Rite Aid converts gain on upsized junk bond deal; El Paso plunges on worries

By Ronda Fears

Nashville, Feb. 5 - New issue activity cooled as a U.S. war with Iraq seemed imminent, which sent stocks into a tailspin after opening higher, but converts were described as flat on the day.

"We were actually pretty busy today, but trading was spotty," said a convertible dealer.

"Converts were mixed, but probably sort of flat as a whole."

United States Steel Corp. priced its upsized $250 million deal, which cleared the week's forward calendar, and no other deals emerged for this week.

The U.S. Steel mandatory came at the cheap end of tightened guidance, with a 7% dividend and 25% initial conversion premium.

It sank in the immediate aftermarket, however, a trader said, on pressure from the war jitters as well as the anticipated high turnover among initial buyers.

U.S. Steel's new convert was quoted closing at 49.25 bid, 49.75 asked - off 0.75 points from par and down 0.25 from gray market levels. The stock ended down 86c to $12.19.

The mandatory structure was an obstacle to holding the U.S. Steel convert, some observers said.

"In our opinion, [the new U.S. Steel mandatory] has an unattractive structure in that it is a preferred behind the curtain rather than the now-typical senior note/stock purchase contract pairing," said Steve Jones, director of convertible research at Wachovia Securities, Inc.

"If things head south, you will not have a note to hold onto here."

Furthermore, he said the U.S. Steel 10.75% senior note contains covenants that may impede its ability to declare dividends on the mandatory. Although the company met the 2-to-1 consolidated coverage test in December, he noted, it failed in the previous quarter.

Convertible deals recently put into circulation by McData Corp., Micron Technology Inc., and International Game Technology also were lower Wednesday.

El Paso Corp. dropped sharply on its turnaround plan, which one dealer said "inspired little to no hope among investors."

Rite Aid Corp., however, got a dose of medicine from a new junk bond.

"People were heartened by the fact that the [Rite Aid] junk deal got upsized and came with better terms than they expected," said a convertible trader at a boutique in Connecticut.

"They were going for the shorter maturity in the convert, and the equity option is not that far out of the money."

Rite Aid's 4.75% convert due 2006 (Caa1/B-) gained 3 points on the day to 87.5 bid, 88.5 asked. The common closed up 22c to $2.80.

The drugstore chain sold an upsized $300 million of junk bonds at par to yield 9.5%, or a spread of 571 basis points. Guidance had been tightened Wednesday before pricing to 9.5% from the 9.75% area. The second lien senior secured notes due 2011 (B3/B-), which are non-callable for four years, was boosted from $200 million.

Rite Aid plans to use proceeds to repay senior secured shareholder settlement notes due 2006 and for general corporate purposes.

On Tuesday, Rite Aid reported January same store sales rose 5.7% over the prior-year period but guided fiscal fourth quarter same store sales lower. The company said it now expects same store sales for the quarter to be up by 4.75% to 5.75%. In December, the company forecast a 6% to 7% gain.

Rite Aid reaffirmed its EBITDA guidance for the quarter and fiscal 2003, which ends March 1, however. Based on current trends, the company said it expects fourth quarter EBITDA of $160 million to $170 million and EBITDA for fiscal 2003 is expected to be $605 million to $615 million.

El Paso's turnaround plan for 2003 failed to inspire anything but heavy selling, traders said.

The company cut its common dividend by more than 80% and plans assets sales to help pay down debt, along with several other measures.

While the plan seems to make sense, one dealer said, El Paso convert holders were alarmed by the company's statement that it might tap all of its undrawn $2 billion bank lines to support liquidity in 2003.

The dividend cut would boost the El Paso mandatory, but it was already considered expensive and heavy selling drove it sharply lower.

The El Paso 9% mandatory closed down 3.82 points to 26.08 as the common fell $1.80 to end at $6.20.

El Paso's 0% convertible due 2021 also was sold off, dropping 1.5 points to 33 bid, 35 asked.

Elsewhere, traders said FelCor Lodging Trust Inc. and Host Marriott Corp. also lost ground on recent weak earnings, which for both names prompted a negative watch from Standard & Poor's Corp.

FelCor's convert lost 1 point to 18.5 bid, 19 asked while the stock closed down $1.49 to $8.76.

Host Marriott's convert lost 0.625 point to 36.25 bid, 36.5 asked as the stock ended down 25c to $7.90.

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