Beverly Enterprises launches $100 million deal for Wednesday; Ptek pays off on Texas hedge

By Ronda Fears

Nashville, Oct. 13 - It was a relatively slow day in convertibles for the most part, with Columbus Day taking lots of straight bond players out of the playing field. But convert traders still managed to find some activity, particularly with new paper.

On the new deal front, after the closing bell, Arkansas nursing home operator Beverly Enterprises Inc. launched a $100 million registered convertible offering for Wednesday's business.

Beverly's 30-year convertible subordinated notes are talked to yield 2.5% to 3.0% with a 36% to 40% initial conversion premium, via sole bookrunner Lehman Brothers. (For full details, see report elsewhere in this issue.)

Meanwhile, sellside traders said new convertible fodder from Quanta Services Inc. and Placer Dome Inc. gained more ground, around 1.25 to 2 points, on a dollar-neutral basis.

Quanta's 4.5% due 2023 were quoted at 106.4375 bid, 106.6875 offered, with the stock at $7.61. The shares closed up 25c, or 3.4%, to $7.61.

Placer Dome's 2.75% due 2023 were quoted at 105 bid, 105.125 offered. The stock ended up 32c, or 2.32%, to $14.11.

In large part, however, traders droned about slow convertible activity amid light volume in stocks as well.

"There's not much to talk about," said a manager at a hedge fund in New York.

"The interesting stuff is what we are trying to do now, which I cannot talk about."

On a less sensitive note, he noted that his firm bought "a lot" of Ptek Holding Inc.'s convertibles when they were issued two months ago.

CIBC World Markets, lead manager of the deal, closed the convert Monday at 171.5 bid, 172.5 offered. Ptek shares ended off 32c, or down 3.3%, to $9.38.

"We actually traded some [Ptek converts] today and it was a painfully slow day," said a sellside convert trader.

"We haven't had any trouble trading this one since it was sold. It's a very liquid issue."

The new Ptek convert was sold at par in early August at par to yield 5% with a 28% initial conversion premium. Proceeds of the $85 million issue were earmarked to take out the old 5.75% convertible notes due July 2004.

"We bought them on a Texas hedge, and the stock is up 87% from the issue date. Ptek must be the best performing convert of the year. We picked the right one for a Texas hedge," the manager said.

A normal convertible hedge strategy is based on a long convertible position while shorting the underlying common stock.

A Texas hedge is long the convertible, plus long call options on the underlying common stock.

"It gives a double kicker to the equity upside," the manager said.

Why do they call it a Texas hedge?

"I don't know," he said. "I had thought it was because things are done in a big way in Texas."

A lot of the juice may have already been squeezed out of the Ptek convert, but traders said it seems as if there are still positions being set up.

The $10 strike is now an at-the-money option, so it offers the most gamma, the portfolio manager said, and the Ptek convert also has a provisional call price at $10.035, so holders can sell the volatility.

"Open interest for these options is not that high, so I kind of doubt that many bond holders are using the Ptek options this way," he said.

"We bought the August $5 calls; at the time of the bond issue it was the at-the-money call options - the stock was at $5.22 - and with the shortest time to expiration, has the smallest time premium built in. We expected a bounce in the stock after the convert was issued, and we got it."

What may be even more interesting with regard to the Ptek situation, however, is whether there is a coupon ever paid on it, he said.

"What's really interesting with the Ptek bonds is that they could be the first NCAA convertible issue since Fine Host," the manager said.

NCAA doesn't have any "slam dunk" connotations stemming from the National Collegiate Athletic Association basketball organization. Rather, it stands for "No Coupon At All" and refers to the unusual case of a bond issued but never paying a coupon.

"This has happened in some rare cases, notably when the issuer goes bankrupt before the first coupon gets paid, like Fine Host," the manager said.

But with Ptek, a NCAA situation would be a nice development because the bonds have a soft call provision with the stock over $10, and it's now close to that.

"Well, Ptek, because of the provisional call and the sharp rise in the common stock, might actually be called before the first coupon gets paid," the portfolio manager said.

What made the Ptek convert particularly juicy, he said, was the cheapness at-issue, five-year make-whole protection, the improving credit profile and improving earnings landscape.

"Make-whole protection is why the possibility of the bond being called is not a problem for convert holders, including hedgies, as the premium gets repaid to convert holders regardless," he said.

Convertible hedge funds continue to eke out gains, evidenced at least by the Merrill Lynch convertible index, which was reported up 0.2% on the week. It was the seventh consecutive week of gains, bringing the year-to-date total return to 11.6% before fees.

Yaw Debrah, head of U.S. convertible research at Merrill Lynch, said improving spreads were the biggest factor contributing to returns, noting the Merrill Lynch high yield index returns were up 0.7% on the week.

High yield bond spreads were driven relentlessly lower to 497 bps this week, down from last week's 513 bps level. A backup in U.S. Treasury yields fueled this compression, pushing spreads down to early-2000 levels. Double-B and single-B yields now stand at record lows, since 1988 at least, he said.

"The strength of the association between high yield bond mutual fund cash flows and high yield total returns dropped to the lowest point in the past three years as of September 2003," Debrah also noted.

"This suggests that the strong role that mutual fund flows have played in driving recent total return performance is on the wane.

"The last time this coincidence occurred - a sagging flow-return correlation against a recent total return surge - was in 1991-1992, and high yield total return performance faded going forward into 1993."

The top 5 weekly performers for hedge funds by contribution to total return were Ford Motor Co.'s 6.5% trust preferred, General Motors Corp.'s 6.25% due 2033, Nortel Networks' 4.25% due 2008, Freeport-McMoRan Copper & Gold's 7% due 2011 and Credence Systems' 1.5% due 2008

The bottom 5 weekly performers for hedge funds by contribution to total return were Tyco International Ltd.'s 3.125% due 2023, SanDisk's 4.5% due 2006, Tyco's 2.75% due 2018, Gilead Sciences' 5% due 2007 and Freeport-McMoRan's 8.25% due 2006.

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