By Ronda Fears
Nashville, March 13 - The recent spate of upside surprises in incentives offered by issuers of convertibles facing impending puts has caused a number of putable converts to trade up in anticipation of such incentives.
But some, like the Franklin 0% convertible due 2031, have little to no additional value left at current prices, according to Lehman Brothers head of convertible research Venu Krishna. Thus, he recommended in a report Thursday to sell into the strength.
"We suspect the market has bid up the value of BEN 0s way too much," Krishna said in the report.
"At current trading levels [60.13], there appears to be minimal additional value left should an incentive offer come through."
Given that Franklin's stock is currently at $30.40, there appears to be a relatively high probability of the put being exercised. But since the convert has contingent conversion and contingent payment that provide earnings per share and tax benefits to the issuer, the company will likely weigh the option to keep it outstanding.
There could even be a negative backlash to holders, however, due to the issue getting bid up in anticipation of a sweetener, the analyst said.
"In fact, ... should an incentive be offered with less than a 0.5 point cushion, or if the stock should rise slightly, even to the $32 level, negative incremental value could result (i.e. the convert holders are likely to experience a value leak)."
A low volatility stock and negative carry resulting from the common dividend yield of 0.99% add to the valuation risk in the security, he added.
"Accordingly, we recommend holders of the BEN 0s sell into the current strength," Krishna said.
"It is worth noting, that even if an incentive comes through, once the record date for the incremental payment passes, the convert is likely to promptly drop in value close to its intrinsic value.
"We do note that the higher the 'point cushion' the issuer builds into an incentive, the more will be the incremental value created. However, as our numbers show, the 'point cushion' will have to be meaningfully higher than 0.5 for one to extract value, the likelihood of which is limited as per our assessment."
Franklin 0% convertible due 2031
| Price: | 60.13
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| Common price: | $30.40
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| Conversion premium: | 111.3%
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| Fair value: | 59
|
| Volatility input: | 25%
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| Credit spread: | 100 bps over Treasuries
|
| Put: | May 11, 2003, at 59.301
|
| Yield to put: | -9.14%
|
| Ratings: | A2/A
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