Rite Aid trades up 0.25 point in gray market; Beverly Enterprises takeover chatter squeezes hedgies

By Ronda Fears

Nashville, Jan. 25 - Players on both sides of the desk eagerly awaited final terms on the Rite Aid Corp. convertible on tap after the closing bell. While some buyside sources found the 50% premium difficult to swallow, banker types saw it as prognosis for deals waiting in the wings.

"We're all watching everything right now, where it prices, how it does in the aftermarket, all that. This is interesting," said a convertible underwriter. "There are deals sitting here on what's called the shadow calendar, and a lot of the others [banks] have a backlog, too."

Rite Aid's $115 million of three-year mandatory convertible preferreds are being pitched with a 6.5% to 7.0% dividend and 50% initial conversion premium. In the gray market Tuesday, a buyside trader saw the issue trade a quarter-point over par.

Though buyside sources were not pleased with the premium, a sellside analyst noted that with Rite Aid shares so low it wouldn't take much to put the issue in the money.

"I haven't spent any time on Rite Aid since they almost went away a few years ago. That said, we did hear that some people thought the premium on the new mandatory was on the high side," the analyst said. "That may be true, but with a $3 stock it wouldn't take much to put the [mandatory] shares in the money."

Rite Aid shares on Tuesday lost a dime, or 2.72%, to end at $3.57.

Beverly buzz buries hedgies

Elsewhere, the speculation of a takeover of Arkansas-based nursing home operator Beverly Enterprises Inc. roiled convertible players, or at least the arbitrageurs with a standard hedge position.

Shares of Beverly Enterprises shot up more than 25% on Tuesday after a Lehman Brothers Inc. research note clued the market into the development of an investor group considering a bid for the company.

The Beverly 2.75% convertible was crushed by the news, as arbs got caught in a short squeeze when the underlying stock shot up on the news. At a first look Tuesday at the bonds, traders said the convertibles opened lower by 5.5 points on swap and steadily lost ground as arbs forced to cover shorts exaggerated the situation.

By the end of the session, buyside traders said the Beverly convertibles lost somewhere around 10 points on swap. Outright, however, with the stock rising, the issue added 15 to 20 points, traders said. Likewise, the nursing home operator's junk bonds were lifted on the noise, with the 7.875% due 2014 quoted up 4 to 6 points to the 110 bid, 112 offered neighborhood.

According to the Lehman piece, investors including Appaloosa Management, Franklin Mutual Advisors, Formation Capital and Eureka Capital Markets have contacted Beverly about buying the company at $11.50 a share, in cash. Investors are pegging Beverly stock at $11.50 to $13 a share, but Lehman analysts said the price tag could end up higher.

Beverly break-up talk panned

Or, the investor group might only buy Beverly's nursing home assets at $9 per share, leaving its remaining assets in a separate business that potential buyers value at $4 a share, Lehman said. In addition to nursing homes, Beverly conducts hospice and home care centers, and rehabilitation therapy services, plus owns some outpatient clinics.

"I don't like the break-up plan," said one Beverly holder, who was selling out of the convertible.

"There is a lot (estimated $300 million) of revenues derived from the nursing home side of the business, referrals, etc., which would go bye-bye and leave BEV with $1.2 billion in cash but a declining revenue base. BEV would have to go out and acquire something to have a business, but what, who?"

Another hedge fund manager said he was getting involved in the situation on a risk arb basis, lightly for now, but had no interest in the converts, as they looked too expensive in the 165 area, especially with the stock zooming.

"The bidding could probably go higher than even the $13 mark," he said. "That's just where the negotiations are beginning. Risk arb guys are all over this."

Secondary "feeling" better

Moreover, though, the secondary market was "feeling" a lot better if not actually better bid, traders said.

"There isn't an awful lot of bids on the table, because the stuff that has come in needed to come in; that doesn't make it cheap," said a buyside trader at a hedge fund in New York.

Charter Communications Inc. and Level 3 Communications Inc. convertibles have softened over the past week, but sellside sources saw no action in those issues.

But, improved earnings at U.S. Steel Corp. moved its 7% mandatory due 2006 up 7 or 8 points to 170.5.

In another natural resources area, Schlumberger Ltd. and Halliburton Co. - both oilfield services firms - edged a tad higher. Schlumberger's 1.5s moved up slightly to the 109 area after the company raised its dividend for the first time in a decade, although nothing was seen on the 2.125s.

Cooper Cameron Cos., though, was a tad weaker on concern about dividend risk after the Schlumberger event. The 1.5% convertible was active, settling the day around 107.5 while the stock dropped 34 cents, or 0.61%, to $55.40.

Halliburton's 3.125s edged up to around 128.75 as it announced the final $2.8 billion payment that will settle the asbestos claims that led to several of its subsidiaries filing bankruptcy.

FLYi flying on savvy buying

FLYi Inc., having bounced back tremendously in the last few months, is still turning heads upward. But there are still onlookers who think the company will succumb to bankruptcy if a white knight does not appear on the horizon.

The convertible bonds, issued under the company's former name Atlantic Coast Airlines Holdings Inc., have come back from the high 20s in October to around 50 now. And the bonds are still climbing, with interest from a couple of savvy investors who specialize in distressed paper.

"There are two guys [who] now own 5% or more of the common and, after checking around, I'm told these folks are smart airline investors and have funds to make things happen," said a broker. "While I don't see this company having figured out what business they want to be in - they are losing $50 for every passenger that flies - and [the company] probably gets dissolved; the smart distressed guys like this one."

FLYi stock on Tuesday gained 3 cents, or 1.73%, to $1.76.

Meanwhile, most of the remaining field of airline issues was on higher ground Tuesday as well.

AirTran convertibles at stalemate

Yet, holders in some of the airline paper - which has taken a routing over the last few months - remained reluctant to sell out at the still-lower levels. AirTran Holdings Inc.'s convertible was a particular sticking point.

The 7% convertible bonds ended Tuesday up slightly at about 110, traders said. AirTran stock gained 55 cents on the day, or 7.33%, to end at $8.05.

"We're at a stalemate. I've made money in these [convertibles] - the company made money last quarter, too - but I really would like to get out now. But, now, no one will touch them because it's an airline," said a hedge fund manager holding the AirTran converts. "I'm having to take my medicine because we're not selling them here" at these levels.

A sellside analyst agreed, noting that the lack of takers for AirTran was "kind of surprising given the up move for the [airline] group this morning (AAI reported pretty good numbers and expects to be profitable again in '05)."

Part of the blame for "throwing the baby out with the bath water," the buyside source said, was the bad news dogging the major carriers like Delta Air Lines Inc. and the recent return to bankruptcy by US Airways Inc. Another black eye has been recent sound bytes from investing guru Warren Buffett - the Oracle of Omaha - declaring he's finished with investing in airlines for now.

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