Sepracor, Vitesse deals emerge; Delta converts steady; Nortel, Lucent tumble; Providian better

By Ronda Fears

Nashville, Sept. 16 - A couple of new deals emerged Thursday and "it was like feeding fresh meat to sharks," as one salesman put it. Sepracor Inc. launched a $500 million deal after the close, and before the opening bell Vitesse Semiconductor Corp. had begun marketing a small $90 million issue.

"People are starved for paper," said a market source familiar with the Vitesse deal. "They didn't even know what it was, what the deal terms were, they were just calling saying they wanted in."

It was about the same with the Sepracor deal, another source said, although after looking at the "no-no" terms - 0% coupon, 0% yield - several buyside sources said the drugmaker's new deal didn't look all that appetizing.

Elsewhere, in secondary dealings, several telecommunications equipment issues were lower in sympathy with Nortel Networks Corp. as the Canadian firm warned that third-quarter revenues would fall short of expectations. Lucent Technologies Inc., Ciena Corp. and ADC Telecommunications Inc. were notable losers in the convertible universe.

Delta Air Lines Inc. was a source of excitement in the distressed trading trenches in the wake of the troubled airline's debt exchange offer, which prompted downgrades to the notes involved. Delta's convertibles, which are both long-dated paper, and the airlines' 8.3% junk bonds due 2029 were rather steady - moving up or down by a quarter to half-point.

Meanwhile, short-dated Delta junk bonds - the 7.7s due 2005 - traded as high as 58 bid before easing back to 49 bid at the close, for a gain of 5 points. Delta stock ended off by more than 2%.

"No one knows how to value this company," said a former Delta bondholder, who sold out of the credit several weeks ago.

To some degree volatility was propelling, or compelling, action in the Delta converts, traders said. Volatility plays have been a source of the market's search for the cheapness to exploit, and a sellside trader provided several candidates in that area, including Providian Financial Corp., whose converts edged up Thursday on a boost to the credit outlook.

In another distressed situation, the Foster Wheeler Ltd.'s latest, and perhaps last, extension to its debt-for-equity exchange offer will expire Friday and its chances of success may be slim, although less than a handful of the convertible preferred holders are blocking it.

Sepracor existing issues easier

Sepracor's new overnighter was talked to yield 0% with a 26% to 34% initial conversion premium, which did not overly impress potential buyers, but some were keen for the drug company's existing 0% converts on the company getting a big capital infusion.

"There is demand for the new [Sepracor] paper just because it's new paper, but also because it has dividend protection and takeover protection. Basically, the terms at face value are not that different" between the new issue and existing zeroes, said a sellside market source. The new notes will be senior to Sepracor's other three convertible issues.

"With that cash, though, it also makes holding the older zeroes a good idea because they have been buying that issue back aggressively."

The Marlborough, Massachusetts-based company said it will use up to $100 million of the proceeds to buy back common stock and, otherwise, for general corporate purposes.

Sepracor has already said it exchanged $504.18 million of the 0% convertibles for 16.516 million shares of stock and $66.457 million in cash, in a series of privately negotiated transactions Oct. 29 through Sept. 1, and a further $25 million for 838,000 shares and $3.313 million in cash on Sept. 8. The company sold $750 million of the convertibles in January.

The two-tranche 0% convertibles due 2008 and 2010 were both down 1 point before news of the new deal surfaced. Sepracor's 5% convert due 2007 was quoted off about 0.125 point Wednesday at 103.25 bid, 103.75 offered, and a trader said it is likely not to move much as that issue could be taken out as well.

Sepracor converts had shot up sharply in March when the drugmaker announced its insomnia treatment had received an "approvable" letter from regulators, with the 0% issues gaining some 40 to 50 points as the stock rose a whopping 56.5%.

On Thursday, Sepracor shares closed off 33 cents, or 0.63%, to $51.69. In after-hours trading, the stock was down another $1.69, or 3.27%.

Vitesse 4% converts gain 1 pt

Vitesse said with cash on hand and proceeds from its new $90 million convert - talked to yield 1.5% to 2.0% with a 30% to 35% initial conversion premium - it would take out the remaining amount of its 4% convertible due 2005 ahead of maturity. That moved the 2005 issue up 1 point to about par, a trader said.

As for the new Vitesse convert, a buyside market source said that, relative to other recent new deals, the terms were "somewhat attractive" but indeed proof that "the market is starved for paper."

The Camarillo, Calif.-based company, which makes optical devices used in the networking, communications and storage industries, said up to $20 million of proceeds would be used to repurchase stock from note purchasers. Remaining proceeds, plus cash on its balance sheet, are expected to be used to retire Vitesse's 4% convertible notes due march 2005.

There is about $195 million of the 4% convertible issue outstanding. The issue originally totaled $720 million.

Vitesse shares ended Thursday off a nickel, or 1.69%, to $2.90.

Nortel drags Lucent down

Nortel's revenue warning really just barely budged its convertibles, traders said, as the issue is considered ripe for plucking by the company either in terms of buybacks or a call or redemption. But the news sent Lucent lower in sympathy along with other telecom equipment makers.

Contrary to snapbacks seen following similar warnings, however, Nortel's converts were off just a quarter-point or so, and in addition to Lucent, notable "other" decliners in telecom equipment converts were Ciena and ADC Telecom.

"Nortel's converts have priced in pretty much any and all of the bad news. They are holding up because everyone knows, or thinks, the company will be taking the issue out fairly soon," a sellside trader said.

"Nortel cleared out its executive offices a while back [after an accounting scandal came to light], and then there is the restatements that go back a while, too. All that is priced into the bonds."

Nortel's straight bonds also were described as steady, with the 6.125% notes due 2008 at around 101.

Lucent's 2.75% converts dropped about 1 point each, with the 2023 issue at 127.625 and the 2025 issue at 133.375. Lucent shares ended off by 4 cents, or 1.2%, to $3.28.

Delta converts holding steady

Delta's convertibles, which mature in 2023 and 2024, held steady, along with its straight 2029 bonds Thursday in the wake of the troubled airline's exchange offer, which prompted downgrades to the notes involved. But the short-dated Delta junk bonds shot up sharply during the session before easing back by day's end.

Delta's 8% convertibles due 2023 added about a half-point to 34.5 bid, 35.5 offered and the 2.875% convertible due 2024 slipped by about a quarter-point to 37.5 bid, 38.5 offered, while the 8.3s of 2029 were pretty much unchanged on the day at 26.5 bid, 27.5 offered.

The Delta's benchmark 7.7s of 2005 traded as high as 58 bid, 60 offered, a distressed trader said, before retreating to close at 49 bid, 51 offered, though still up about 5 points from Wednesday's close.

"They tried to take the long Delta paper higher, but it ended the day unchanged," the trader added.

Delta shares, meanwhile, closed Thursday down 9 cents, or 2.2%, to $4.01.

"It's totally crazy," said a desk analyst at one of the big convertible sellside shops. "Personally, I don't see how folks, and there are some, can say the converts are worth 30 to 40%, especially if they file [bankruptcy], the stock will go to zip, most likely."

Delta exchange success iffy

Several market sources said they feel like Delta's exchange offer is doomed to fail, mainly because it's too little, too late, although current levels for the bonds seem to suggest a reasonable recovery rate to some onlookers, even if the airline files bankruptcy.

Philip Baggaley, S&P credit analyst, said the Delta exchange offer would only be a net $875 million net debt reduction, which he said would clearly not make much of a dent towards reducing its total debtload of $20 billion.

"We don't like the DAL exchange - it's essentially too little, too late - and the company is going into the winter months when they will suck up a lot of cash," said Michael McNulty, a credit analyst with Context Capital in Connecticut.

"If JetBlue and the other non-union carriers were smart, they would institute a massive fare war right now, making things much worse for DAL and US Air. I would not be surprised to see this happen, by the way. Also, oil looks higher and no matter what DAL does, they cannot operate with the high oil costs. I think it's a goner, as well."

However a fund manager in New York - adding a disclaimer that "we are not distressed experts" - noted that the Delta convertibles have a high delta, making them very sensitive to stock movements, so "you know the convertibles will trade up if anything positive happens, regardless of the 135% premium on the 8s, and the stock could be very volatile.

"Yet, on the downside," in the event of a bankruptcy filing, he added, "surely Delta has some assets, including a brand name that isn't the worst in the airline industry. It may be realistic to expect 30-40 cents on the dollar in a bankruptcy."

Pilot retirements a wildcard

Delta said late Thursday that its managers and pilots will meet again Friday, and likely negotiate through the weekend, to find a way to keep the airline staffed with pilots, as many opt for early retirement. The next round of early retirements hits on Oct. 1

S&P's Baggaley said the possibility of Delta's pilots retiring en masse was the biggest wildcard. He said S&P has not evaluated the exchange or rated the new notes offered but he did mention that unsecured bondholders usually get pennies on the dollar, in the form of equity, in a bankruptcy case, so an exchange could offer a higher recovery rate.

The exchange offer expires Oct. 14, but the more pressing issue of pilot negotiations faces a threat by the union flyers to take early retirement en masse Oct. 1.

Delta CEO Gerald Grinstein had hoped a deal with pilots could be in place by the end of this week, but he backed off that deadline as it proved to be too difficult to arrange on such short notice.

Foster Wheeler hold-outs slim

With the clock ticking toward Foster Wheeler latest, and perhaps last, extension to its debt-for-equity exchange offer, onlookers said it is difficult to find the logic among the two or three convertible preferred holders who are barring the deal's success.

The preferred holders are holding up the exchange. The company suggests it may be forced to file bankruptcy if the exchange fails. But in the event of a bankruptcy, the preferred holders would be the lowest among debtholders involved in the exchange - holders of the Foster Wheeler 6.5% convertible bonds, three series of "Robbins" bonds and an issue of straight notes, nearly all of which have agreed to participate in the exchange.

"They are very close but there are two or three [holders of the restricted convertible preferreds] in a position of blocking the whole thing," said a distressed analyst at a sellside shop.

"It doesn't make sense, it's not logical, as a group for them to veto the thing. But as an individual holder it makes sense, I suppose. It's greed, a game people play in negotiations."

The strategy, he said, is that the preferred holders holding out want other preferred holders to tender their converts instead of them, as they believe the preferreds would trade up once the exchange is done.

Furthermore, he added, Foster Wheeler has no change of getting any other debt exchanged if the convertible preferreds hold out because noteholders would not agree to equitizing their positions, which would subordinate their stake to the preferreds.

A buyside market source said earlier in the week that the preferred holders seem to believe that Foster Wheeler will not file bankruptcy just because of 800,000 shares of the convertible preferreds not getting tendered.

Foster Wheeler on Tuesday again extended the exchange to 5 p.m. ET Friday, saying the 60% participation threshold for the 9% convertible preferreds had still not been met. That threshold also has been reduced several times from the original 85% target. The company also indicated that if the exchange fails, it would likely seek to effect the debt exchanges through bankruptcy court.

Thus far, only 49.3% of the preferreds have been tendered, up from 48.7% at the last report on Sept. 10.

Cheap volatility plays explored

While new issues have been extremely sparse throughout the summer, some convertible players have alternatively been looking for volatility plays although many have been disappointed with the lack of an upswing in volatility thus far as the old VIX market volatility index hovers at lows not seen for some eight and a half years and the VXN Nasdaq volatility index slumping as well.

But as one sellside convert trader noted earlier this week, it's not necessarily a sign that the stock market is feeling bearish. The trader noted an industry report that showed the last time the VIX was as low as it is now, in early 1996, was a very good time to be in stocks. Also, historical data shows that in regard to a contrarian use of the VIX, it is more of a bullish signal when very high but not as much a bearish signal when very low.

The trader offered several ideas in terms of cheap volatility plays within the convertible universe, including as a sample, Nabors Industries Ltd., Priceline.com Inc., Providian Financial Corp. and OSI Pharmaceuticals Inc.

Nabors' implied vol on its converts range from 34.3 to 27.3 versus the one-year average on the stock of 39. Priceline's implied vol is 49 versus a 52 average. Providian's implied vol is 32.3 versus a 33 average. And, OSI Pharma's implied vol is 45.4 to 47.7 versus a 55 average.

Providian issues up modestly

Providian Financial has turned heads among some credit analysts and convertible players, but not all think there is any upside potential left in the name. Still, its convertibles edged higher Thursday.

Kathy Shanley, bond analyst at Gimme Credit, said Thursday that takeover speculation is behind some of the recent rebound in valuation levels for Providian (B2/B) and, with that, suggested there doesn't seem to be much more upside potential.

"Providian had a positive story to tell at this week's Lehman Brothers investor conference, but still faces competitive and perhaps even regulatory challenges," Shanley said in a report Thursday.

Buoyed by the favorable credit loss data, Providian's shares touched a 52-week high on Wednesday and are at the highest level since before its meltdown in 2001. With the improvement in fundamentals, S&P raised its outlook for Providian credit to positive.

Overall, though, Shanley said Providian's bonds don't seem to show much upside opportunity.

"Providian's new management team deserves credit for pulling the company back from the brink of disaster, but further improvements may come more slowly," Shanley said. "We view Providian [bonds] as fully-valued at current levels."

Providian's 2.75% convert due 2016 gained about 0.25 point to 115.25 bid, 115.75 offered and the 4% due 2008 added about 0.5 point to 130 bid, 130.5 offered, while the underlying stock ended up 7 cents, or 0.47%, to $15.12.

Hedge fund returns get better

While nothing to get too excited about, hedge fund returns are getting a little better following a negative trend through most of the summer.

The CSFB/Tremont convertible arbitrage subindex was up 0.28% for August for a year-to-date return of 0.55% and a trailing 12-month return of 6.3%. The CSFB/Tremont overall hedge fund index was up 0.14% for August for a year-to-date return of 2.75% and a trailing 12-month return of 8.97%.

Merrill Lynch's convertible hedge index was up 0.14% net of a 2% annual management and a 20% performance fee during the first week after Labor Day, taking the year-to-date net return to 1.1% before hedging out interest rates.

In subdued post Labor Day markets, Merrill analysts said the major contribution to convert arb returns came from spreads, noting the spread on the Merrill Lynch high yield index contracted from 397 bps to 387.

Merrill Lynch high yield strategists noted the average market spread does a fairly poor job at gauging future average excess total returns, however. Looking at the excess average return history, they said when spreads are narrower than 340 basis points, this usually results in high yield underperformance of Treasuries over the next year and only mild outperformance follows an initial spread in the 350 to 500 bps range.

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