Lehman convertible analyst likes Ford preferred, despite downgrade in stock

By Ronda Fears

Nashville, Jan. 29 - Venu Krishna, head of U.S. convertible research at Lehman Brothers, said the 6.5% convertible trust preferred issue of Ford Motor Co. is attractive alone or as a swap candidate out of the stock into the convertible, even though a Lehman equity analyst downgraded Ford's stock.

"Despite the [equity] downgrade, we believe the convertible remains attractive on a standalone basis and as an attractive swap candidate (out of the common, and into the convert) for investors positive on the long-term turnaround prospects for the company," Krishna said in an e-mail bulletin Thursday.

He said the convertible has an attractive valuation, higher income pickup compared to the common stock and a balanced risk-reward profile. Also, there is three years of remaining call protection on the issue.

Ford's $5 billion 6.5% due 2032 convertible trust preferred (Baa2/BB), originally issued at 50 in January 2002, was recently quoted at 56.2 versus the underlying common stock at $15.58, for a 5.78% current yield and 27.7% premium.

Since issue, the convertible has outperformed the common stock, for a total return of about 25.4% relative to the common stock's total return of 14% over the same time frame.

At current levels, Lehman analysts estimate the convertible to be roughly 2.75% cheap on a valuation basis. It is also cheap on an implied volatility basis with an implied volatility of 19.6% relative to the listed options and 100-day volatility of 29% to 30%. In addition, the implied spread on the convertible is around 409 basis points, compared with five-year default protection trading at 150 basis points to 160 basis points over Libor and senior straight debt quoted around 150 basis points over Treasuries.

Krishna noted that the Ford convert has a 320 basis points current income advantage over the common stock by virtue of the 5.77% current yield on the convertible compared to the 2.57% common dividend yield.

On risk/reward, he said the convertible is estimated to provide 65% upside participation and 37% downside participation relative to a 25% move in the common stock over one year.

The convertible ranks higher in the capital structure to the common stock, but it ranks junior to all Ford senior and subordinated debt.

"Long call protection of three years is a positive in the current environment where call risk for convertibles continues to remain high. In addition, long call protection implies investors have ample room to participate in any potential upside in the common stock over the next three years," Krishna said.

"Investors should note, however, that the Ford 6.5% convert does not carry dividend protection language, a feature common to nearly all converts issued since June 2003. This makes its valuation vulnerable to future common dividend increases."

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