Convertibles flat, gridlocked on unsettling events

By Ronda Fears

Nashville, Tenn., Feb. 7 - With selling abated and buyers scarce, convertible traders said the market was gridlocked amid the unsettling events whipping through the financial world. The lack of new issues contributed to the stalemate, as well, but syndicate officials said the many deals in the wings are just waiting for some cooperation in stocks.

"The selling is pretty much over and buyers are not stepping up, so you have gridlock," said a convertible trader at a hedge fund in New Jersey. "It is really dead. Everyone was glued to the Enron hearings and that whole situation has put a damper on market activity."

Players had hoped new issues would provide a diversion as well as a place to put cash, and investment bankers say there certainly is still a very heavy list of prospective new deals on the shadow calendars.

"With all the choppiness, it is a tough market right now," said a top origination official at one of the leading convertible underwriters. "There are deals coming, lots of deals. We are just waiting for things to settle down, a little cooperation from the stock market. We are all aware that there is high demand right now. Buyers are eager, but the timing is just not right for some of these issuers."

Qwest Communications has provided the latest high-profile point of interest for new issue buyers, but market sources said the deal right now is up in air while the company shops for a lead underwriter. The company said the deal will be about $1.25 billion, but the structure and terms have not been identified. That is the subject of the pitches being made by the various investment banks looking to get the business.

Qwest shares closed off 27c to $8.75.

Outside of speculations about who and what the primary market might bring, convertible market players were holding pat and watching the Enron hearings.

"All eyes were watching the Jeffrey Skilling testimony. It was historic, you had to be watching that," said a fund manager in Boston.

Skilling, former president and chief executive officer of the failed Enron, testified before the U.S. House of Representatives Subcommittee on Oversight and Investigations. CNBC along with several other broadcasters aired the testimony live, or large portions of it. To a great degree, Skilling denied any knowledge that anything was wrong at Enron before he resigned in August 2001, which he said was for personal reasons. He referred to the liquidity crisis at Enron as a "classic run on the bank." U.S. Rep. John Dingle, D-Mich., said Enron executives were "incompetent, or corrupt, or perhaps both." Several key Enron executives have refused to testify, taken the Fifth Amendment or claimed ignorance about the goings-on at the former seventh-ranked company.

Holders of Enron debt, and particularly the convertibles, are not optimistic at all that there will be any recovery to speak of on their investments. There is roughly $2.75 billion (face) of Enron convertibles, $2.5 billion (face) of the 0% convertible due 2021, which was issued at 65.52 with a 45% initial conversion premium in February 2001, and $255 million of 7% mandatory exchangeables due 2002, which convert into Enron Oil & Gas shares.

Very little activity was taking place in the convertible market itself, traders said, although some arbs were busy in the stock market.

"I'm fighting not to reach for things. I find something interesting and the analyst crunches the numbers and we find it's just not worth it," said a convertible trader at a hedge fund in New Jersey. "Every day there's another one, some target of accounting irregularities or some other misconduct or misleading business practice. One more blowup and we're going to be in real trouble. The market is already at a standstill practically."

Shelter was the order of the day, traders said, for any activity taking place. Investors were looking to the defense area and some of the safer names among higher risk issuers, like Ford, Xerox and Lucent. Tyco continued to gain ground in the wake of management's conference call, and Calpine was recovering nicely, traders said, but Elan faltered as it acknowledged an SEC investigation.

Rite Aid, after rising on an upgrade to the stock by Robertson Stephens, gave back most of its recent gains on Thursday due to a credit downgrade. Rite Aid's credit ratings were cut by Moody's, which expressed concern that the drugstore chain could not make interest payments going forward. Rite Aid's new 4.75% convert due 2006 dropped 3.75 on the day to 63 bid and the stock dropped 27c to $2.58.

"We are surprised by the downgrade in our corporate debt ratings by Moody's and believe the action fails to understand and reflect the current financial position of Rite Aid," said Bob Miller, Rite Aid chairman and chief executive officer, in a company statement.

"We also believe the ratings do not take into account our recent substantial reduction in debt and the extension of the majority of our debt maturities to March 2005 and beyond. We believe that Moody's ratings do not accurately reflect the company's liquidity. We currently have the full $500 million provided by our revolving credit facility available to us. We also have proceeds from the recent sale of $250 million of 4.75% convertible notes due 2006 and we expect to generate $100 million to $150 million of free cash flow in fiscal 2003, which begins March 3," Miller continued.

"This gives us sufficient funds to continue to pay our vendors on a timely basis, to continue to pay our cash interest when due as we have in the past, to pay the $27.5 million of principal payments due on our bank term loan in fiscal 2003 and to retire our $150.5 million of debt maturing in September and the $83.6 million of debt maturing in October 2003. We have made a lot of progress on our turnaround plan. Today we are a company with a solid cash position, substantially reduced debt and thanks to a refinancing completed last June, the time to continue to execute our plan."

Moody's said it believes that operating cash flow may not grow enough to support all of the company's liabilities over the intermediate term, in spite of balance sheet debt reduction of $2 billion during 2001. In a distress scenario, Moody's added that it does not expect that the company's liquidation value would prevent a substantial loss to Rite Aid creditors and minimal recovery for some holders of Rite Aid debt.

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