distributions from subsidiaries such as EDC and other properties in 2002, as well as $300 million in project financing proceeds to go along with $567 million in cash and revolver availability. Standard & Poor's said it views AES's liquidity position as "strained, and pressure on cash distributions will put additional strain on AES's liquidity."

S&P acknowledged that it "does not believe that even the complete elimination of cash flows from EDC in and of itself would result in a credit crisis at AES. However, substantial diminution of these distributions, combined with the current capital market environment could pressure the rating." S&P expressed further concern about the economic environment as a whole in Latin America, where AES has other interests in addition to EDC, and the potential for continued negative impacts on distributions from AES's businesses there. "If distributions from EDC appear to be substantially negatively affected, a one-notch downgrade or negative outlook is possible," the ratings agency concluded.

The Fitch ratings agency cited similar concerns, as it chimed in with a one-notch downgrade of the company's credit ratings, dropping the senior unsecured bonds to BB from BB+.

"Everyone's pretty much figured out what kind of exposure they have in some of these other countries," a trader opined, in analyzing the steep fall which AES debt took. "They are involved in any number of countries which don't have the best credit ratings."

And potential trouble spots for AES aren't necessarily limited to the Western Hemisphere. Besides their Latin American exposure, for instance, he said, "in Third World countries, they've done joint ventures with governments in those countries, they've built power plants in those countries as well. They're heavily involved in places like Southwestern Asia - Pakistan and India, so their (Third World) exposure looks pretty immense."

All of this comes at a time, he said, when "the market as a whole does not want any credit that has any hint of trouble about it - it will go straight down, no announcements or anything."

With accounting problems proliferating among companies at home and currency problems and political instability seen in many places abroad, "we want credits that don't have any kind of oddball story - no accounting problems, no unfavorable news coming out, no amending your third-quarter statement (as AES rival Calpine Corp. was forced to do this past week at the urging of the Securities and Exchange Commission), nothing like that. Any of those credits will get punished, absolutely punished. And AES is a prime example."

Meanwhile, the trader said, Calpine's bonds were off somewhat from the closing levels seen Thursday. As an example, he pointed to the benchmark 8½% notes due 2011, which had finished Thursday around the 75 mark, "but I would imagine they were lower" in sector sympathy with the AES debt, he said. At another desk, Calpine's bonds were quoted down a point or so to 73 bid across the board. Calpine's 8 5/8% notes due 2010 were pegged about three points lower at 73.

Late in the session, the San Jose, Calif.-based independent power producer and Kinder Morgan Energy Partners LP said that they had canceled a new natural gas pipeline project in California after failing to get shipping agreements from other companies.

Kinder Morgan and Calpine said they had not spent "significant" capital on the project .The pipeline had been slated to begin operations in 2004. The agreement stipulated that binding transportation contracts would have to be in place for it to go forward, the two companies said.

Elsewhere, a trader said that "the only real activity" of the day he had seen was in Gap Inc. - newly downgraded to junk bond status Thursday by both S&P and Moody's Investors Service. Fitch on Friday followed the other agencies' lead and likewise lowered its notes to junk.

The trader quoted one of the San Francisco-based apparel retailer's more liquid issues, the 6.90% notes due 2007 as having moved down to about the 78-80 level from Thursday's finish at 81-83. "There was heavy selling in the morning" in apparent response to the Moody's downgrade, which occurred after the market had closed Thursday, "and buying later in the day. It was back and forth."

He also saw the Gap's 5 5/8% notes due 2003 down a point to 93 bid/95 offered.

At another desk, Gap's 8.80% notes due 2008 were being quoted down just a quarter of a point, at 88.75 bid. But a market-watcher there observed that "they're already trading over 600 basis points off Treasuries. Sometimes," he added, the ratings agencies downgrade bonds "and they stay steady or even rally, because they didn't take them down far enough."

The trader said that "other than that, it was pretty quiet, because it was a shortened day" (in accord with the recommendation of The Bond Market Association, trading wrapped up at 2 p.m. ET Friday, and the market was closed Monday for Presidents Day).

He saw no trades in Revlon Inc., despite a management shakeup at the New York-based cosmetics company. The Wall Street Journal reported Friday that Revlon majority owner Ronald Perelman would likely dump the company's president and chief executive officer, Jeffrey M. Nugent - who at one time was high in the billionaire financier's good graces - and replace him with former Coca-Cola Co. President and Chief Operating Officer Jack Stahl.

During the session, Revlon in fact announced that Nugent had quit, effective immediately, but did not mention the appointment of a successor. Nugent walked the plank after two tumultuous years at the top of the once-high-flying beauty products maker, whose market share has been steadily eroded in recent years by such competitors as Procter & Gamble Co.'s Cover Girl line and L'Oreal SA's Maybelline brand.

Revlon's 8 1/8% senior notes due 2006 were seen unchanged on the session at 60 bid, and its 8 5/8% subordinated paper likewise the same at 42. At another desk, Revlon's 9% senior paper was quoted around its 63 bid/66 offered opening level, and its recently issued 12% notes due 2005 at 95 bid/96.5 offered level.

A trader said that with Revlon facing continually declining sales, instability at the top was "not a good situation." But referring to the company's controversial and much-criticized principal owner, he pointed out that Perelman "is a really bad guy. Nothing he does will be in the interest of the either the bond or the stockholders."

One of the big equity movers on the session was Halliburton Co., whose shares jumped $1.61 (10.98%) to $16.27 in NYSE dealings, on news that the U.S. Bankruptcy Court in Pittsburgh had issued a temporary stay of some 200,000 asbestos liability claims filed against the Dallas-based oilfield services company's Dresser Industries unit. The court order was issued at the request of a former Dresser unit, Pittsburgh-based Harbison-Walker Refractories Co., which accounts for about two-thirds of Dresser's asbestos claims, and which filed for bankruptcy protection. Harbison-Walker was a unit of Dresser until it was spun off in 1992 and subsequently acquired by another company, Austrian-based RHI Refractories. Halliburton inherited the claims against the Harbison-Walker when it bought Dresser in 1998, and its Baa2/A- bonds have been driven down to levels well below par over the past several months on investor concerns about its proliferating potential asbestos liability problem.

The former unit said it will work with Dresser and with its current corporate parent, to set up a trust to negotiate settlement of its claims, thus potentially lightening Dresser/Halliburton's asbestos claim load by about two-thirds. Harbison-Walker sought the stay in order to protect a valuable asset - Dresser's asbestos liability insurance coverage - while it sets up the mechanism to settle the claims.

While Halliburton's shares were up sharply on brisk volume - the 26.4 million shares traded, seventh most active on the NYSE, were more than twice the usual daily handle - its bonds were "a little better - but not that much," a trader said. "With most people not here" due to the impending three-day holiday and many away from the market all week at the Morgan Stanley bond conference in Florida, "reaction to the news was not priced into its levels, and there was no real trading going on" in the credit. Halliburton's most recently active issue, its 6% notes due 2006, were seen unchanged at 87.5 bid.

Also among nominally investment grade issues being scrutinized by junk marketeers after getting into trouble, Qwest Communications International - whose debt widened out sharply and whose stock nosedived Thursday after the company failed to roll over its commercial paper, drew down its whole bank credit line and then got downgraded by the ratings agencies - was relatively steady on the bond side, losing just another one-eighth to one-quarter point, while its battered stock actually rose a few pennies on the session.

WorldCom Group's bonds were being quoted offered, but with no bids seen, around the same levels where they had finished Thursday, with the dull market showing little reaction to a Wall Street Journal report that the Number-Two U.S. long-distance phone company had suspended three employees and had frozen the commissions of at least 12 sales people while it probed allegations of an order-booking scandal that boosted sales commissions in three branch offices. Its 8¼% notes due 2031 were quoted bid at levels 365 basis points over the equivalent Treasury bond, and offered 340 basis points over, but "in very inactive trading," an observer said. "It was just one of those days."

There was likewise little bond market reaction seen to Tyco International Ltd.'s late-Thursday disclosure that it might change its plan to repurchase $11 billion of debt via tender offers.

The Bermuda-based industrial conglomerate said on Jan. 22 that it would bolster its balance sheet by eliminating some $11 billion of its $23.4 billion of debt, while splitting into four separate companies and selling its plastics business. But in a Securities and Exchange Commission filing Thursday, Tyco said it may buy back debt on the open market to capitalize on bonds trading at a discount, rather than tendering for them at a premium. Reuters news agency quoted Brad McGee, a Tyco executive vice president, however, as acknowledging that if the company were to start buying back bonds at a discount on the open market, attractive spreads between a bond's market price and face value could begin to close quickly.

With few players around to react, bonds such as Tyco's usually actively traded 6¾% notes due 2011 held steady at 88 bid.

And back on the pure junk side of the ledger, there was little real bond market response to Sanford Bernstein's suggestion that Nextel Communications Inc. might be a possible candidate for a management-led buyout or a leveraged buyout by outside investors. The Briefing.com Internet financial news advisory service quoted sources at the investment house as saying that with Nextel's current market capitalization, available cash, and cash flow generation potential, the Reston Va.-based Number-Five U.S. wireless carrier's management "must consider" taking the company private or selling out should outside investors make a pitch; Bernstein reportedly said that with all of those real and potential assets, taking the company private "would be a zero net investment for buyers."

A bond trader saw Nextel's bellwether 9 3/8% senior notes due 2009 up two points on the session at 61.5 bid/62.5 offered, but didn't put much stock in the buyout buzz; he said Nextel, one of the most widely traded junk issues "can trade up two points any day on nothing - just on air." Nextel's stock was up just a penny (0.21%) to $4.86 in Nasdaq trading although volume was a hefty 35 million shares, more than double the usual activity.

Late in the day, after trading had already closed down, Globalstar LP said it had filed for Chapter 11 bankruptcy protection under a prepackaged restructuring plan with its creditors. The battered satellite telecommunications operator's bonds had been knocked down to deeply distressed levels months ago, and had rarely been quoted recently.

As the high yield primary market watched the clock wind down toward the Presidents' Day weekend - and there seemed to be scarcely anything better to do - a couple of sell-side sources noted that just under $487.9 million worth of dead presidents had flowed out of high-yield mutual funds over the seven days that ended Feb. 13, according to the widely watched AMG data.

One syndicate official, noting the $1.062 billion that priced last Thursday alone ("a phenomenal day"), allowed that it was a "pretty good-sized outflow," but ultimately not of major consequence.

"I think people are just seeing that as a hiccup on the radar screen," the official commented.

"I'm not convinced that money's going to continue going out."

This sell-sider expressed the opinion that high yield investors continue to hold strong cash positions.

"People talk about all the cash that's on the sidelines - that's exactly what was being put to work (in the five deals that priced on Valentine's Day)," the source said.

"You look at a lot of the deals that are getting done, they're all pretty good companies, at pretty good yields for investors. It's the best-case scenario for the investor and the issuer."

Asked if the buy side could conceivably be less ecstatic over those yields, the official replied: "Investors never think they're getting a good deal. But at the end of the day they're earning anywhere from 9% to 11% on some pretty large companies that have pretty good track records in some pretty stable industries.

"And they're getting security in a lot of these situations; as opposed to a $100 million deal for a senior subordinated, or a senior discount note, for a low single-B rated name that has negative trends.

"There are a lot of positives going for a lot of these issues."

When Prospect News asked Bob Franklin, portfolio manager of the Neuberger Berman High Yield Fund, to comment on the mutual fund outflow, he conceded that $487.9 million is an amount that possesses a certain heft.

"I think it's a large amount, given that we've had mostly inflows this year," Franklin stated. "But I'm personally still expecting a better year in high yield than we've had in the past few."

Through Friday Feb. 15, $3.039 billion of new issuance had priced in the month. And the year-to-date total was $9.741 billion at Friday's close.

And for the week of Feb. 11 - factoring in Thursday's "phenomenal" total - $1.455 billion of new issuance had priced.

Another sell-side source who spoke to Prospect News declined to look back on the week of Feb. 11. Rather this official pointed ahead, observing that the forward calendar at Friday's close - containing four announced deals totaling $640 million - does not exactly embody the aspirations for heavy issuance which the high yield market brought with it into the new year.

This official commented that unlike the week of Feb. 11, the week of Feb. 18 would not likely have "a billion dollar's worth of paper on the road."

Although circumstances are favorable for strong credits to bring new paper into the high yield primary, those credits are not showing up in notable volume, the source added.

"With the conservative nature of portfolio managers' thinking right now and the offerings that are available to them in the secondary market, I think they're going to be content to sit on their cash for one of two reasons," the official said. "One, either the calendar is going to pick up, and they're going to want to play that calendar or, two, they're starting to get hit with redemptions and they'll want to have that cash on hand for that purpose.

"This isn't the time of year when you typically have portfolio managers talking about getting hit with redemptions," the sell-side source continued. "And I'm not saying that I'm hearing a whole lot about redemptions. But it is being whispered out there."

This official laid out a line of reasoning by which it is conceivable, he said, that a lot of cash from accounts is indeed going into the secondary market - and then quickly took exception to the argument.

"Everything that is of quality on the secondary side is already overbought," the source stated. "Why chase the quality secondary issues higher when, I think, they're already in an overbought situation?

"I wish I had product to throw in front of these guys," the official said. "I really do.

"If I had a three-B, or a low-rated four-B $500 million deal on a good, stable, recession-resistant or improving sector you would see the ultimate food fight for that paper."

If the forward calendar of the high yield primary market contains a dearth of new issuance going into the week of Feb. 18, several sell-siders have recently hinted that sizable new issuance will soon come into view on the horizon.

"Next week," said one source. "In the coming week or two," said another. "You'll see a couple of big deals in March, in the $500 million to $1 billion range," forecasted another syndicate source.

Finally, some primary market observers through the course of the week of Feb. 11 told Prospect News that the market had anticipated hearing terms emerge by the end of that week on New World Restaurant Group's $155 million of seven-year notes (B3/B-) via Jefferies. However on Friday a syndicate source advised that New World Restaurant Group is anticipated to price during the week of Feb. 18.

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