Brocade convertibles lift on default notice; market activity quiets ahead of holiday weekend

By Rebecca Melvin

Princeton, N.J., July 1 - Brocade Communications Systems Inc. saw its convertibles move a little higher Friday after news of a default notice, but overall the market was inactive, with skeleton crews on trading desks and clients marking their books ahead of the Fourth of July holiday weekend, market participants said.

"It's about as quiet as I've ever seen," a New York-based sellside trader said shortly before noon. "Not much is happening."

The bond market officially closed at 2 p.m. ET, but many brokers left at noon, sources said. At least theoretically, the stock market put in a full day.

About the only topic of conversation was the fact that San Jose, Calif.-based Brocade disclosed late Thursday that the trustee for the holders of its 2% convertible notes gave notice on June 24 of a potential default if the San Jose, Calif.-based networked storage company fails to file its fiscal second quarter 10-Q within 60 days.

If the deadline isn't met holders of at least 25% of the outstanding principal could declare all unpaid principal and accrued interest as due.

Whether Brocade has made or will make a consent solicitation isn't yet known. The company's investor relations director Shirley Stacy told Prospect News that she had no information about a consent solicitation, and added that the company, with $746 million in cash and investments, would be able to pay the issue's $279 million of principal outstanding at June 29 if necessary.

"I have no other information," Stacy said.

The size of the deal when it was issued in 2001 was $550 million, but the company has bought back portions of it. The issue matures Jan. 1, 2007.

Presumably, it is in the company's best interest to offer holders a sweetener to avert default or redemption, said a buyside source in New York.

"It would be a loss to them. That 2% is cheap money. I don't think they'd want to let that go," the source, who doesn't have holdings in Brocade, said.

Brocade reported in a June 8 8-K that it was delaying the filing of its Form 10-Q for its second fiscal quarter ended April 30 until an audit committee review of the company's stock option accounting on leaves of absence and transition and advisory roles from 2001 through 2004 is complete.

Brocade's 2% convertible traded Friday at 96 bid, 97 offered, compared with a recent level of 95 bid, 96 offered, a New York sellside trader said.

While other recent default stories have surfaced lately, the phenomenon is a relatively new development and without much precedent, the buyside source said. "I just can't remember companies failing to file on time unless they were in distress."

"The indenture provisions of these issues were written before the rules of the Sarbanes-Oxley Act went into effect and I don't think there was any expectation that they [the provisions] would be used in this way," the source continued.

Other recent default notice cases have involved Saks Inc., Impax Laboratories Inc. and Navigant International Inc. Impax and Navigant negotiated with holders to avert default, and Saks has offered a consent solicitation that has received mixed reaction from holders.

GM, Ford trades mixed

General Motor Corp.'s $25 convertible bonds traded mixed in very slim volume despite news that sales for the Detroit-based automaker soared 41% in June to the highest monthly level in nearly two decades.

The increase was due in large part to a heavily promoted discount that allowed customers to buy cars and trucks at the employee rate.

GM's U.S. dealers sold 558,092 new cars and trucks in June, GM's best sales month since September 1986.

GM sales for the first six months of the year rose 2.7%. Its truck sales rose 6.3%, while car sales fell 2.3%.

Ford, meanwhile, said its domestic sales fell 2.5% in June from a year ago and dropped 4.3% for the first six months of the year.

Nevertheless GM's 5.25% issue slipped 0.06 to close at 18.64, and the 4.5s closed down 0.07 to 24.25.

But the 6.25% convertible went out at 21.29, up 0.19 point, or nearly 1%, on the day. Volume was slim overall, with only 170,800 shares of the 6.25% traded, compared with its average three-month running average volume of 2.39 million.

GM stock rose 65 cents, or 1.91%, to 34.65.

Ford's 6.5 convertible preferred added 11 cents to 40.44, while its stock edged up seven cents to $10.31.

Still moving up

Other issues that continued to retain interest were CV Therapeutic Inc.'s new 3.25% convertible, which priced midweek and was at the 107 level on Friday.

Agilent Technologies Inc. saw its convertible edge higher as its stock gained 1.65%. The 3% convertible has gained favor because the company "has a rock solid balance sheet and it's been selling pretty cheap," a Connecticut-based sellside analyst said. "At double B credit, it's just below investment grade and it's yielding 4.3%."

Agilent's 3% convertible was at 98.5 bid, 99 offered versus a stock price of $23.44, a trader said Friday. The issue was quoted going out by a sellside shop Thursday at 98.50 bid, 98.75 offered.

June gains, reports say

In lieu of much activity in either the primary or secondary markets, market participants had plenty of reports and analysis to read.

Merrill Lynch said that for the month of June, convertibles gained 2.11%, including a 2.82% gain in speculative-grade issues and a 1.20% rise in investment-grade paper.

The underlying stocks of those issues during June rose a slightly better 2.71%, with speculative-grade stocks up 3.64%, according to Merrill Lynch's Convertible Daily Monitor.

However performance for convertibles for the year's first half remained in negative territory. All convertibles for the year to date were off nearly 3½%, while performance in their underlying stocks for the same period was a loss of 3.17%.

"I think it's been picking up steadily since late April, early May," said a Connecticut-based sellside analyst. "But at the same time it's getting a little richer."

With 12 new issues in June, "issuance rebounded strongly," with proceeds of more than $4.8 billion, Citigroup Smith Barney said in its new issue monthly report. The total number of new issues included a deal from Impax Labs, which was issued to a single buyer but should be registered within 60 days. It also included a pre-IPO from GSC Capital, which isn't a convertible as yet.

But among issuers that saw strong play were Cephalon Inc., Symmetricom Inc., Invitrogen Inc., MetLife Inc., Oil States International Inc., Calpine Corp., Reckson Associates Realty Corp., Evergreen Solar Inc., and CV Therapeutics Inc. Five of those deals were registered and four were Rule 144A.

Issuance terms continued to "moderate" as the weighted average yield topped 5% and premiums hit a three-year low, down 13 basis points to 21.77%. Calpine's 7.75% convertible had the biggest coupon and Cephalon's 2% deal had the smallest.

The pickup in activity came on the heels of the weakest month for convertible issuance in more than two years, Citigroup said. And it wasn't clear what to expect going forward.

"The new issue market may be warming up. There is certainly a willingness to put cash to work...the prospect of fund liquidations may be subsiding for the time being....Still, we're into the slow summer season" so it wouldn't be a surprise if the recent acceleration eases off, the 14-page report stated.

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