Merrill analysts say zeroes with short puts offer insurance, high yields

By Ronda Fears

Nashville, Tenn., Oct. 10 - As the Nov. 15 put date draws nigh for the Tyco International zero-coupon convertible due 2020 - the first of what's become a long line of convertibles with short puts - and market volatility continues, investors have become keenly focused on short-term paper. Short-dated puts are typically viewed as an insurance policy. Now, in many cases, the short paper offers a means to accelerate an opportunity to capture yield and hedge undervalued stock options.

"Imminent puts represent a catalyst for investors to capture either an attractive static yield or isolate an under-priced option through an arbitrage trade," said Merrill Lynch convertible analyst Anne Elliott in a special report Wednesday. "From an arbitrage perspective we are attracted to issues with strong credit quality and respectable levels of equity sensitivity."

Issues on the Merrill pick list for arbitrage include Cox Enterprises' 2% convertible, Omnicom's zero-coupon convert and Masco's zero-coupon convert. All offer solid downside support and sufficient valuation discounts to augment returns as the approaching puts push the bonds closer to fair value, Elliott said.

Market volatility has created another arbitrage opportunity among the asset manager group with converts. The Merrill order of preference among the group, all of which have zero-coupon convertibles in play, is Legg Mason, Eaton Vance, Franklin Resources and Neuberger Berman.

"From a static yield perspective, we are attracted to issues trading at a discount to investment value, offering either cash alternative opportunities or simply good outright credit plays," Elliott said. Merrill's yield picks, all of them carrying zero coupons, include Starwood, Calpine and Cendant The report suggested monitoring the Marriott zero-coupon convertible, which could become attractive at lower levels.

The report identifies 36 issues putable in the next 24 months, totaling some $21.6 billion. Tyco's issue, which priced in 2000, opened a floodgate of convertibles issues - most with zero coupons - with short dated puts. End

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