Ford, GM convertibles see little traffic ahead of Sept sales; Schering-Plough shoots up

By Ronda Fears

Nashville, Sept. 30 - Ford Motor Co. and General Motors Corp. convertibles were slightly higher Thursday but saw very little traffic and severely trailed gains in their stock ahead of September auto sales figures due out Friday.

While the auto sales data is expected to be flat for Ford and GM, one convertible dealer said the reversal of negative trends seen recently prompted some short covering in the stocks by hedge fund players, but that sparked no excitement about the credits.

Ahead of the data, GM stock rocketed higher by $1.38, or 3.36%, to $42.48 but its three convertible issues barely closed higher amid very thin volume. Ford shares gained 19 cents, or 1.37%, to $14.05 while its convertible preferred added a quarter-point to 52.25 in thin trading.

Wall Street expects positive results from ongoing incentive programs implemented to boost flagging sales that have created mounting inventories. In addition, at least Ford and GM have cut production levels to address the inventory problem.

Drug issues were quiet for the most part, as well, despite the market-roiling headlines that Merck was pulling its arthritis drug Vioxx, which fetches about $2 billion in annual sales, off the market. Studies linked the drug to heart problems.

Drug stocks were very active, in mixed fashion, however, and there were some specific drug convertibles higher but mostly due to news of their own. Gilead Sciences Inc., for example, added 4.5 points on news of a joint venture for its hepatitis C drug. And Schering-Plough Corp. shot up sharply on a Merrill Lynch report speculating that its prospects as a buyout candidate improved on the Merck news.

Agere Systems Inc. was steady though, following its news of further efforts to rein in costs with 500 layoffs, as analysts said most of the bad news is priced in. The convertibles are hovering around the par level, which traders attributed to hopes that the company would make a move to take out the 2009 issue early by tapping into its hefty cash vault.

Calpine Corp.'s new convertible edged a half-point higher to 89 bid, 90 offered but nothing else emerged on the primary market front. Some sources in the capital markets camp did say that a decision on the accounting rule on contingent conversion convertibles - requiring issuers to report earnings per share as if the issue were converted - should remove the overhang that the regulation had caused.

Some CoCo questions linger

On Thursday, the Emerging Issues Task Force of the Financial Accounting Standards Board adopted the new accounting rule, which had been proposed in July, and now that the matter is resolved, market sources expect the forward calendar to return to more normal levels. Plus, some think it might lead to on onslaught of exchanges for those existing CoCo converts, but there are still questions lingering.

"Uncertainty is bad, so this is good," said a convertible fund manager in New York.

The new CoCo convertible accounting rules are to be implemented by Dec. 15, but Venu Krishna, Lehman's head of U.S. convertible research, pointed out that there are still some unknown matters involving the new regulations.

In a report late Thursday, he said that lacking an official release by FASB on these changes, it is still uncertain as to the matter of retroactive application of the accounting change, or whether there is a grand-fathering provision, and if there is any flexibility for issuers of existing CoCos to address the accounting change.

Regarding the latter matter, Krishna noted that many new issues subsequent to the accounting issue surfacing in July include the net share settlement feature as an alternative to the CoCo feature. Both are aimed at limiting the dilution to underlying stock.

According to Lehman's research, there are 331 CoCo convertibles with an outstanding face value of $133.5 billion and of those about 134 would show a dilution of 5% or higher to earnings per share under the new accounting methodology.

Furthermore, the Lehman research shows that where issuers have multiple CoCo converts outstanding, such as Tyco International Ltd., GM and several others, the dilutive impact will be additive. In all, there are 31 issuers with multiple CoCo converts currently outstanding.

Drug issues quiet on Merck

Convertible traders said there was lots of drug paper trading Thursday on the Merck news but not to the magnitude one might guess. An uptick in drug stocks was sparked by the headlines as some onlookers suggested the Merck mess could create a boon for other drugmakers like Amgen Inc. and Biogen Idec, among several others and many of which are convertible names.

While the biotech index rose about 0.73%, not all drug stocks were higher, nor their convertibles. In many cases, the convertibles stood unchanged against some sharp moves in the stock, traders said.

Biogen Idec's stock gained 45 cents, or 0.74%, to $61.17 but the converts were essentially flat, or up "a tad," a sellside trader said.

On a positive note for convertibles, he added, Amgen's convertible, the 0% due 2032, also was steady at 73.5 bid, 73.75 offered, while the underlying stock dropped $1.22, or 2%, to $56.81.

"There was some 'cautious' statements, I guess, from a UBS analyst on Amgen and Medicare reimbursements getting cut back, but that isn't news really," the trader said.

Schering-Plough buyout buzz

It's not news that many view Schering-Plough as a takeover candidate, with Merck as the suitor, but the Merck development caused it to seem more probable now.

"Apparently the thinking is that without the $2 billion in Vioxx sales, Merck would be looking for another way to pad its revenues," the sellside trader said.

A Merrill Lynch report Thursday said the odds of Merck acquiring Schering-Plough indeed have increased on the event.

"We view this as positive for investor perception about Schering-Plough," the Merrill report stated. "This is because corporate pain often is a trigger for strategic action, and the pain Merck is experiencing may make it more likely that it attempts to acquire Schering-Plough."

Schering-Plough's 6% mandatory convertible due 2007 shot up 1.125 points to 52.75 bid, 53 offered, the dealer said. On the New York Stock Exchange, the issue moved up 1.07 points, or 2%, to 52.95 with 1 million units changing hands. The stock rose 56 cents, or 3%, to $19.06.

Agere steady, hovering at par

Agere's 6.5% convertible remained firmly at a par bid, traders said, following its latest efforts to curb costs. The stock was little changed, as well, slipping by a penny to $1.05.

"There is some hope they will be looking to flush this issue out. They've got the cash," a sellside market source said.

He pointed to the company's cash and equivalents balance of $785 million at June 30 against the only debt, the convertible, which totals $410 million.

Credit analysts note that Agere's situation has not changed much, at least not enough to warrant a big selloff.

"For investors that own Agere or are thinking of short selling, we do not recommend selling at this point. The current stock price embeds much of the bad news. The stock is grossly undervalued even given the financial revisions, which makes it a potential buy for investors with a long time horizon," said CreditSights analysts Zhiping "Ping" Zhao and David M. Reich in a report Thursday.

Analysts waver, but supportive

Agere's credit outlook has weakened somewhat, but its balance sheet still looks good, the credit analysts said. Still, they suggest the company could have gone farther to cut costs.

"Despite weaker growth prospects for the firm, the new restructuring actions have minimal impact on Agere's credit quality," Zhao and Reich said in their report. "There is adequate liquidity to absorb the cash charges and hopefully the restructuring will help offset the negative revenue impact to profitability measures. However, the credit outlook has weakened from the more favorable trend observed earlier this year."

The Allentown, Pa., chipmaker for networking equipment on Wednesday announced the layoff of 500 employees and other cost-cutting measures but reaffirmed its guidance for fiscal fourth-quarter revenue of between $420 million and $445 million.

"We believe that Agere will remain a viable concern both in terms of balance sheet and its long-term business prospects. However, cost reductions reflect a painful admission that revenue is unlikely to rebound quickly," Zhao and Reich said. "With updated financial guidance, we believe that cost reduction measures did not go far enough."

Agere augurs badly for sector

The worse of Agere's warning, the credit analysts said, is that it is the first guidance for the industry in the December quarter and bodes ill for the sector.

Agere forecast a sequential revenue decline of roughly 5% in its fiscal first quarter. The company attributed its view to inventory adjustments by customers buying certain mobile phone and telecom equipment, plus a seasonal decline in revenue from internet protocol products and shipments of chips for satellite radio.

Agere also said it expects gross margins to decline on sequential basis in the quarter due to lower capacity utilization and the lower revenue levels.

"Agere's December quarter revenue guidance could be the first firm indication that the December quarter will be an ugly one for both the telecom equipment and handset markets," the CreditSights analysts said.

"The handset market could be even worse than current expectations, which already call for lower than normal seasonality. A telecom equipment market with much lower seasonality for the December quarter will raise serious questions regarding the state of the [telecom equipment sector] recovery."

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