OSI Pharma 4% convertible falls 6 points on call; Delta soars on bets pilots cave, no bankruptcy

By Ronda Fears

Nashville, June 18 - Cheapening in the convertible market subsided as paranoia levels were calmed by economic data and assuring comments from Federal Reserve chairman Alan Greenspan that interest rate hikes will be gradual. Overall it was a quiet session, however, and there were not many notable gainers outside Delta Air Lines Inc., which again saw a bevy of distressed and junk buyers swoop in for the paper.

Among issues heading south, OSI Pharmaceuticals Inc. dropped sharply as the biotech concern called its 4% convertibles, which fell to about parity as a 3% plunge in the stock sent the 3.25% convertible lower in tandem.

"The market has been in much better shape after the CPI number this week. Valuations have firmed and liquidity feels better. A couple of well priced and received new deals helped the tone as well," said a fixed-income manager in New York who dabbles in the convertible market.

"Fed Fund futures contracts show that [the] market now expects rate increases at a 'measured pace,' per Greenspan's guidance, and fears of a rampaging Fed, as was experienced in 1994, have receded.

With more certainty about modest future rate increases, which are fully imputed to security valuations via the yield curve, we are now able to confidently resume security selection activity based on relative value metrics."

Sellside market sources said Ford Motor Co. and General Motors Corp. were both active along with International Game Technology and Beazer Homes USA Inc.'s new issue, which was at 99.25 bid, 99.75 offered, amid a quiet session.

Blockbuster deal speculated

As the typical Friday session was quiet, chatter turned to speculation about what new deals might be on the immediate horizon and many market participants as well as onlookers are watching out for a blockbuster deal. Buyside sources say there is still a lot of money on the sidelines, ready to be put to work.

Blockbuster, in fact - literally, Blockbuster Inc. - happened to be mentioned at a couple of sellside shops on Friday, as the video rental giant had film rolling on a new $1.45 billion bank facility.

"I'd heard the name Blockbuster mentioned on the desk this morning, but nothing more," said one sellside convertible market source, "no details, or any other information, which would substantiate the rumors of a deal."

A source in the bank loan market told Prospect News on Friday that Blockbuster is expected to launch the new $1.45 billion credit facility next week to help fund its split from Viacom Inc.

Delta 8s at 52.5, 2.875s at 60

Overnight headlines to the effect that Delta's union pilots are ready to offer new concessions catapulted the two convertibles up sharply, by 1 to 3 points on swap, with the 8s around 52.5 and the 2.875s at about 60. The Delta junk bonds were seen about 1 to 2 points higher.

Early Friday, a sellside trader said some "smart distressed guys" were buying the 8s and selling the 2.875s at an 8-point spread.

"I see the 8s trading at par with the 2 7/8s in the near term," he said. "I think all the [bankruptcy] filing chatter is just positioning to get them [union pilots] to the table. I think the pilots will cave in. And, if you are set up on the converts, you will own them in the low 30s - the right price if they do have to file [bankruptcy]. I like the 8s here a lot."

After losing altitude on remarks Wednesday from Delta chief executive Gerald Grinstein, the Delta convertibles have since been gaining altitude as speculators surmise the remarks were designed to spur pilots to the negotiations table.

A sellside trader at a shop that handles a considerable amount of distressed paper said the 30 mark might be overshooting the value if Delta files bankruptcy, however.

"United is trading in bankruptcy at 6 or 7. There's no way Delta files and the bonds trade at 30. They will trade to 20 or lower," he said. "Convert guys have no clue."

Strategy shift seen, PIPEs hot

Some market participants may be reaching for junkier or distressed paper to boost yields, and others are continuing to shy away from that level of risk, but participants say there definitely is a shift in strategy taking place.

"It seems fund of funds expect, and for the time being are okay with, low absolute returns in convertible arbitrage, but are waiting to find the next new alternative strategy," said a fund manager on the West Coast. "Meanwhile cash builds up on the sidelines."

Observers as well as participants have commented repeatedly in recent months about hedge funds particularly ramping up their expertise level in investing in private placements and not the traditional Rule 144A deals but PIPEs - Private Investment in Public Equity.

Certainly, volume in PIPEs continues to grow. According to Sagient Research, so far in 2004 there have been 653 deals for $7.08 billion compared with 915 deals for $12.6 billion for all of 2003. The firm's statistics shows that of $362 billion in PIPEs deals since 1995, $296.75 billion were convertible in some form or fashion.

An investment banker on the West Coast said Friday that it has opened up a bigger world for banks just below the bulge bracket firms, too. For instance, a small deal his firm handled on Monday for a regional air carrier was placed with seven hedge funds, he said, and that set of investors would not have been available six months ago.

A report by Moody's Investors Service on Friday also noted that closed-end funds uncomfortable with recent volatility gyrations are looking for new investment strategies.

Volatility plays growing

Lehman Brothers' monthly volatility watch for the convertible market for June, which was released Friday, shows a growing number of volatility plays with 11 considerations, up from only seven in May. Most of the plays are in names with below-average volatility, reflecting the low volatility in the broader market.

On below-average volatility, if one takes a positive view on the stock, consider buying calls if holding any of the three Carnival convertibles, Fluor Corp.'s 1.5% due 2024 or the Costco Cos. 0% due 2017.

On below-average volatility, if one takes a negative view on the stock, consider buying puts if holding the Fluor 1.5% issue, Costco zeros, Lowe's Cos. Inc. 0% due 2021 or 0.86% due 2021, or the Walt Disney Co. 2.125% due 2023.

On above-average volatility, if one takes a positive view on the stock, consider selling calls if holding the General Mills Inc. 0% due 2022.

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