HealthSouth plunges before trades are wiped out; Fleming off; El Paso Energy sells 7-year notes

By Paul Deckelman, Paul A. Harris and Carlise Newman

New York, March 19 - HealthSouth Corp. bonds fell sharply in early dealings Wednesday on news that the Securities and Exchange Commission had accused the healthcare company of having indulged in what it called "massive accounting fraud." But the market was further flummoxed by the news that the SEC had suspended trading in all of HealthSouth's securities as of 9:30 a.m. ET - meaning that any trades taking place after that time would have to be unwound.

Primary market activity consisted of the unexpected pricing, late in the session, of a quickly shopped $300 million issue of seven-year notes for El Paso Energy Partners LP, a 27%-owned subsidiary of El Paso Corp., and the pricing as expected of MTR Gaming Group Inc.'s $130 million of seven-years.

But junk market attention was clearly riveted on the bizarre turn of events surrounding HealthSouth. Traders said they were flabbergasted by what they called the unprecedented undoing of all trades in the issue which had already been done.

"All the trades [in HealthSouth] have been broken," mused one veteran trader in reaction to the fiasco. "It's never happened before that I can remember, although there's been plenty of opportunities where it should have been done - WorldCom, Enron, they let them trade all day, and nothing. But this . . . ," he said, significantly leaving the sentence dangling.

Indeed, the weird turn of events in which all of the trades - and there were loads of them - were posthumously rendered null and void resembled nothing so much as bad fiction, something out of "The Twilight Zone." One market wag likened it to the notorious and much-criticized season finale one year of the popular 1980s TV series "Dallas" in which a major character - who had supposedly been killed off in the first show of the season in September, causing all kinds of plot ramifications - unexpectedly stepped out of the shower in the last episode during the May ratings sweeps, walked into the bedroom and greeted his TV wife. She then realized that all of the dramatic events of the whole preceding season had never really happened - she had just "dreamed" everything. Viewers who had been along for the ride, feeling that they had been manipulated with a cheap plot trick, were not amused.

Neither were junk bond traders and investors on Wednesday.

"I've never seen anything like it," one distressed-debt trader, livid at the news, fumed. "Everyone was in HRC today. It traded like crazy - and then it was halted and everything was just wiped out."

He said HealthSouth's bonds across the board "dropped like a bomb, about 50 points."

The company's 7 5/8% notes due 2012 were quoted at 48 bid/50 offered about half the previous price of 94 bid/96 offered, while the 7% senior notes due 2008 were seen at 45.5 bid/47.5 offered, compared with earlier levels of 90 bid/92 offered.

"Guys were unwinding trades like crazy. They just pulled the rug out from under us," said a clearly irate distressed trader. "I can't believe this ****."

At another desk, all of the company's formerly Ba3/BB- senior notes - including the 6 7/8% notes due 2005, the 7 3/8% notes due 2006, the 8½% notes due 2008 and the 8 3/8% notes due 2011, as well as the 7 5/8s and the 7s, were quoted as having fallen to bid levels around 49-50 from late-Tuesday levels ranging from 85.5 to 93.5, depending on the coupon and maturity, while HealthSouth's formerly B2/B 10¾% subordinated notes due 2008 plummeted from 85.5 bid all the way down to 23.

Standard & Poor's announced later Wednesday that it had cut the ratings on the senior notes to B- from BB- previously, and on the subordinated notes to CCC from B previously. Moody's lowered the senior notes to Caa1 from Ba3 and the subordinated notes to Caa3 from B2,

"Whew. It was a very strange day," another trader opined. He said the bonds had opened the day's trading down four or five points from Tuesday's close, apparently reacting to the announcement shortly after midnight by the Birmingham, Ala.-based provider of outpatient surgery, diagnostic imaging and rehabilitative healthcare services that FBI agents armed with a search warrant had raided corporate headquarters on Tuesday night seeking documents and had also served an additional grand jury subpoena on the company on behalf of the U.S. Attorney's office for the Northern District of Alabama in connection with a previously announced probe.

HealthSouth, in announcing receipt of the original grand jury subpoena back on Feb. 6, indicated it thought that the inquiry might be focused "on transactions by individuals in HealthSouth common stock."

Then, news hit the tape that the SEC had charged that the company and its chairman and chief executive officer, Richard M. Scrushy had engaged in "a massive accounting fraud." The commission's complaint, filed with the federal district court in Birmingham, alleged that "since 1999, at the insistence of Scrushy, HealthSouth systematically overstated its earnings by at least $1.4 billion in order to meet or exceed Wall Street earnings expectations. The false increases in earnings were matched by false increases in HealthSouth's assets. By the third quarter of 2002, HealthSouth's assets were overstated by at least $800 million, or approximately 10 percent."

Steven M. Cutler, the SEC's director of enforcement, said that the company and its chief had committed "an appalling betrayal of investors. HealthSouth's standard operating procedure was to manipulate the company's earnings to create the false impression that the company was meeting Wall Street's expectations."

The regulators further charged that Scrushy had "certified HealthSouth's financial statements when he knew or was reckless in not knowing they were materially false and misleading." The SEC, reacting to an epidemic of alleged book-cooking and other corporate chicanery at major companies like Enron Corp., WorldCom Inc., Tyco International and Adelphia Communications Corp., had ordered last year that executive officers of major public companies certify the accuracy and completeness of their companies' financial statements.

Government prosecutors may have an important weapon in trying to prove that Scrushy and HealthSouth had deliberately finagled the financial figures, with the news that the company's former chief financial officer, Weston Smith, had pled guilty to charges related to the alleged fraud - and had agreed to cooperate with the ongoing probe as part of the plea-bargain deal.

The company had not issued any response to the SEC allegations as of Wednesday evening.

Mid-morning news of the SEC's fraud charges and that Smith had decided to roll over on his former executive colleagues knocked the bonds for a loop, the trader said, as the senior notes "hit a 79 bid, then a 69 bid, then a 52 bid, then they kind of went 45-55." At that point, he said, "bids started coming in, and they were trading around that low 50s type level."

He estimated that it was around 1 p.m. or 2 p.m. ET that news percolated through the market that "the SEC was basically saying we're canceling all trades."

The commission put out a separate announcement, indicating that a temporary suspension of trading in HealthSouth's securities went into effect at 9:30 a.m. ET on Wednesday and would remain in effect until 11:59 p.m. on Thursday, citing the questions raised about the accuracy of HealthSouth's public representations about its earnings, assets and overall financial condition.

Technically speaking, the commission did not itself order any trades which had been done to be unwound, according to the SEC's director of public information, Christi Harlan, who told Prospect News late Wednesday that "it's up to the NASD [the National Association of Securities Dealers] to do whatever they do with it - but they were notified [about the trading suspension]. The commission's order covers all bonds and securities."

Trading in HealthSouth's New York Stock Exchange-listed shares was halted almost immediately after it had begun, with the stock unchanged from Tuesday's close at $3.91 and only 200 shares having been traded, against the average turnover of some 1.8 million shares.

Harlan said that the SEC had not actually "dictated" to either the NASD or securities firms that the trades be cancelled, but had notified the group of the suspension. She also said that the agency could not estimate the volume of securities affected by the order, and said that it had ordered a suspension of securities trading in at least one case previously, last year.

The NASD, the securities industry's main trade group - under federal law, virtually every securities firm doing business with the public in the U.S. is a member - said on its website that "The SEC has asked NASD to notify member firms that all trades executed within this time frame [9:30 a.m. ET Wednesday through 11:59 p.m. Thursday] must be cancelled. Trades executed prior to the implementation of the trading halt at 9:30 do not need to be cancelled."

Once news got around that almost all of the trades in HealthSouth would have to be undone - all except those executed before the trading halt took effect at 9:30 a.m. - traders and investors had to scramble to junk all of the trades.

Where those bonds will be once trading finally does resume is anybody's guess, but a trader - who lamented the SEC order, noting "I had some decent trades" - said that "what we are hearing is that people are saying that the $300 million that they stated as cash on the balance sheet in the most recent quarter could be overstated by as much as $300 million." He guesstimated that "it would very well work out that the subordinated notes and the converts are worth zero, and the [senior] bonds are somewhere between 35 and 45. But who knows?"

The trader said he had seen no dramatic slide Wednesday in the junk bonds of other healthcare companies in response to HealthSouth's fall. He noted that "they really don't have many peer companies [in the high yield healthcare sector] because a lot of them are high grade-type names. There's not a lot in our universe." Still, he said that among the few high yield names that came to mind as peers were Beverley Enterprises in the medical facilities field and Alliance Imaging in the diagnostic imaging field, along with such companies as Insight Health, MedQuest, and Radiologix.

"You've got to figure that these guys [HealthSouth] are involved in outpatient rehab services as well as imaging. If all of these assets suddenly come up for sale, it's got to have an impact on some of these imaging companies. Stuff is going to be lower."

Likening HealthSouth's situation to that of Enron, Adelphia or WorldCom, he concluded: "The question is how much fraud is there? How deep does it go? And what does it mean for the issues?"

Apart from the HealthSouth debacle, a trader said there was "a lot of flapping around in Fleming," with the Lewisville, Tex.-based wholesale grocery products distributor's 10 1/8% senior notes due 2008 having fallen four points on the session to 38 bid/39 offered, while its 10 5/8% subordinated notes lost two points to 14 bid/16 offered. No fresh news was immediately seen Wednesday; Fleming's bonds have recently been fallen as the company has wrestled with a big debt load, revelations of accounting irregularities, a formal investigation by the SEC, the ouster of CEO Mark Hansen, and the drag on its earnings from its money-losing retail supermarket operation, which is in the process of slowly being sold.

Fleming has also been adversely affected by the bankruptcy of its largest customer, Troy, Mich.-based discount retailer Kmart Corp; the two companies last month mutually terminated a multi-billion-dollar contract for Fleming to supply Kmart stores with product and Fleming has since been trying to diversify its client base.

Elsewhere, airline bonds were said to be flat to higher again, even as the sector digested a slew of events in past days, most significantly the threat of war.

UAL Corp.'s United Airlines' 9¾% notes due 2021 were quoted hovering around 7 bid/9 offered, around the same levels as Tuesday, when the company forecast a first-quarter operating loss of $877 million and said for the first time publicly that going out of business altogether is a "distinct possibility" as war looms.

The news had cheered the airline sector as it considered the marketplace without heavyweight UAL. However, Wednesday's looming threat of war may have kept a damper on any significant action, traders said.

American Airlines' 9% notes due 2012 rose about a point to 16 bid 18/offered compared to a closing price Tuesday of 15 bid/17 offered. Delta Airlines' 6.65% notes due 2004 were seen rising about a point from Tuesday's levels of 73 bid/74 offered, while Continental Airlines' 8% notes due 2005 were likewise more than a point better, rising to 47.5 bid.

Metris Company Inc.'s 10 1/8% notes due 2006 were quoted at high as 50 bid, up from recent levels in the mid-40s.

Metris said Wednesday that it had obtained $850 million of 364-day warehouse financing facilities, had terminated its $170 million and that its subsidiary, Direct Merchants Credit Card Bank entered into an operating agreement with the Office of the Comptroller of the Currency that includes liquidity and capital maintenance provisions for the bank.

Goodyear Tire & Rubber Co.'s bonds were "a bit better," a trader said, its 6 3/8% notes due 2008 at 71 and its 11% notes having firmed to 68.5 bid/70 offered; the Akron, Ohio-based tire maker - the world's biggest - said it would try to sell its chemicals business, and had hired Credit Suisse First Boston to advise it in pursuing a sale of the unit, which has $750 million in annual revenues. Proceeds are expected to be used to help pare down Goodyear's blimp-sized debt load.

Lyondell Chemical's debt was seen "up a little," a market observer said, its 9 5/8% notes due 2009 a quarter point higher at 98.75 bid and its 10 7/8% notes due 2009 half a point better, at 91.

While the high-yield primary market kept one eye on the news for word of an imminent U.S.-led invasion on Iraq, the investment banks completed two transactions on Wednesday - one of them a drive-by.

El Paso Energy Partners pumped investors for an extra $50 million, Wednesday, upsizing its rapidly marketed new issue of notes due June 2010 to $300 million and coming with a yield of 8½%.

Also on Wednesday MTR Gaming Group, Inc. raked in $130 million from the accounts, pricing its new eight-year paper to yield 9.99%.

During a Wednesday morning conversation with Prospect News, Prescott Crocker, fund manager of the Evergreen High Yield Bond Fund, expressed exasperation with a high yield market that is "all bid."

"I just think it would be nice to have some sellers," the Evergreen Investments fund manager said.

"There's a tremendous amount of cash out there, coming from every Sam, John and Harry who doesn't believe in the stock market, and is going out the risk curve and heading into high yield," he added.

When Prospect News sounded out Crocker on the theory that much of the recent cash coming into high yield has been following the lead of billionaire investor Warren Buffet, who recently expressed a liking for the asset class, the Evergreen fund manager pointed to his own firm's new fund and responded that cash has been coming into high yield regardless of Mr. Buffet's persuasions.

In late February Evergreen Investments announced the initial public offering of common shares for the Evergreen Income Advantage Fund, a closed-end high yield bond portfolio. The new fund raised $900 million with its IPO, with the potential to be increased by 15% to over $1 billion if the underwriter exercises its over-allotment option.

"We raised a billion dollars in that closed-end fund," Crocker replied to the suggestion that investors were playing follow-the-leader behind Mr. Buffet. "That same week the rest of the world had no trouble raising a billion and a half dollars."

Crocker stated that for a high yield investor looking to put cash to work the present new issuance market definitely does not spell "relief."

"You can't get in," he said. "You're getting allocations of 10% of your request at best. And three days afterward nobody's selling. So there's no relief there.

"It's a high-yield market where they're printing deals at 7¾%. That seems to be a contradiction in terms.

"What you need is some bearish days in the stock market - something that scares the dickens out of high yield players - or this thing is going to grind higher, higher, higher."

In the absence of a big sell-off in the equity market, Crocker said, the buy-side can expect to continue to have to shop in a seller's market.

"We're not going to see cash dry up for a long time unless we have a slam-dunk sell-off in the stock market," he said. "My take is that we're in a muddle-through economy, and that the war is going to go well. If you believe that you have to be optimistic about stocks.

"It's not that stocks are going to take off," he added. "But as long as they are stable money will flow into high yield."

Prospect News interviewed Crocker shortly after word circulated the market that El Paso Energy Partners, LP was bringing a drive-by deal. The Evergreen Investments fund manager said that the deal was of interest and correctly predicted the yield on the company's new notes.

The upsized offering of $300 million of senior subordinated notes due June 1, 2010 (BB-) later priced at par to yield 8½% via JP Morgan, Goldman Sachs & Co. and UBS Warburg, at the tight end of the 8½%-8¾% price talk. It was increased from $250 million.

"I'm interested, but it's not going to yield too much," Crocker said of the credit. "It's a nice easy operating company with a lot of projects and growth. They have a lot of reserves in the San Juan Basin. And they have 50% debt-to-equity, which is not too bad.

"I'm guessing it will come around 8 ½% - that'll pay my 11% dividend, won't it?" Crocker quipped.

In trading, the El Paso Energy Partners bonds, "a drive-by out of nowhere," a trader said, were heard to have firmed to 100.5 bid from their par issue price before easing back to close at 100.25 bid/100.5 offered.

In addition to the El Paso Energy Partners drive-by the market heard terms Wednesday on a deal from Jefferies & Co. that had gone with a full roadshow.

MTR Gaming Group, Inc. priced $130 million of 9¾% seven-year senior notes (B2/B+) at 98.806 to yield 9.99%.

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