Level 3 falls outright, better hedged on loss; Xilinx gains on guidance; Freeport-McMoran slips further

By Kenneth Lim

Boston, April 26 - Earnings-related news kept convertible trading robust on Thursday as Level 3 Communications Inc. fell outright but stayed firm on a hedge basis after the company reported a wider quarterly net loss but beat estimates.

Xilinx Inc. also rose outright after the company announced better than expected earnings and guided for a stronger quarter ahead.

Freeport-McMoran Copper & Gold Inc. continued to ease despite reporting a surge in earnings.

Level 3 steady in loss

Level 3's 2.875% convertible due 2010 slipped about 1 point outright on Thursday after the company beat estimates despite a wider first-quarter loss and reaffirmed its guidance for the year.

The convertible traded at 110.25 against a stock price of $6.18 on Thursday. Level 3 stock (Nasdaq: LVLT) fell 7.28% or 45 cents to close at $5.73.

"A bunch of them traded in the afternoon," a sellside convertible trader said. "The stock got hit because of their results, but the bonds are holding up well. They're up slightly dollar neutral."

Level 3 on Thursday reported a net loss of $647 million, or 44 cents per share, for the first quarter. It lost $168 million, or 20 cents per share, in the same period a year ago. The latest loss included a debt restructuring charge of $427 million, or 29 cents per share. But the Broomfield, Colo.-based telecommunications backbone services provider said earnings before interest, tax, depreciation and amortization and adjusted to exclude $24 million in non-cash compensation expense was $170 million, at the high end of its own guidance. Analysts were expecting about $163 million.

Level 3 said it expects second-quarter adjusted EBITDA between $180 million and $200 million and between $860 million and $920 million for the full year. Analysts are projecting about $881 million for the full-year adjusted EBITDA.

"I think the losses that you're seeing come are essentially integration costs because of all the acquisitions that they've been doing," a sellside convertible analyst said. "They said they're ahead of schedule in terms of their integration plans, but some of these costs are probably going to keep appearing into next year. I think this is going to be a concern for the next few quarters and people will be watching closely to see if the integration is really going as well as they're saying."

But the analyst said Level 3's credit profile has improved and could continue to strengthen.

"They're in a good space," the analyst said. "The demand for broadband services is growing very fast and with all the acquisitions that they've made, if they can make it all work together, puts them in a very good position to capture that growth. Their balance sheet also looks better after they restructured their debts, and their interest expense is lower now and debt maturity is longer."

The Level 3 convertibles continue to be worth a look, the analyst said.

"I think the 2.875s are still interesting," the analyst said. "They're trading at a bit of a premium now, but this is a stock that has quite a bit of volatility if you're hedged. If you're outright and you believe in the stock, the upside-downside participation is also decent."

Xilinx gains on guidance

Xilinx's 3.125% convertible due 2037 gained about 2 points outright after the company beat estimates for its fiscal fourth quarter and guided for a better three months ahead.

The convertible changed hands at 111 against a stock price of $30 on Thursday. Xilinx stock (Nasdaq: XLNX) closed at $30.18, up by 3.36% or 98 cents.

Xilinx said late Wednesday that net profit for the fiscal fourth quarter fell 21% to $87.6 million, or 27 cents per share, from $110.7 million, or 32 cents per share, in the year-ago period. Street estimates were for a net profit of about 23 cents per share. Xilinx, a San Jose, Calif.-based maker of programmable logic solutions, also guided for sales growth of 1% to 5% for the fiscal first quarter.

Credit Suisse equity analyst Michael Masdea maintained a neutral rating on the stock but raised his target stock price of $29 from $25. Masdea noted that a slowdown in the programmable logic devices segment has been taking a toll on at Xilinx and Xilinx rival Altera Corp.

"Xilinx is seeking returns through cost cutting cost cutting and buybacks/dividends," Masdea wrote in a note. "As growth is slowing for Xilinx and Altera in their core markets, we see the dynamic of focusing on line items outside of revenues continuing until PLDs can gain traction in high volume applications outside of communications."

Masdea said the weak long-term picture offset hopes of shorter-term improvements.

"With more rational spending, we are increasingly optimistic on a potential short-term, demand recovery trade for the PLD sector," Masdea wrote. "However, longer-term we maintain our neutral view as new growth opportunities are overshadowed by slowing growth possibilities in the core end-markets."

A convertible analyst said Xilinx could be an interesting outright play.

"Guys who are optimistic about this are also looking at Altera, which also reported growth and guided for a better second quarter," the analyst said. "So if the two competitors are upbeat about the next three months, that's an indication that the sector is doing well."

Freeport-McMoran settles back

Freeport-McMoran's recently priced 6.75% mandatory convertible preferred stock came down about a point outright to 111 against a stock price of $70, continuing to be dragged by a weak stock.

Freeport-McMoran stock (NYSE: FCX) declined 2.2% or $1.54 to close at $68.46.

"I saw a few of them trading," a sellside convertible trader said. "They look like they came down in line dollar-neutral."

Freeport-McMoran stock eased on Wednesday and Thursday after the New Orleans-based copper and gold mining company reported first-quarter net income of $476.2 million, or $2.02 per share, from the year-ago profit of $251.7 million, or $1.23 per share.

A buyside convertible analyst said the convertible, which has an upper conversion price of $73.50, remains interesting because of a volatile stock.

"The way the stock has been moving, it won't take a lot to push this convert in the money," the analyst said. "Barring concerns about the Phelps Dodge acquisition, this company continues to have a pretty solid story."

Credit Suisse equity analyst David Gagliano maintained his outperform rating on the common stock, citing a view that the stock remains undervalued in the current copper price environment.

"Even if copper prices decline 36% to our current 2008 assumption of $2.30/lb, FCX shares are currently trading at 6.0x our 2008 EBITDA estimate and a FCF yield of 8.1%," Gagliano wrote in a note. "In our view these are low multiples for the largest copper producer globally, the last remaining large-cap U.S. domiciled copper producer, and a company that we believe also has an attractive organic growth profile in the coming three years."

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