By Ronda Fears
Nashville, Tenn., Dec. 17 - Deutsche Bank Securities Inc. analysts said the convertible bond exchange offers from Alkermes Inc. and Cell Therapeutics Inc. attest to a growing realization that many U.S. biotech firms are unlikely to attain profitability before burning through their remaining cash.
Convertible analysts Jeremy Howard, Jonathan Cohen, Jonathan Poole and Robert Barron see the Alkermes offer as most likely to succeed. While Cell's offer may see some holders decline, the analysts still expect a majority of holders to participate.
"By 're-striking' (i.e. lowering) the conversion prices on their convertible bonds, these companies are effecting a thinly disguised debt for equity swap, relying on arbitrage investors to bid up the price of the new (and undervalued) convertibles and ensuring that the existing ones are exchanged," the analysts said.
"For good measure, issuers are subordinating the existing convertibles by giving the new ones subordinated (senior) status, making it doubly difficult for existing holders to resist an exchange offer."
In both cases, the issuers are reducing the debt amount but also increasing the likelihood that the issues will be converted for stock.
In Alkermes' case, the convertible issue could be reduced to $115 million with the possibility of a $50 million add-on for cash, versus the existing $200 million issue.
In Cell's case, the convert could be cut to $102.9 million from $175 million.
The analysts said the existing Alkermes 3.75% due 2007 is a very interesting way to get into the new Alkermes 6.52% convertible due 2009. They also see the potential for Alkermes stock to rally substantially once the conversion price averaging period ends Dec. 19.
Holders can exchange all or some of their bonds and those who exchange at least some bonds can also subscribe to the additional $50 million tranche of the new 6.52% convertible.
Most holders will participate, the analysts said, because of subordination risk to holding the 3.75s, the likely downward pressure to the 3.75s afterward and greater upside sensitivity to the stock in the new 6.52s.
Subordination risk is crucial because of the post-exchange debt profile and balance sheet of Alkermes, the analysts said.
While Alkermes' 3.75% moved from around 51/52 versus the stock at $10.73 before the exchange offer to 62/63 level versus the stock at $6.46 afterward, the analysts anticipate the issue will decline once the exchange is completed.
"While the old bonds might not drop right back to the level at which they were trading before the announcement, it is probable (in our opinion) that they will decline substantially," the analysts said.
"Importantly," the analysts added, "the exchange offer document states that for a period of two years following the issuance of the new 6.52% 2009 notes, Alkermes is prohibited from engaging in any private repurchases, debt-for-equity swaps or similar transactions with respect to the existing 3.75% 2007 notes."
The analysts see fair value of the new Alkermes convert as 107.38, using a credit spread of 1,100 basis points over Libor and 55% volatility, with the stock at $6.46. The right to participate in the new convert add-on, the analysts said, could add another 1.845 points of value.
Cell's exchange offer, which expired at midnight Tuesday, could see more holders hang on to the paper, the analysts said, mainly because of the absence of a 'lock up' clause even though it will be subordinated to the new issue.
The analysts put fair value of the new Cell convert at 98.08, using a credit spread of 1,400 basis points over Libor and 60% volatility, with the stock at $7.40. They noted the reason for the poor theoretical value is the absence of hard call protection on the new convertible.
Subordination of the old issue is also a factor.
"Unlike Alkermes, Cell does not have any substantial revenue base, and although its cash position appears healthier at $171 million (Sept. 30), its operating loss rate at almost $76 million (9 months to Sept. 30), is a heavy burden," the analysts said.
Post exchange decline may also be great, the analysts said, and they found no reference in the Cell exchange offer to any 'lock up' preventing Cell from purchasing the old bonds either for cash or stock following the exchange.
"We think this is important, because a holder of the old bonds may be encouraged into thinking that they will be able to extract some value from being the only holder of a 'rump' issue," the analysts said.
"One must set against this the (potential) absence of liquidity and the subordination issue, but we concede that there may be something in this argument, and for this reason, we would not be surprised if a few long term high yield holders pass on the public exchange is the hope of extracting (even) better terms from a (perhaps healthier) Cell at a later date."
Alkermes 3.75% convertible due 2007
| Ask: | 63
|
| Equity price: | $6.46
|
| Parity: | 9.535
|
| Premium: | 561%
|
| Yield to maturity: | 16.37%
|
| Current yield: | 5.95%
|
| Conversion ratio: | 14.7601
|
| Conversion price: | $67.75
|
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| Cell Therapeutics 5.75% convertible due 2008
|
| Ask: | 61
|
| Equity price: | $7.40
|
| Parity: | 21.765
|
| Premium: | 180.27%
|
| Yield to maturity: | 16.94%
|
| Current yield: | 9.43%
|
| Conversion ratio: | 29.4118
|
| Conversion price: | $34.00
|
| Call: | June 13, 2001
|
| Call price: | 100
|
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