Moderate buying lifts convertibles of Cephalon, Micron, Maxtor; Emdeon, Mercury Interactive see interest

By Rebecca Melvin

Princeton, N.J., Aug. 31 - Some moderate buying hit the convertibles market on Wednesday, the last day of the month, as investors took advantage of opportunities resulting from market softness experienced through much of August and certainly during the last two weeks.

But traders said overall the session was still a relatively quiet one. The broader markets were cheered however by comments seen as favorable regarding interest rates and the Bush administration's promise to release oil from strategic reserves to help Gulf Coast refiners shut by Hurricane Katrina.

Specific bonds, like Cephalon Inc., "were bid up, but there was no step up in prices," said a Connecticut-based buysider. The convertibles of Micron Technology Inc. and Maxtor Corp. gained with a jump in their underlying shares, traders said.

Buyer interest materialized for Emdeon Corp., formerly known as WebMD Corp., which received a lukewarm reception last week when the issue first priced, a trader said.

The convertibles of Mercury Interactive Corp. continued to trade a day after news that two of its issues received a notice of default, with market sources pointing to the large Chicago-based hedge fund, Citadel Investment Group, as the sender of the notice. Citadel didn't respond by press time to Prospect News' inquiries.

Selling was also a feature of the day, with the convertibles of Providian Financial Corp. and Reebok International Inc. cited as among those issues under pressure.

Mixed expectations on redemptions

How redemptions will affect the market in September was also a matter of debate. A buysider lamented that it's difficult for him to do his job as a convertibles manager when investors are impatient for performance numbers on a monthly basis.

"It's a longer-term strategy," he said, "A lot of managers in shoes like mine are finding it hard to do our jobs when investors in the strategy are asking how performance is on a day-to-day, week-to-week basis."

A sellside trader said he thought that redemptions were "a bigger deal a month ago" and "certainly hadn't caused a lot of selling."

Another buysider said that it was too early to tell whether redemptions will cast a pall on the market. "In September we'll start to know what the end of the year will look like," he said, indicating that redemptions will be made based on those expectations.

Overall, "volatility is up, and while credit spreads to Treasuries are a little bit tighter than they should be," there are still signs that convertible arbitrage performance may pick up," he said.

The stock markets Wednesday moved higher after Philadelphia Federal Reserve president Anthony Santomero called increasing oil prices a "tax" and told CNBC it was too early to say whether the Fed would change its interest rate policy in light of the hurricane's wreckage. Many traders took the comment as a signal that the Fed's year-plus streak of rate hikes might end sooner than expected.

In addition, the Bush administration agreed to tap the Strategic Petroleum Reserve as an effort to keep production of gasoline and other fuels steady.

"Free oil [SPR] and lower interest rates" contributed to Wednesday's market moves, a buysider said.

Modafinil news boosts Cephalon

The 2% convertibles of Cephalon were traded actively and enjoyed the biggest boost among the West Chester, Pa.-based biotechnology company's convertible issues, sources said. But the Cephalon 0% A tranche and B tranche were also firmer.

The rise was attributed to company news after the bell Tuesday that Germany's Federal Institute for Drugs and Devices approved the marketing of Cephalon's modafinil tablets for the treatment of shift-work sleep disorder for patients with excessive sleepiness who work night shifts.

Cephalon said Germany is the third country in Europe to approve modafinil to treat the disorder. The medication, marketed under the Vigil trade name, has been available in Germany since 1998.

The Cephalon 2% convertibles due 2015 were seen up about a point at 100.5 bid, 101 offered. Shares of the company closed higher by 69 cents, or 1.73%, at $40.52.

Micron, Maxtor notch gains

The convertibles of Micron Technology gained as much as 3 points and its stock climbed 5.3% on Wednesday. The move may have been related to news that demand is rising for flash memory chips used in popular music players and digital cameras that the Boise, Idaho-based company makes.

Micron's 2.50% convertible due 2010 traded at 107.9 on Wednesday, according to a NASD trace trade, compared to a level of 104 bid, 104.5 offer on Tuesday.

Meanwhile, Milpitas, Calif.-based Maxtor saw its 6.80% convertibles gain as its stock jumped 4.3% after news that the disk-drive maker may have a promising new market in selling hard disks that act as home-entertainment hubs whether or not they are connected to a personal computer.

The new system would allow the hard-disk supplier to begin marketing a product as a home-entertainment center that bypasses PCs and allows consumers to watch movies or play music or video games.

The Maxtor 6.8% convertibles traded at 99, up from about the 96 level. Its shares closed up 20 cents, or 4.3%, at $4.86.

Emdeon, Mercury

Emdeon's 3.125% convertibles due 2025 attracted buyers in the 96-ish range, down from 97 last week, when the $300 million convertible priced Thursday at a 97 reoffer price.

"Emdeon is finding interest at 95, 96. Now it's viewed as cheap enough," a sellside trader said.

Meanwhile, Mountain View, Calif.-based Mercury Interactive continued to have buyers in the 4.75% convertible right around par and in the 0% convertible at 97.

Those convertibles traded actively Tuesday at those levels amid uncertainty about what would happen following a notice of default received on the $500 million 0% coupon convertible due 2008 and the $300 million 4.75% convertibles due in 2007.

Some speculated that the company could make a deferred call, similar to action taken last week by Brocade Communications Systems Inc.

Brocade, a San Jose, Calif.-based networked storage company, found a loophole in the indenture of its 2% convertibles following a default notice on that issue that allowed it to call the issue in a year on Aug. 22, 2006.

Merrill Lynch analyst Tatyana Hube said in a research note that Mercury could cause early defeasance of the 4.75% convertibles' indenture, but not in that of the 0% convertibles.

"Per our reading of the indentures of both MERQ convertibles, we believe that Mercury Interactive has the ability to push back its looming default put payment on the $300 million of the 4.75% notes due 2007. This could be done by calling the notes with a redemption date set within one year and by delivering to the trustee funds necessary to pay the principal and interest remaining until such delayed call date, similar to that done by Brocade Communications with their 2% notes of 2007 to avoid its technical default," Hube said in the note.

But a buysider questioned whether Mercury would make such a move with the 4.75% convertible because of the higher coupon of that issue.

"Why would they?" he asked. "I'd be surprised if they did a 'Brocade.' They're looking at losses if they did that. Brocade with its 2% coupon only had to pay out 2%. But Mercury has a lot of cash and they have options. They could do straight debt or a new convertible" rather than pay a 4.75% coupon.

A second buyside source suggested that the company could issue a new convertible or extra bonds to the holder of one-quarter of the issue, similar to the move that Impax Laboratories Inc. did for Highbridge International.

Impax Labs sold $75 million of seven-year convertible notes at par with a 3.5% coupon with an initial conversion price set at 130% of the average closing price of its common stock during the 10 trading days beginning and including June 20.

The transaction, with Highbridge, was negotiated without a placement agent. It said proceeds from the Section 4(2) deal, along with cash on hand, will be used to redeem its 1.25% convertible notes due 2024, plus pay interest.

The Hayward, Calif.-based biotech firm said it had received a demand to accelerate payment on the 1.25% notes from a holder representing more than one-quarter of the $95 million issue. The company also noted that it had $78 million of cash as of May 31.

The Mercury 0s don't appear to have such a loophole for delaying the technical default put, which seems likely given the company's current intention to file its overdue 10-Q in November or later.

Merrill Lynch's Hube said: "Investors should look out for similar language in other convertibles that they deem to be likely subjects of a technical default due to delayed financial filings."

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