Airborne soars amid sea of sinking prices on protracted war buzz; HealthSouth trades in teens

By Ronda Fears

Nashville, March 24 - After a weekend of war news, including U.S. casualties and troops taken prisoner by Iraq, the markets reversed the line of thinking that the conflict would be short lived and stocks plunged in a flight to safety in bonds.

Mandalay Resort Group, Alaska Air Group Inc., Carnival Corp. and Continental Airlines Inc. all reversed course, heading south.

Hotels and retail names followed suit.

Starwood Hotels & Resorts Worldwide Inc. withdrew its operating estimates for 2003, and a Standard & Poor's report on the negative impact of the war on the lodging industry hurt that group.

Toys 'R' Us Inc. getting cut to junk by Fitch Ratings and J.C. Penney Co.'s warning that March sales are below its expectations weighed on the lot of retail issues.

Airborne Inc. was a bright spot as convertible investors received positively news that it is in talks to sell its ground operations to a Deutsche Post AG unit.

As stocks plummeted more than 3.5% on the day, convertible traders said moods were somber and trading was muted, although hedged accounts were feeling pressure on their returns ease somewhat.

"Moods were kind of weird again, like we woke up all over again to being in a war, like a déjà vu from last Wednesday," said a convertible dealer.

"Of course the arbs are loving a day like this. They were needing some relief."

HealthSouth Corp. was not the focal point on convertible desks, although plenty of folks were still talking about the situation and watching levels for the converts.

Most of the HealthSouth paper, including the 3.25% convertibles that mature April 1, are trading from distressed desks.

The HealthSouth converts were seen trading in the mid-teens Monday, but closed at 19 bid, 19.5 asked, traders said.

"They (HealthSouth converts) were down about 4 to 4½ points from Friday and we were hearing that there are still buyers - mostly lawyers, firms that specialize in bankruptcy," said a convertible trader at one of the big firms.

"We even heard that the HRC 7 5/8s were higher, in the mid-40s."

Distressed traders confirmed that HealthSouth's straight 7 5/8% bonds had been higher but gave up the ground and more after independent director Betsy Atkins resigned.

Most convertible accounts have sold out, the convert trader said.

Indeed, Stuart Novick, convertible analyst at Salomon Smith Barney, said most convertible investors would not want to wait out a bankruptcy case, if it comes to that.

"Personally, I don't have the stomach for that game," Novick said.

Neither do most convertible investors, like one who said Monday that he unloaded his position on Friday in 20s.

"It makes me sick, you've seen the reports that show there's a potential that these converts are absolutely worthless, going to zero, if there's a bankruptcy," the fund manager said.

"So, 23 is better that zero. There are a few hedge funds, I'm hearing, that invest in this kind of situation, the type that buy these so-called toxic converts. More power to 'em."

While it is generally considered that the HealthSouth financials are of no value it trying to assess the situation, because of the massive fraud charges, there are some hard assets.

"It's just a mess. We can't rely on anything that's out there," in terms of past financial records, said Andrew Hayward, healthcare analyst at Wells Fargo Ragen MacKenzie.

"We do know that HealthSouth has been making payroll, so they have had some cash or access to cash in the past.

As for assets, he said HealthSouth has four different centers - inpatient rehabilitation, surgery, diagnostics and outpatient rehabilitation.

"I am told or am of the understanding that the surgery units may be a good business, that it can be a good business," Hayward said.

"It's an asset that may be worth something. As for how much, we don't know."

Obviously, the markets do not believe there is enough to cover all the creditors, and skepticism is deeper with regard to the convertibles since HealthSouth's banks have frozen its revolver.

It has also increased the scrutiny of convertible holders to the risk of holding short-term paper.

Over the past year or so, convertible holders have become more leery about short-dated puts and recently that expanded to near-term call dates. Now, it's the actual maturity date, as well.

"People are going to actually take a harder look at the really, really short-term paper," Novick said.

Some of it trades up to par or near par with people buying who figure maybe they don't really like the name, because of fundamentals or the credit profile, but it's about to mature and they get paid, he said.

"Then something like HealthSouth happens. It makes people think twice about that," Novick said.

"Because this could be a total wipeout, going from par to zero."

Uncertainty also surrounded Airborne but the market took a positive stance on its news.

Airborne and German postal operator Deutsche Post confirmed they are in negotiations involving the ground operations but have not confirmed any of the speculation about the value of the deal.

Market buzz based on reports from Dow Jones and Reuters put it as high as $1.1 billion in cash.

Standard & Poor's said the sale price implied a total consideration of $800 million. The rating agency placed the ratings of Airborne and unit Airborne Express Inc. on positive watch due to the development.

As part of the transaction, Airborne's air operations would become an independent public company that would continue to be wholly owned by Airborne's current shareholders.

But the fate of the 5.75% convertible due 2007 (Ba3/BBB-) - as to which entity would be the guarantor, or whether it would be transformed into a straight piece of debt - was unknown.

"There was a lot of trading in that name [Airborne] but no one knows what going to happen," Novick said.

"Is the guarantor going to be ABF or Deutsche Post? What would the underlying credit be? Will it still be a convertible, into a new ABF that is only the air operations? If it goes to a straight bond, the spreads will narrow but you lose all the optionality. The market right now is devoid of any details."

Airborne's 5.75% converts were quoted up about 3 points to 112.875 bid, 113.375 asked at a couple of major desks. Another, however, quoted the issue at 116 bid,116.75 asked. The stock closed up $1.36 or 8.15% to $18.05.

Most of the convertible universe was softer, though traders said the drastic drop in stocks was mitigated by tighter credit spreads.

Starwood pulled back, along with other lodging names, as the war is expected to have a negative impact on their business.

S&P analysts said in a report Monday that "travel and leisure industry performance will clearly decline in the weeks to come" due to the heightened U.S. security alert and the start of the war in Iraq, which gave rise to worries about retaliatory attacks on the U.S.

"However, the magnitude of the decline in U.S. lodging demand remains in question," S&P analysts said.

"The longer the war drags on, the greater the likelihood that there could be additional ratings and outlook changes. However, a short war and a short period of decline in travel would not be significant to most ratings."

Presently, S&P has four investment-grade lodging companies on negative watch or with a negative outlook. Those are Marriott International (BBB+/A-2), Hilton Hotels Corp. (BBB-/A-3), Starwood Hotels & Resorts Worldwide Inc. (BBB-) and Four Seasons Hotels Inc. (BBB-).

All of those are convertible issuers. And all those showed weakness Monday.

Starwood's 0% convertible due 2021 dropped 0.75 point to 54 bid, 54.5 asked while the stock closed down $2.69, or 10%, to $24.11.

Hilton's 5% convertible due 2006 fell 1.125 points to 97.125 bid, 98.125 asked with the stock down $1.29, or 9.8%, to $11.64.

Retail names also were finding better sellers.

A combination of the Toys 'R' Us downgrade and J.C. Penney's warning "put the kibosh on the entire retail group," said one dealer.

J.C. Penney said March sales thus far are tracking below its expectations, and the trader said most of the market "figures things are bed for everyone, with the war, the economy, etcetera."

The J.C. Penney 5% convertible due 2008 was quoted down 2.5 to 3 points at 103.5 bid, 104 asked. The stock closed down $1.18, or 5.5%, to $20.17.

Toys 'R' Us saw a huge exodus, as issues commonly due when downgraded to junk status, traders said, even though the convertibles were likely not affected by the rating. Still, one dealer said because some funds are prohibited from holding issues that are below investment grade, "they didn't want to be holding even a mandatory that was linked to a junk name."

The 6.25% mandatory was quoted by a dealer down 1.25 points to 30.875 bid, 31 asked. The issue closed on the NYSE down 1.21 points, or 3.78%, to 30.8. The common stock ended down 69c, or 7.4%, to $8.63.

One trader also noted that some convertible holders were nervous about the company filing an $800 million debt shelf on Monday, too.

Fitch lowered Toys 'R' Us Inc. senior notes to BB+ from BBB-, citing soft operating results that have weakened bondholder protection, along with growing competitive pressure from Wal-Mart and Target.

Traders also noted that many healthcare, biotech and pharmaceutical names were sharply lower.

Convertibles linked to metals concerns like Freeport McMoRan Copper & Gold and Inco Ltd. also were lower.

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