Ford picks up buyers as selling in supplier Lear accelerates; Imclone crushed on delay; Goodyear skids

By Ronda Fears

Nashville, April 13 - A selling theme continues to dominate the convertible market this week particularly, as more and more players - mostly convertible arbitrageurs - are seen exiting the strategy. On the other side of that coin, believers who are weathering the latest storm front are seeing the market cheapen up to a point that they can add to current positions or put on new ones.

Among issues sold off Wednesday on specific news were those of Imclone Systems Inc., which has come across a delay in approval for its cancer drug Erbitux, and Magma Design Automation Inc. on a setback in its patent dispute with Synopsys Inc.

Goodyear Tire & Rubber Co. was another convertible mentioned in regard to heavy selling as the 4% convertible dropped 3.75 points to 121.5 with the stock down 34 cents, or 2.63%, to $12.58. A sellside trader said the convertible had lost considerable traction after the tiremaker closed $3.65 billion in new credit facilities earlier this week, which further subordinated the convertibles.

Weakness in the auto group also hurt Goodyear, he continued, but added that Ford Motor Co. was "finally seeing a few buyers step up" on weakness in the wake of Ford's 2005 and 2006 profit warnings last week. The Ford 6.5% convertible picked up 0.25 point to 39.25, while the underlying shares lost a penny to $10.05.

Lear Corp., an auto parts maker for Ford and other beleaguered automakers, was another name mentioned in regard to selling Wednesday, with its 0% convertible off 0.125 point to 44.625 as Lear shares dropped 7 cents to $41.07.

General Motors Corp. was a factor in the weakness in auto suppliers as the Securities and Exchange Commission requested documents from GM regarding Delphi Corp., which was spun off from GM in 1999, as it investigates possible accounting irregularities at Delphi. GM's convertibles were lower by 0.25 to 0.375 point, with volume described as light to modest.

Fearful sellers manifest fears

On the whole, however, players continue to report, on a more regular basis lately and with a stronger note of panic, that buyside shops are shutting down or bailing out of the strategy. There has been some noise about sellside shops downsizing convertible desks, too.

"I'm hearing from someone in the business that convert liquidations are really piling up and money is coming out of the strategy," said a convert arb fund manager in New York, who admitted he has trimmed his convertible positions by something north of 75% over the past year or so.

Another buyside source in Connecticut said those selling out of the convert arb strategy because of lousy returns not only are to blame as the root of the downturn in returns - by flooding into the market with perhaps unreasonable expectations and thus were willing to pay up to participate in some issues that were mispriced - but the lousy valuations that stem from the sell-off itself.

In other words, by staging a sell-off due to poor valuations, valuations become even weaker.

Moving parts hedged manifold

Part of the current problem for convertible returns right now is that too many players have essentially out-smarted themselves by trying to hedge every moving part of a convertible - a rho hedge, volatility hedge, credit default swaps and, in more recent history the addition of junk bonds or straight bonds, the fund manager in Connecticut continued.

As for the fundamental drivers for convertibles, one fund manager pointed out that everything supporting a take-off for the market this year has happened - stocks have rebounded sharply and credit spreads are widening. Rather, convertibles have been "destroyed" because hedging strategies have backfired.

Most of the people who drifted into the newfangled hedging strategies are younger, at least as a player in the convertible market, he speculated. He is a veteran in the market, with experience on both the buyside and sellside.

"The descent into Hell is easy. It's the climb out that's hard," he said, adding to clarify, "It's easy to put on these trades, but very difficult to unwind them."

Grassroots players steadfast

Moreover, several veteran convertible players assert that they are hanging on and will be the backbone of the market once again by going back to the basics that have always made convertibles popular.

We've dumbed down," one said. "We're just trying to hang on because we believe it's going to turn around. I've never been more sure professionally of anything in my life."

Meanwhile, those remaining must suffer negative returns, and the pain is evenly distributed among convert arbs and outright players.

"Anyone who says they are making money in convertibles right now are short, and lying," said the manager in Connecticut.

But, he said, that the shift from a playing field where leverage was cheap and valuations were expensive to one where leverage costs more and valuations are lower should, mathematically dictate that returns will improve.

"When," is the so-called $64,000 question, however, and most players as well as onlookers won't even venture a guess.

Imclone 1.375s lose 2.5 points

For the moment, though, some things were clear by the day's trading activity, which largely showed a significant drop in several convertible issues. Many were driven by particular items of news, though, such as Imclone, whose 1.375% convertibles fell about 2.5 points to 81 bid, 82 offered.

Imclone shares also plunged, falling $4.13 on the day, or 11.7%, to $31.18 as a couple of equity analysts downgraded the stock on the news.

On Tuesday, Imclone announced it would hold off seeking approval for its Erbitux drug in treating head and neck cancer until later in the year. An FDA snag at year-end 2002 led to a scandal that sent former chief executive and Imclone founder Sam Wachsal, as well as celebrity homemaker Martha Stewart, to jail for securities fraud.

Imclone was scheduled to seek approval in the second quarter, and positive views on the drug had supported the stock, as well as the convertibles. Now, analysts said other drugmakers are closing in on Imclone's territory, which might also squeeze its profits. One specifically mentioned was Genentech's rival drug Avastin, which seems to be picking up steam in the use of colorectal cancer, currently Erbitux's domain.

Magma Design 0s fall 5.75 pts

Magma Design's convertible plunged 5.75 points as the underlying stock lost a whopping 40% on a major obstacle in its effort to fend off a patent dispute with Synopsys, but traders reported little traffic in the zero-coupon convertible.

A sellside shop pegged Magma Design's 0% convertible at 73.25 bid, 74.25 offered. The stock closed Wednesday at $5.58 - a new 52-week low - after losing $3.84, or 40.76% on the day.

In court documents filed in connection with the lawsuit, one of the founders of Magma Design said that three patents at issue concern inventions - which have been described as fundamental to Magma's technology used for the automated design of computer chips - he conceived while employed at Synopsys.

Magma said in a statement that the declaration by Lukas van Ginneken doesn't change its position that Synopsys' claims have no merit.

"The biggest concern is if Magma Design is based on intellectual property stolen from Synopsys," one sellside convertible desk analysts said. "This is the core technology of the company, the one new thing they had to offer. If the founder admits he doesn't own the intellectual rights, this company is toast."

Chesapeake terms a surprise

Chesapeake Energy Corp.'s convertible priced at the cheaper end of guidance, which surprised some players and onlookers. The $400 million of perpetual convertible preferreds came with a 5.0% dividend and 30.5% initial conversion premium - at the cheaper end of talk of 4.5% to 5.0%, up 30% to 35%.

Many expected the deal would price aggressively due to strong demand, but one buyside source suggested that the convertible terms were loosened by bankers after the company sold $600 million of junk bonds at a discount.

"We thought the deal would probably price aggressively, until the junk bond terms came out," said a sellside convertible analyst at a firm not involved with the Chesapeake convertible offering. "It looks like whatever caused the junk deal to price below par spilled over into the convertible."

The Oklahoma City-based independent oil and gas producer also on Wednesday sold $600 million of 11-year senior 6.625% notes at 99.069, which were seen trading up roughly 0.25 point to 99.25 bid, 99.375 offered shortly after pricing.

A convertible fund manager who participated in the new deal, who also holds positions in existing Chesapeake Energy convertibles, said there is a lot of concern about oil and natural gas prices falling from inflated levels, although the company has hedged out a lot of its exposure to fluctuating commodity prices. Another area of concern, he added, is Chesapeake Energy's aggressive acquisition strategy.

Nabi on tap

Elsewhere in primary market activity, also at bat after Wednesday's close was Nabi Biopharmaceuticals' new deal, which was still not mentioned in regard to any gray market activity.

The $125 million of 20-year convertible notes - talked to yield 2.375% to 2.875% coupon and 30% to 35% initial conversion premium. Sellside analysts put the issue about 1.0% cheap at the middle of price talk.

Nabi Biopharma shares ended at $11.015, down by $1.005, or 8.36%.

Meanwhile, El Paso Corp.'s new 4.99% perpetual convertible preferred, which was reoffered by underwriters at 97.5, was described as "lingering at 97." El Paso shares closed Wednesday lower by a nickel at $10.35.

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