Freeport deal at record premium gets gobbled up; market surprised at activity level

By Ronda Fears

Nashville, Feb. 6 - New issue activity re-ignited the convertible market early Thursday, much to the surprise of many players, with a drive-by deal from Freeport McMoRan Copper & Gold Inc. that fetched a whopping 70% conversion premium with a 7% coupon.

The terms of the offering "dumbfounded" some convertible players, particularly arbs, but Freeport's deal was upsized as outright players flocked to it.

"The record conversion premium is another example of underwriters testing the limits of what people will buy, and it looks like they pulled this off," said Matt Hempel, convertible analyst at Bear Stearns.

"Due to the attractive coupon, the deal still models out better than some other aggressively priced recent deals, such as McData and Micron Technology."

After the close, buzz continued with rumors of an overnighter but no action came to pass.

Rather, Crown Cork & Seal Co. Inc.'s $250 million deal that was slated for next week's business was scrapped, according to a sellside market source.

Crown Cork "seems to be out of the picture," the source said, adding they had heard the aluminum can maker's junk bond deal was upsized to $2.05 billion from $2.75 billion (see the Prospect News High Yield Daily commentary elsewhere in this edition) and the convertible deal was abandoned.

Freeport's deal, an upsized $500 million bond that priced before the market open, got eye-popping terms at a 7% yield, up 70%. It priced at the middle of guidance and was boosted from $350 million.

Wachovia Securities, Inc. analysts put the deal 2.37% cheap with Freeport shares at $18.16, using a credit spread of 725 basis points over Treasuries and 35% volatility in the stock, plus accounting for a 1.98% common dividend yield.

Deutsche Bank Securities Inc. put it 4.5% cheap, using a spread of 600 bps over Libor and 40% volatility.

The Freeport terms match the highest premium convert, Quantum Corp.'s 7% due 2004, which was issued with a 70% conversion premium in August 1997, said Venu Krishna, head of U.S. convertible research at Lehman Brothers.

Freeport's convert closed at par bid, 100.75 asked. The stock fell $1.32 to end at $16.84.

The deal was said to get the most participation from outright accounts.

"The deal looks okay versus the high yield deal they just did," said Yuri Garbuzov, portfolio manager for PIMCO Convertible Fund.

Freeport sold $500 million of seven-year senior notes in late January at par to yield 10.125%.

"The high premium [on the Freeport convert] is explained by a very high coupon for a convertible," Garbuzov said.

"The deal is going well and it's a hot sector."

Outright convertible investors like the downside protection from the high premium. They are willing to give up some upside participation in the stock, primarily in the case of the Freeport deal due to a fat coupon and a hot sector.

While gold futures retreated Thursday after U.S. Secretary of State Colin Powell addressed the United Nations Security Council on Iraq, earlier this week gold hit an eight-year high.

There were some hedge funds playing the Freeport deal, but most said it was not one for the arbs.

"I humbly believe the risk in this deal to arbs is too great. Deals seem to be getting more aggressive as the market trades down. Is there something I do not know?" said Michael Revy, who manages a convertible hedge fund for Froley Revy.

"On a hedge it offers you little protection. It seems to me Freeport wants to hurt the arbs. They issue a bond that cannot be hedged and they raise a dividend. There is no proper hedge on a dicey credit trading at large premium."

After the deal priced, Freeport said it would begin paying a 36c per share annual dividend on its common stock.

While Revy did not participate in the new Freeport, he said he holds Freeport's 8.25% convertible due 2006.

"If you think there is upside in [Freeport shares], then the 8.25s offer better participation as the 7s will eat premium. If you believe there is a lot of downside, the credit here is what I would worry about and here in the 7s you are much more sensitive to investment value than the 8.25s," Revy said.

"The investment value in the 7s is out 5 years longer than the 8.25s. The financing makes the 8.25s a better credit as well. The worries on the 8.25s are that call protection runs out in 19 months and they are at a premium much larger than their expected payout to call date.

"So both look a bit rich to me. However, gold is the new internet. It might be a compelling case for buying commodities."

While the new Freeport bonds hovered at par, most other new paper recently put into circulation was below par and lower on the day.

El Paso Corp. also continued to lose ground, as did American International Group Inc., both still feeling the pain of news from earlier in the week.

El Paso's 0% convert was quoted down 1.5 points to 31.5 bid, 33.5 asked. The stock ended down $1.16 to $5.04.

AIG's 0% convert was quoted off 0.375 points to 64 bid, 64.5 asked. The stock closed $2.62 lower to $48.20.

In fact, most of the secondary market was lower, traders said.

But it was a very busy day on the trading desks.

Some of the more notable movers, to the south, were Agilent Technologies Inc. and Merrill Lynch's floating-rate convertible.

Agilent dropped on a warning that first quarter revenues and EPS would not meet forecasts. The 3% convert (Baa2/BBB-) plunged 6.25 points on the day to 89.75 bid, 90.25 asked while the stock closed down $4.06 to $12.26.

Merrill's floater convert was quoted down 0.25 point to 96.75 bid, 97.25 asked. Merrill shares ended off 62c to $33.76.

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