Deutsche: Allergan seen at discount due to uncertainty with Advanced Medical spin-off

By Ronda Fears

Nashville, Tenn., June 21 - Allergan's spin-off of Advanced Medical Optics and the uncertainty about how the Allergan convertible will be affected is expected to cause the convert to trade at a discount, said Deutsche Bank Securities Inc. convertible analysts.

On June 4, Allergan announced the ratio for its tax-free dividend of Advanced Medical Optics. On the day of the spin-off, currently set for June 29, each holder of Allergan will get 1 share of Advanced Medical Optics for every 4.5 shares of Allergan, or 0.2222 Advanced Medical for 1 Allergan.

The press release made no mention of how the conversion ratio on Allergan's 0% due 2020 would be adjusted.

"Regrettably, the indenture does not provide full clarity either," said analysts Jeremy Howard, Jonathan Cohen and Robert Barron in a report Friday.

"Until this clarity is forthcoming, we would expect the bonds to trade at a small uncertainty discount."

The distribution is around 3%, based on the when-issued price of Advanced Medical Optics, and is therefore not small enough to be ignored.

Advanced Medical Optics when-issued shares closed Thursday at $11.25, the analysts noted.

The delta is small and the bond is held by many outright funds, but the situation would certainly be helped by some guidance from the issuer.

While the prospectus for Allergan's 0% of 2020 does not specify how the conversion ratio is adjusted in the case of a stock dividend, the analysts said an adjustment methodology is given in the bond's indenture.

"While the documentation does give a conversion ratio adjustment formula, it gives no information about how the company, and investors, can arrive at values for the average quoted price of Allergan stock or the fair market value of Advanced Medical Optics," the analysts added.

No mention is made as to whether these values are calculated over an averaging period, as in Lucent's recent spin-off of Agere, on one trading day, or in some other way.

"Nor do we know when Allergan is required to tell convertible investors how the values will be calculated, and when the adjustment to the conversion ratio made," the analysts said.

"The indenture merely states: 'The Board of Directors shall determine fair market values for the purposes of this Section 11.08.'"

The analysts spoke with Allergan investor relations and were told that the board is not scheduled to meet regarding this issue until late July, well after the spin-off is complete.

"Given that a 'when issued' stock for Advanced Medical Optics is already trading, a close reading of the documentation might suggest the last when-issued price before the spin-off as the fair market value," the analysts said.

"But, then, an averaging period could be considered 'fairer.' Although unlikely, we cannot see anything that would prevent the Board from applying some kind of theoretical analysis which had no reference to market prices at all."

It would certainly be dangerous to try to guess the adjustment without some kind of signal from the company, the analysts said, because anything between a one day snap shot the day before, to a 20 trading day averaging period after, as with Lucent/Agere, is possible.

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