Four Seasons goes to 102; 3 new deals emerge; Red Hat crushed on CFO's resignation

By Ronda Fears

Nashville, June 15 - A better tone pervaded the convertible market Tuesday as Federal Reserve chairman Alan Greenspan's testimony suggested that with tame inflation data the interest rate hike will be more gradual than the market had come to fear. That was enough to nudge three deals out of the shadows, on heels of a new Four Seasons Hotels Inc. deal that was upsized.

Greenspan's remarks, however, sparked heavy buying in Treasuries and that knocked yields lower, so players who were hedged for higher interest rate contingencies got stung. A sharp dip in volatility compounded the pain, and many expressed concern about vol in the coming summer.

The Greenspan headlines were good for bringing some new paper to the table, though, as one fund manager noted, "it's back to a rising rate playbook."

Before the market opened, Charles River Associates Inc. returned to tap convertible investors for $75 million with a deal launched early for a full day of marketing. After the close, Kellwood Co. and Advanced Medical Optics Inc. tossed two more deals into the ring for a total of $455 million.

Meanwhile, Canadian hotel chain Four Seasons sold an upsized $220 million deal at the middle of price talk, and buyside traders said it was rather quiet, hanging around the par mark for most of the day. The paper, however, ended the session 2 points higher.

Red Hat loses 7 points

In the trading trenches, with many players anxious about volatility, traders said convertibles were exhibiting a better tone and a few bids were seen, but there were some stand-out declines like Red Hat Inc.

"The market looks a little stronger today along with the bond market, but I'm not sure if there's real buy interest or just short covering," said a buyside trader at a large hedge fund based in New York. "I'm not convinced we're out of the woods yet and expect a fairly soft summer in the weeks ahead."

Red Hat plunged about 7 points on the resignation of its chief financial officer, although the company on Tuesday said it expects to report better fiscal first quarter results than projected. The 0.5% convertibles were quoted at 110.5 bid, 111 offered, while the stock fell $2.24, or 9.22%, to $22.06 on very heavy volume.

The Raleigh, N.C.-based software firm is due to report earnings Thursday and said it sees net income of more than $10 million for fiscal first quarter, up from a profit of $1.5 million a year ago and better than analysts predict.

On the plus side of the ledger, Yellow Roadway Corp. bonds were "significantly better" by about 1 point on a dollar neutral hedge as the company painted a brighter outlook for second quarter results. The Miami-based trucking firm said late Monday that it now expected second quarter profit of 85 to 90 cents a share, up from an earlier forecast of 70 to 75 cents a share.

Also mentioned was Newell Rubbermaid Inc., with the convertibles picking up about a half point on some tightening in the credit.

Summer session scary, tricky

It is typical for volatility to tank in the summer, but starting at such a low point - again - is making lots of players ever more anxious, fearing the pain could be more intense. The Nasdaq market volatility index on Tuesday dropped more than 6% to 20.88.

Most convertible analysts are not telling players to look for any significant uptick in volatility, but higher interest rates would help give it a boost. It also can be a double-edged sword for those hedging rate exposure, however.

"True, about [sluggish volatility] summer in general," said a fund manager in New York with a multi-strategy focus. "But, I think this time around, people remember last summer, and it's been depressed for so long now, there seems little likelihood on a rebound for quite some time.

"Actually, I'm not seeing it in prices yet, but the fear is there, I believe."

It is especially hard right now, he said, to find quantitative plays. He is tackling the market, "mostly playing defense," or taking a view on some out-of-favor paper.

Higher interest rates will help volatility, but another convertible arbitrage fund manager said when rates go up too fast or Treasury yields collapse suddenly then a hedged position becomes moot or, if overshot, is counterproductive.

For instance, on Tuesday convert arbs hedged with interest rate swaps or bond futures didn't make money because rates spiraled on the buying frenzy in Treasuries. But as one manager put it: "At least in this way, one is insulated from interest rate increases."

Deals surface to beat rate hike

Advanced Medical Optics was pitching $275 million of 20-year convertible notes talked to yield 2.5% to 3.0% with a 40% to 45% initial conversion premium for pricing after the market close Wednesday, and market sources pointed out that the issue includes cash takeover protection for holders.

The takeover protection directly relates to the market turmoil since Mandalay Resort Group became the target of an all-cash takeover by MGM Mirage, which slaughtered holders that had the issue set up on a hedge.

Apparel maker Kellwood also tossed a deal into the market after the close Tuesday. The $180 million of 30-year convertible notes are talked to yield 3.125% to 3.625% with a 30% to 35% initial conversion premium.

Charles River had launched a one-day marketing effort early Tuesday for $75 million of 30-year convertible notes talked to yield 2.25% to 2.75% with a 20% to 25% initial conversion premium, with up to $20 million of proceeds earmarked to buy back stock from note purchasers.

None of those were seen in the gray market, but buyside traders said that is not so unusual these days as players are more squeamish about buying in the when-issued market right now.

Four Seasons slightly ups deal

The new Four Seasons Hotels issue wasn't seen much either, buyside traders said, after it broke for trading early Tuesday. The Vancouver-based hotel chain boosted its deal to $220 million from $200 million and printed the 20-year convertible with a 1.875% coupon and 30% initial conversion premium.

It also has special takeover protection for holders, which was a magnet for buyers.

The deal priced at the middle of guidance for a 1.625% to 2.125% coupon and 28% to 32% initial conversion premium. At that precise point, one sellside analyst put the issue 1.3% cheap, using a credit spread of 150 basis points over Treasuries and a 25% stock volatility.

Bookrunner Morgan Stanley & Co. Inc. bedded the new Four Seasons convertible at the close Tuesday at 101.5 bid, 102.5 offered while the underlying stock ended up $1.46, or 2.65%, to $56.57.

"In some rising rate environments, hotels and restaurants, leisure do well," said a convertible fund manager on the West Coast. "You also have some improvement in travel, so Four Seasons looks okay.

"It also has takeover as well as dividend protection language, so there's no all-cash Kerkorian buyout worries," he added, referring to the biggest MGM stockholder, billionaire Kirk Kerkorian, who led the $6.4 billion buyout of Mirage in 2000.

There is a premium make-whole provision in the new Four Seasons convertible in the event of a "fundamental change."

The Four Seasons 0% convertible due 2029 (BB+/Ba1) - a $650 million face amount issue callable and putable in September at 32.873 - dropped back to the put/call price Monday from a closing level Thursday at 34 bid, 34.5 offered with Four Seasons shares at $58.20.

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