Wells Fargo, Disney open below par; Photronics new deal soars 4 points in gray

By Ronda Fears

Nashville, April 9 - It was another moderately quiet trading day, except for the new paper in play, as Wednesday got off to a slow start with many players enrapt by the television footage of Iraqi citizens tearing down icons of Saddam Hussein in central Baghdad while U.S. military forces rolled into the heart of the capital city.

"There wasn't much going on outside of the new deals," said Rao Aisola, head of convertible research at Bear Stearns & Co.

Both jumbo deals of Wells Fargo & Co. and The Walt Disney Co. opened under par Wednesday, traders said.

While there has been a healthy amount of new paper already in play this week, more than $4 billion, buyside sources estimate upward of $30 billion in new paper is needed to quench demand enough to steal pricing power away from issuers.

"There will have to be at least 10 deals the size of Wells Fargo ($3 billion) to sop up enough demand for us to get any decent terms," said John Siebel, head of trading at Silverado Capital Management.

"Meanwhile, we're at the mercy of the bankers and the issuers and the people who are chasing the new deals."

Wells Fargo sold $3 billion of 30-year convertible floaters at par to yield 3-month Libor minus 25 basis points with a new record conversion premium of 110.75%.

That came on the heels of Disney's upsized $1.15 billion of 2.125% converts with a 72% initial conversion premium.

"Could they try any harder to make these not be a convertible?" posed a source at a big outright fund in Boston.

"They have these huge premiums to begin with and then a CoCo and now are adding call spreads or warrant kickers. Whatever you call it they aren't convertibles because they are designed to ensure the issuer that they will never be converted."

In particular the Wells Fargo deal was deemed onerous to convertible investors.

The issue provides for a conversion ratio adjustment if the stock at conversion is between $100 and $150 that adds up to 33.5 calls struck at $100 plus the 10 shares per bond, but caps the conversion ratio at 21.0748.

If after five years, Wells Fargo shares remain below $100, the bonds may be remarketed as zero-coupon straight debt.

"At least they put in a provision to one day (in five years) just make it a straight bond and not even pretend it's a convertible," the outright fund source said.

Many hedge fund managers are no more pleased with the deals.

"Given the large premium at issue it seems [Disney] thinks they can pay off this in cash one day," said Michael Revy, who co-manages a hedge fund for Froley Revy.

Yet, he added that while Disney has been adding debt for the past five years, cash flow has been weakening and revenue growth has failed to materialize.

With Disney paying a roughly 1.2% dividend on the common stock, another hedge fund manager in New York said there was not enough income to lure him into the convert.

"I ran the numbers through but it wasn't even worth it," he said.

"Even as investment-grade paper, it's a push."

Thus, while capital markets sources insist new deals of late have been oversubscribed by several multiples, players appear to be manic-depressive when it comes to the new paper, as they have traded below par right out of the gate.

Wells Fargo's deal opened at 98.25 bid, 99 offered, traders said. It recovered to close at 99 bid, 99.25 offered. The underlying stock ended down $1.07, or 2.26%, to $46.38.

Disney's deal opened at 99.625 bid, 100 offered but came back to close at 100.125 bid, 100.25 offered. The stock ended off 3c, or 0.18%, to $17.10.

"I don't' think that these recent issues are good for convert investor in the long run," said Anu Sahai, a convertible portfolio manager at ING Funds.

"But from a company's point of view, why wouldn't I come to a desperate market that is willing to let me price something at 0% coupon and 100% premium. I'm getting free money! I think the investor base has to come together and say we won't accept deals at these terms.

"The positive side to the new issue market is that it helps replace the faster pace of issue redemptions hat we have seen recently, and thus helps maintain, if not continue to grow, the convertible market."

To be certain, there are critics of the deals on the sellside as well.

"Now convertibles are truly becoming a Mickey Mouse business, with Disney coming to our market with a $1 billion deal. It must truly be a market top, but I guess that when a market will offer you, the issuer, a 2.125% coupon (uh, that is Treasuries less 228 bps for all you fixed income junkies out there)...Of course, there is no free lunch, so the company has agreed to sell you stock at $29.46 per share - a level not seen since June 27, 2001. It seems fair...NOT," said Steve Jones, head of U.S. convertible research at Wachovia Securities, in a report Wednesday.

"Oh, and right after that beauty was digested (or not as we may see this morning), Wells Fargo decided it was a prime time for a large, diversified financial service company to plug our market with a structure that appears designed to impress either a blind date or one of the underwriters' mommies because it certainly does not provide a lot of value to convertible investors."

Wachovia Securities convertible analyst Kimberlee Brody put the Wells Fargo deal 2.43% rich, at the final terms, using a credit spread of 175 basis points over Treasuries and a 34% stock volatility.

Deutsche Bank Securities put it 0.6% rich, using a spread of 25 bps over Libor and a 20% stock volatility.

Thus, on the heels of the Disney and Wells Fargo deals, the new offering from Photronics Inc. - while a high-yield credit - was getting a raving response from buyers.

Photronics launched around noon $125 million of five-year convertibles talked to yield 2.25% to 2.75% with a 37.5% to 42.5% initial conversion premium. Pricing was slated for after the close Wednesday. At the midpoint of the guidance, sellside analysts put it 2% to 3% cheap.

"At least this one actually fits into a convertible model," said a trader at a hedge fund in New Jersey.

The new convert traded as high as 4 points above issue price in the gray market and was closed at 2.5 points over on the bid side, 3.5 points over on the offer.

Photronics shares ended down 81c, or 6.77%, to $11.15.

Some proceeds of the new deal will be used to redeem part of Photronics' old 6% convertible due 2004, which traders said was flat at about par on Wednesday. There is about $70 million outstanding on that issue, sources said.

Photronics' 4.75% convertible due 2006, a $200 million issue, was quoted up about 2.5 points to 91.125 bid, 92.125 asked.

Also at bat after the close was another small deal - $90 million from Manor Care Inc.

Manor Care was pitching $90 million of 20-year convertibles talked to yield 1.75% to 2.25% with a 55% to 60% initial conversion premium in tandem with $200 million of split-rated 10-year senior notes and a new three-year $200 million bank revolver.

Manor Care shares closed off 13c, or 0.66%, to $19.45.

Yahoo! Inc.'s new convert was described as holding up well as the stock took a hit ahead of the internet company's earnings.

The new Yahoo 0% convert, which sold at par last week, was quoted down about 1.625 points to 94.375 bid, 94.875 asked with the stock down 94c, or 3.95%, to $22.87.

Yahoo reported first quarter revenues of $282.9 million, a 47% increase from a year earlier, and net income of 8c per diluted share versus a net loss of 9c per diluted share a year ago.

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