Peabody, Freeport-McMoran gain dollar-neutral on volatility; Spansion slips on outlook; Best Buy gains

By Kenneth Lim

Boston, Jan. 5 - Convertible bond players sought out volatility plays on Friday, as equity markets took a downturn amid lowered expectations of interest rate cuts.

Commodity names like Peabody Energy Corp. and Freeport-McMoran Copper & Gold Inc. were seen to improve slightly on a dollar-neutral basis amid the higher volatility.

Spansion Inc. was lower outright in line with its stock after cutting its fourth-quarter sales forecast.

Meanwhile, Best Buy Co. Inc.'s 2.25% convertible due 2022 gained 1.5 points outright after the company reported strong December sales. The convertible traded at 113.5 against a stock price of $50.75. Best Buy stock (NYSE: BBY) increased 0.32% or 16 cents to close at $50.

"Their stock was up," a sellside convertible bond trader said. "They had good numbers for December. The convertibles are in the money, so you're just going to see them move with the stock."

Best Buy said same-store sales rose 7% in December, better than the 5% expected by analysts. Overall sales for the month reached $6.6 billion, about 15% better year-on-year. Minneapolis-based Best Buy is an electronics retailer.

Volatility prompts activity

The convertible bond market in general was active for a Friday, as falling stock prices provided gave volatility shoppers something to look out for.

"Some vol names were better to buy today," a buyside convertible bond trader said. "We're seeing better vega names. It's fairly active trading-wise."

The Dow Jones industrial average dropped more than 100 points early Friday, and finished at 12,398.01, down by 82.68 points or 0.66%, while the S&P 500 declined 8.63 or 0.61% to 1,409.71. Underlying the retreat was non-farm payrolls data that showed improvements in new jobs and wages and a steady, low unemployment rate, fueling concerns that the U.S. Federal Reserve may not cut interest rates soon and may even raise them.

But a convertible fund manager said the news may not have been that significant.

"Right now the news may create volatility, which is good for convertibles," the fund manager said. "But there isn't really a big change in terms of interest rates. I don't think you're going to see the Federal Reserve raise interest rates, and if anything they're probably going to hold rates steady for a while more. Nothing's different if the interest rates remain the same."

Commodity names gain

Peabody's 4.75% convertible due 2066 gained 1.5 points outright on Friday, buoyed by the common stock's modest gains coming off a poor week.

The convertible traded at 93.125 versus a stock price of $37.25. Peabody stock (NYSE: BTU), which ended the year at about $40.41, closed at $37.22 on Friday, a gain of 1.97% or 72 cents.

Peabody's stock has taken a beating over the past month as unusually warm weather in December resulted in softer prices in energy prices. St. Louis-based Peabody is a coal company that supplies the fuel to power plants around the world.

"We did a lot of BTU," a sellside convertible bond strategist said. "It seemed like those improved pretty well here. I was recommending them all week. I think people were recognizing the volatility attribute of the bond, even though they didn't really like the structure initially. But when you count it against the other perpetual preferreds out there, it's still cheap volatility."

Meanwhile, Freeport-McMoran's 5.5% convertible preferred fell slightly midday as soft metal prices depressed the stock.

The convertible, which has a $1,000 par, traded at 1,225 against a stock price of $51. Freeport-McMoran stock (NYSE: FCX) closed at $51.48, up by 1.02% or 52 cents.

Freeport-McMoran, a New Orleans-based copper and gold mining company, saw its common stock fall earlier in the day as metal prices fell amid strong economic data that boosted the dollar. February gold contracts fell $19.03 per troy ounce to $606.90 on the New York Mercantile Exchange, while March copper slipped 6.7 cents per pound to $2.535.

The sellside strategist noted that in general commodity names were somewhat improved on a dollar-neutral basis across the board on Friday.

"In general, the last couple of days, even with all the energy and energy-related names moving, most were kind of in line," the strategist said. "People expected that with the commodities kind of crashing, some of the names on swap would improve, but for the most part most of them were in line until today. Probably the bulk of them improved slightly dollar neutral."

The strategist added that not all the improvements could have been from hedged plays.

"It could be also that there are more outright buyers, guys trying to whack it when the stocks are low," the strategist said.

Spansion falls with outlook

Spansion's 2.25% convertible due 2016 fell about 2 points outright on Friday, dragged by its stock after the company lowered its fourth-quarter sales forecast.

The convertible changed hands at 101 against a stock price of $13.80. Spansion stock (Nasdaq: SPSN) closed at $14.12, down by 2.75% or 40 cents.

"They did trade a little in the morning," a sellside convertible trader said. "They were down with the stock."

Spansion on Friday said it expects net sales of $680 million to $690 million in the fourth quarter, lower than the $710 million to $740 million that it initially forecast. Spansion also does not expect to break even in the quarter.

The Sunnyvale, Calif.-based maker of flash memory products said the shortfall was due to a delay in customer demand for some flash memory devices. But Spansion expects those devices to be sold in the first quarter of 2007.

"It's obviously not good," a sellside convertible bond analyst said. "The stock's down."

But the analyst said the equity market may have overreacted a little.

"They said they expect to sell those devices in the first quarter, so it looks like it may be just delayed revenue, and there's a chance it's not a widespread problem," the analyst said. "There's still a bit of concern about how long it will take Spansion to turn profitable, and whether they'll be able to stay competitive in the product sector, but these aren't new concerns, and they've mostly been priced into the stock and the credit."

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