Merger news pushes DoubleClick, Valero higher; Calpine continues slide; Sepracor 0s up, 5s decline

By Ronda Fears

Nashville, April 25 - Merger news helped lift the convertibles of Valero Energy Corp., although traders say the issue is difficult to snag because the stock is such a hot item. On its $8 billion takeover of Premcor the heat intensified, and was fueled, perhaps by nothing more than hope, of Valero eventually tapping the convertible market for acquisition funding or refinancing.

DoubleClick Inc.'s converts shot up considerably on news of a $1.1 billion buyout by private equity firm Hellman & Friedman LLC, as that could trigger a par put on the issue, which was trading in the high 80s last week.

Calpine Corp. convertibles continued to freefall, however, extending a deep slide from last week on rumors that the San Jose, Calif., independent power producer - burdened with an $18 billion debtload - had hired bankruptcy counsel. The company refuted the rumors, but the credit has continued to track the stock lower.

On Monday, the Calpine 4.75% convertibles were described as 4 to 4.5 points lower and the 6% converts off 3.5 to 4 points, while the stock lost another 6% to close at $2.05.

One seller remarked that Calpine convertible investors were particularly concerned that even without a bankruptcy restructuring, Calpine will be having to make significant debt refinancings this year, and the fear is that Calpine will be looking to take out its unsecured debt in the junk bond market before looking to buy back the converts.

During 2004, Calpine repurchased or refinanced $1.8 billion of corporate debt, including nearly $715 million of convertible preferreds, plus completed $2.1 billion of liquidity-enhancing transactions. Calpine intends to repurchase another $1 billion of debt this year.

Europe, Asia plodding back

Not that there is a party going on in Europe or Asia regarding convertibles, but sources in London expressed some optimism on Monday.

"Life is slowly returning to Europe," said a convertible analyst in London.

"Lifting an offer is no longer seen as an act of convertible investing suicide. I wouldn't exactly call it rude health though."

The dearth of new issues that has plagued the U.S. convertible market has been a source of discomfort there, as well.

"Given the paucity of new issuance, European activity in non-benchmarks remains driven by corporate news, and particularly M&A."

Asia is a brighter spot.

"As with last year, Asia seems to offer some promise: maybe it has the look and feel of the U.S. market a few years back: lots of new issuers in emerging sectors (or in Asia, read geographies) bringing smaller, story-driven deals with some innovation," the analyst said.

Sepracor gains tempered

Sepracor Inc., whose insomnia drug Lunesta was approved in December, on Monday reported a smaller first-quarter loss, but concerns such as call risk and takeover risk held its convertibles issues back from participating in the party going on with the stock.

Sepracor shares gained 97 cents, or 1.61%, to close Monday at $61.25.

Convertible traders on the sellside pegged the Sepracor zero-coupon convertibles up about 1 point with the stock, but one sellside trader said the 5% converts due 2007 dropped 1 point to around 100.5 bid, 101 offered.

A sellside desk analyst said the first-quarter earnings were encouraging in that the "losses were smaller than expected and the stock's pretty much flat."

The company posted a first-quarter net loss of $22.6 million, or 22 cents a share, compared with a loss of $50.4 million, or 59 cents a share, in first quarter 2004. Revenue grew to $106.6 million from $99.5 million.

"There's a ton of [Sepracor] convert paper (four issues, $1.1 billion) out there," the analyst continued, "but there doesn't seem to be a great way to play this, given call risk on the 5% of 2007, the small amount of 0% of '08 out there, takeover risk, etc."

DoubleClick doubles up

Coming back from distressed levels out of worries whether DoubleClick is a going concern, the online advertising firm's convertibles shot up on its buyout news - although there were investors bailing out of the stock.

The 0% convertible was quoted at 96.5 early Monday on the news, and later another sellside market source pegged the issue at 98 versus a stock price of $8.13. DoubleClick shares closed at $8.12, down 5.25% on the day.

DoubleClick agreed to be acquired by San Francisco based private equity firm Hellman & Friedman for $1 billion. JMI Equity, a San Diego- based venture capital firm, also will be investing in the transaction.

"The bonds are trading up to about 96.5 [versus the 100 put price] given the slight deal risk and estimated time until the deal closes (another 6 months or so?)," said a sellside desk analyst. "A takeover (take under?) is certainly one of the better outcomes among those that were talked up in the past couple of months as far as convert guys go. (A one-time special dividend would have been not so good for hedged players or for the credit support for that matter.)"

Under the terms of the deal, DoubleClick said stockholders will receive $8.50 in cash for each share of DoubleClick stock - a 10.6% premium to the average closing price of DoubleClick's stock for the past 30 trading days. Last week, DoubleClick reported a first-quarter net loss of $917,000, or 1 cent a share, compared to a profit of $7.7 million, or 5 cents a share, in first quarter 2004. Sales rose 12% to $76.3 million.

Merrill Lynch convertible analyst Tatyana Hube said convert holders should exercise the par put on the change of control as its obviously worth more than the cash value of the converts - $647.96 per note - based on the $8.50 offer price at a 76.2311 conversion ratio. (See full report, elsewhere in this edition.)

As an explanation for DoubleClick shares declining on the news, one convert holder said: "Everyone is jockeying to make as much as they can out of what has to be. Those who are going to take a loss (not me, but apparently there are some) might as well go ahead and take it in case the deal doesn't go through and they would end up losing even more. Or, for those who bought earlier at, say under $7, they are better off cashing now and using the money elsewhere and let a new buyer in around $7.50."

Another sellside analyst added: "Some are thinking the shareholders [will] not go along. This is a low-ball offer to see what will happen."

Valero may eye convert market

It may just be high hopes, but a sellside desk analyst suggested a convertible may be in the future for Valero as it looks to business beyond the Premcor acquisition. The acquisition itself raised some alarms among credit analysts, but convertible players cheered the event.

Valero's 2% mandatory due July 2006, an issue that is rarely seen in trade, was described by one dealer as up 0.875 point on the day at 75; another pegged it up 0.75 point at 85.125 bid. Valero shares added 83 cents on the day, or 1.11%, to close at $75.87.

Credit analysts criticized Valero, which has been an aggressive acquirer, for the price tag and its financial profile following the merger. Valero is offering Premcor shareholders either 0.99 share of Valero common stock, or $72.76 in cash, for each Premcor share they own, or a combination of the two. The transaction is structured to be half cash and half stock and gives Premcor shareholders a premium of about 20% based on the recent 30-day trading range of Premcor's stock price.

"I've been a Valero fan for a long time," said the sellside convertible analyst.

"The management team consistently delivers and a lot of guys on the Street consistently low ball their estimates, price targets, etc. I think the company does an excellent job of managing their business and their financials. Unfortunately, the [2% converts] only have a year left in them and the stock is likely to tread water for a while now as this deal gets done and they start to squeeze more profits out of the Premcor properties.

"Maybe another convert?" he tacked on.

When asked if there was any market noise to suggest more than just a wish in terms of a new Valero convert, he said, "Not yet. They've got significant cash and, more importantly, operating cash flow this year is likely to be extremely strong so they're thinking that they'll borrow the money from the banks and pay it down as they go. They could term some of it out though, maybe in the form of a convert."

Valero downgraded on deal

While a convertible might help alleviate some of the concerns of the ratings agencies about leverage, the analyst said their concerns are more rooted in the idea of the company being unable to de-leverage as quickly as planned in the event that refining margins shrink, as Valero would have less free cash flow with which to pay down debt.

Moody's and S&P cut or put Valero credit on review for downgrade as a result of the acquisition, expressing concern about the price tag and leverage.

Valero said it plans a quick deleveraging effort following consummation of the merger, which is anticipated by year-end. Valero said the assumption of Premcor's debt will be offset by $800 million in cash. By year-end, Valero expects the combined company to have $2 billion of available cash, so it anticipates issuing approximately $1.4 billion in new debt.

The deal would give Valero a total refining capacity of 3.3 million barrels a day, more than ConocoPhillips and Exxon Mobil Corp. in North America. Besides being seen as a strategic enhancement for Valero, with size and quality into strong margins, however, onlookers remarked that there was significant risk on the price and timing, as Valero could be buying within a year of the top of the market.

Moody's Investors Service put Valero debt on review for possible downgrade, citing concerns about the potential for higher leverage as a result of the acquisition in the event that refining margins, which tend to be highly unpredictable, decline from current lofty levels, plus the relatively rich purchase price of the transaction.

Standard & Poor's cut the corporate credit rating on Valero to BBB- from BBB, and placed the rating on watch for a possible downgrade, reflecting "concerns that refining margins could weaken considerably in advance of the close, jeopardizing Valero's plans for rapid deleveraging."

Valero credit tight, tighter

Even with a credit downgrade, analysts said Valero's credit - already trading extremely tight - tightened up Monday on the Premcor acquisition news.

Valero's earnings from last week and its projections about the impact of the Premcor acquisition largely drove the credit, said one trader. Last Thursday, Valero reported 34% revenue growth for first quarter, while profit from its refining segment nearly doubled. The company projects the Premcor deal as 14% accretive to EPS and about 13% accretive to cash flow per share.

A one-notch cut form S&P to BBB- from BBB didn't have much impact on the credit, the trader said. In the high-yield market, Premcor bonds were also higher on the news, with the 6.125% noted due 2011 at 105.25 early in the day, up from 100.25 on Friday.

GimmeCredit analyst Philip C. Adams said in a report before the merger was announced that although Valero credit is trading tight, he still sees value in the paper. He noted that, in addition to a nice earnings report from Valero, crude oil futures closed last week with the biggest weekly increase for the contract closest to expiration since last December and gasoline futures marked the largest one-week rise since September 2003.

"While there's probably some short-term seasonal factors at play, the prognosis appears to be for continued good refining margins, especially for refiners such as VLO who can take advantage of the large discount for heavy and sour crude oil," Adams said in the report.

"Valero's 4.75% notes due 2013 are trading at 69 basis points over the 10-year Treasury (Z-spread 37), about where they were when we first recommended a buy [Feb.7]. The 7.5% notes due 2032 traded recently at 122 basis points over the long bond (Z-spread 80). We continue to see value in this name."

GM recall

General Motors Corp. announced the recall of more than 2 million vehicles on Monday.

Of the overall total, about 1.5 million full-size sport utility vehicles and pickup trucks mostly sold in the United States, are being called back to the shop to fix the seat belt positioning in the rear seats.

The GM converts snapped back, losing up to a quarter point.

Burnham Securities analyst David Healy predicted the move could cost General Motors between $100 million and $200 million.

Ford was lower Monday, too, as Lehman Brothers Inc. lowered its estimates for both GM and Ford. Meanwhile, there was a sharp advance seen in stocks of Japanese automakers.

Lehman Brothers believes GM's decision not to provide an outlook for 2005 means the company will lose money for the year, and reflects the need for more significant production cuts and pricing actions. Analyst Darren Kimball now expects the automaker to lose 70 cents a share in 2005 vs. his prior forecast of a profit of 30 cents a share. He reiterated his underweight rating, but cut his stock price target to $20 from $25. Kimball thinks the company is moving closer to acknowledging a crisis, which may lead it to cut its dividend in half.

For Ford, Kimball also cut his 2005 earnings estimate to $1.20 a share from $1.40 and his stock price target to $10 from $11 due to industry concerns, but kept his rating at equal weight.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.