Technology sector drops on Intel's earnings, Motorola's revised outlook

By Sara Rosenberg and Ronda Fears

New York, Oct. 16 - It was a fairly active day in the convertibles market as people went bargain hunting in the midst of an equity sell-off. One of the most focused-on sectors was technology as the market reacted to Intel Corp.'s disappointing third quarter results and Motorola Inc.'s poor financial forecasts.

"After yesterday's big rally, I think the market gave back some of its gains," Rao Aisola, managing director and head of convertibles research at Bear Stearns & Co. "Bottom line is the rally we've seen is a bear market rally. [Based on this rally], the credit market is telling us that the worst is behind us but there's still incremental bad news out there."

Intel reported earnings per share of $0.11 for the third quarter, missing the consensus estimate of $0.13, according to Wachovia Securities, Inc. analysts Henry Voskoboynik and Dmitry Melnick in a research report. Revenue for the third quarter was $6.5 billion, up 3% sequentially and flat year-over-year. Net income was $686 million, up 54% sequentially and up 547% year-over-year. Forecasts for the fourth quarter include a revenue guidance of $6.5 billion to $6.9 billion. The company lowered its gross margin guidance by approximately 200 basis points to 49% plus or minus several percentage points.

"Overall, Intel's report was disappointing," Voskoboynik and Melnick said. "The September-quarter revenue was in line with expectations, but the gross margin miss was an unanticipated negative surprise. Guidance for the next quarter did not provide any inspiration, but it still calls for sequential growth."

"A much larger problem, in our opinion, is Intel's financial model," the Wachovia analysts continued. "The company has not seen any meaningful revenue growth in more than six quarters, yet its operating expenses kept on increasing. Its gross margin is down more than 1,500 bps in the past 18 months and is not likely to return to previous highs. The company's cost-cutting efforts on the materials side hit a brick wall in the September quarter. Intel is in need of a fairly large restructuring."

Intel does not have convertible notes in the market, however, according to one trader, its earnings were the "main catalyst" driving the market down. The company's stock closed at $13.54, down $2.98 or 18.04%.

Earnings results for Intel suggest that end-user demand is pretty low, which doesn't speak well for end-user demand in cell phones either, according to Bear Stearns' Aisola.

Also gloomy was Motorola, which announced that it now expects sales in the fourth quarter to be approximately $7.1 billion compared to previous guidance of $7.5 billion. GAAP earnings are expected at 4c per share compared to previous guidance of 11c per share and operating earnings are now expected at 10c per share compared to previous guidance of 14c per share. For full-year 2003, sales are currently expected at $27.5 billion, compared to previous guidance of $29 billion and earnings per share are expected at 40c compared to previous guidance of 45c.

"The company's lowered revenue and earnings guidance is driven by slowing industry demand in a number of the company's end markets, in particular the wireless infrastructure, broadband and semiconductor businesses," a company news release said.

Motorola was also hit with STMicroelectronics' strong denial of a report that it is in talks to buy the company's semiconductor unit. This combined with lowered expectations drove Motorola's convertibles south with the 7% mandatory closing at 29.50, down $6.25 or 17.48% on the day. The stock closed at $7.85, down $2.25 or 22.28%.

The Liberty Media 3.5% exchangeable due 2031 into Motorola shares ended the day down about four points from Tuesday's close at 57¾ bid, 58¼ offered.

"It dropped about five points but it started expanding late in the day as outright buyers came in to the market," a trader said. The company's stock closed at $7.65, down 7c or 0.91% on the day.

Also selling off on Wednesday were the convertibles of General Motors Corp. and Ford Motor Co. The two automakers were hit by growing concerns about their massive unfunded pension liabilities.

Ford was also hurt by its return to a net loss in the third quarter.

GM's 5.25% convertible due 2032 dropped 1.15 points to 20.55 and the 4.5% due 2032 lost 0.53 point to 22.92. GM shares closed down $2.56 to $34.14.

Ford's 6.5% convertible trust preferred fell 2.3 points to 34.5. Ford shares ended off 61c to $8.26. (See separate story in this issue.)

Another sector that was active on Wednesday, and has been for a while now, was the electric utility market. Some names that were labeled as "pretty active" included TXU Corp., American Electric Power Co. Inc. and TECO Energy Inc., according to Stuart Novick, convertibles analyst at Salomon Smith Barney

"There are credit concerns in the sector," Novick said. "[But], they are potentially good plays if and when common dividends get cut. With 12% and 13% common yields the equity market is telling you something is not right. One way of looking at the trade on the mandatory side is that on a cash flow basis, if the dividends get cut, trades will look more attractive."

So far, TXU has been the only company to take this route with Monday's announcement that it is cutting dividends by 80%.

At mid-day, AEP was 29 for the convertibles versus 18 for the stock, which gets you a 16% yield and a 31% premium, and TECO Energy was 14½ for the convertibles versus 11 for the stock, which gets you a 16.4% yield with a 39% premium, Novick said.

By close, AEP's 4.625% convertibles were bid at 29.27 with the stock closing at $18.38, down $1.12 or 5.74%.

The TXU 8.75% convertibles due 2004 notes were quoted as trading around 21. The TXU 8.125% convertibles due 2006 notes were quoted at 17¾ bid, 18½ offered by one shop while a second had them bid at 21.747. The stock closed at $10.89, down $1.12 or 9.33%.

In other news, PMA's deal was getting a nice reception despite the small $75 million size, a buyside source told Prospect News.

It was quoted closing in the gray market at 102 bid, 103.5 asked. The stock closed down 34c to $12.40.

Final terms were not available.

At the midpoint of guidance, Wachovia Securities convertible analyst Kimberlee Brody puts the deal 3.24% cheap. She used a credit spread of 450 basis points over Treasuries and 35% volatility in the stock, plus accounted for a 3.39% current yield in the common.

On Tuesday, Deutsche Bank Securities Inc. convertible analysts put the deal 7.4% cheap at the midpoint of guidance, using a credit spread of 450 basis points over Libor and 40% volatility in the stock, plus accounting for a 3.27% common dividend yield.

The issue is non-callable for four years with puts in years four, eight, 10 and 12. There is a contingent conversion trigger of 120% and a contingent payment trigger of 120%. There is an $11.25 million greenshoe available.

Banc of America Securities and Credit Suisse First Boston are joint bookrunners on the deal.

The Philadelphia insurance firm said it plans to use proceeds to increase the capital and surplus of its insurance subsidiaries to support expected growth in its reinsurance and insurance operations and for general corporate purposes.

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