Trading lulls on impending war hype, but players search for short-end opportunities

By Ronda Fears

Nashville, March 12 - Widely held views of an impending war made for a dull trading day, with many convertible players sitting on the sidelines.

Arris Group Inc. priced its $100 million deal aggressively outside the premium range, but the small size meant the offering did not draw a lot of attention.

It last traded at 2.25 points over par in the gray market and closed with a bid of 2 points over par. Arris shares closed down 99c, or 22%, to $3.50.

With the market anticipating the looming war will incite issuers to bring deals sooner rather than later, there was some buzz circulating about the next offering.

Hanover Compressor Co.'s was one of the names that popped up.

"Certainly, that's a name we've heard tossed about, but I've not heard anything on it today," said Jeremy Howard, head of U.S. convertible research at Deutsche Bank Securities.

With the stock down something like 20% over the past four sessions, he said, the market could be looking at the stock chart and thinking there must be a convert in the works, or there's a convert in the works and the chart is reflecting short selling.

Regardless, nothing came of the speculation.

While traders described convertible activity Wednesday as choppy with trends "dictated by the war - gold, oil, defense," there is some positioning taking place, however, albeit perhaps on a small scale and in tiny increments.

Convertible managers are challenged to find the best seat in the market to safely watch the war play out, as well as find opportunity vis-à-vis the stock market's relationship with the economy.

"We believe that is happening is a re-coupling of the stock market with the economy. In the 1990s, it de-coupled," said Tom Dinsmore or Davis-Dinsmore Management Co.

"The economy is actually stronger than it should be, so that's hopeful."

The economy is a wildcard, but the volatile market swings are driven more by the war near-term.

Dinsmore said his strategy right now is to focus on the short end of the market with a barbell of convertible bonds that have big premiums with decent yield and those with low premiums but low volatility.

"The uncertainty in the stock market is probably creating some bargains. We are looking for those," Dinsmore said.

"The war has created some winners and losers. The airlines are the obvious losers. Defense is a winner, although the market isn't acting like it lately."

He said he is not currently holding any foreign convertibles, after recently exiting a Telecom Italia SpA position. It was a company-specific move, he said, rather than one politically motivated.

Moreover, like many onlookers inside and out of the financial community, he is looking for more direct action with regard to the war.

"The market is clearly saying get this over with - get it done or stop it," Dinsmore said.

Reports that Pakistan would vote for the U.S.-U.K. led resolution against Iraq at the U.N. along with the organization's imminent vote on the matter sparked renewed thoughts that the beginning of the war was at hand.

A bomb threat at a Washington, D.C., building close to the U.S. Treasury also rattled the markets.

Stocks were sharply lower until around midday when buyers stepped in and the major indexes closed in positive territory.

Still, traders said several of the more liquid convertible names were mostly lower.

"It was a flip-flop day," one dealer said. "We [convertibles] were all over the map."

Gold stocks were higher while gold ended lower although it was higher for a good portion of the morning. Oil and drilling names were reacting to downgrades in the stocks, as oil futures were higher and a government report showed inventories were lower.

Freeport McMoRan Copper & Gold's new 7% convertible due 2011 was up about 0.5 point to 102.125 bid, 102.625 asked. Freeport shares closed up 13c to $16.31.

Other metals were lower after Steel Dynamics Inc. warned first quarter earnings would be well below analysts' expectations, cutting its own outlook by 27%.

The Steel Dynamics 4% due 2012 (B3/B) lost about 3 points to 93 bid, 94 asked. The stock closed down $1.20 to $10.50.

The new convertibles of U.S. Steel and Inco also both lost ground.

Defense names like Northrop Grumman Corp. were also lower.

Northrop's mandatory closed off 0.26 point to 93.25 while the stock closed up 71c to $79.21. One dealer pointed out that the convert was down by as much as 0.625 point earlier in the day.

Oil names like Pride International, Anadarko Petroleum, Devon Energy and Chesapeake Energy were all lower.

Chesapeake's new perpetual convertible preferred was quoted down 0.25 point to 52.125 bid, 52.625 asked. The stock closed off 31c to $7.69.

Airline names in the convertible universe tapered off after a bad day Tuesday, however.

The war is compounding the airline industry's struggle that began with the Sept. 11, 2001, terrorist attack on the U.S., in addition to the prolonged economic downturn.

Continental Airlines Inc.'s convertible bonds, which are not typically very liquid, were heavily traded Tuesday as "people are ready to sell," said Jeff Seidel, head of U.S. convertible research at Credit Suisse First Boston.

The Continental convertible trust preferred crashed last Thursday, a trader said.

The Continental 4.5% bonds were quoted Wednesday at 34.75 bid, 38.75 asked. The 6% trust preferred was at 10 bid, 11 asked. The common closed up 49c to $4.72.

Interpublic Group of Cos. Inc.'s new convert continued to get some play, still heading north, and traders said some selling in Omnicom Inc. converts to buy the new IPG was taking place.

The Interpublic 4.5% convert added another 3 points to 110 bid, 110.625 asked. The stock closed up 39c to $8.40.

Arris Group priced its deal with a 4.5% coupon and 41.6% initial conversion premium - at the rich end of yield talk and beyond premium guidance. Price talk had put the yield at 4.25% to 4.75% with a 25% to 30% initial conversion premium.

Wachovia Securities convertible analyst Kimberlee Brody put it 1.76% cheap at the midpoint of guidance, with the common at Tuesday's close of $4.49, using a credit spread of 1,500 basis points over Treasuries and a 55% stock volatility.

At the final terms, Brody put the deal 4.67% rich.

Merrill Lynch convertible analyst Tatyana Hube put it 8.9% cheap at the midpoint of guidance, with the common at Wednesday's open of $3.66, using a spread of 1,140 bps over Treasuries and 60% volatility.

"While pricing seems quite cheap, the virtually non-existent borrow on the common makes this deal unattractive for hedge funds, and the small size of the deal raises concerns about its secondary market liquidity for outright investors," Hube said in a new issue report Wednesday.

"Therefore, we expect that the new bond will trade well below its theoretical value, and we anticipate that there should be no significant tightening in the proposed terms."

Bear Stearns convertible analysts put the deal 7% cheap, using a spread of 900 bps over Treasuries and 45% volatility.

"This deal has attractive terms for hedge as well as outright accounts," the Bear analysts said in a new issue report Wednesday, also noting the company recently turned the corner to become cash flow positive.

"The high degree of cheapness is due to the fact that the deal is probably marketed toward outright accounts more than the average deal because of the borrow issues on the common."

Deutsche Bank Securities analysts put it about 10% cheap at the midpoint of guidance, with the common at Tuesday's close of $4.49, using a spread of 850 bps over Libor and 60% volatility.

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