HealthSouth, ArvinMeritor deals get warm reception; Woodson says convertibles making comeback

By Kenneth Lim

Boston, March 1 - New deals continued to drive activity in the convertible bond market on Wednesday, with the fresh HealthSouth Corp. preferreds rising six points above par on their debut. ArvinMeritor Inc. upsized a new deal by about 30% and priced on the rich end of talk late in the day after the gray market pushed the original issue about 2.5 points above par.

Conexant Systems Inc. also said late Wednesday that it would offer $200 million of 4% convertible bonds due 2026, and market sources said talk was guiding for pricing 98.5% to 99% below par.

The biotech sector was also active. Nektar Therapeutics convertibles dipped slightly with the stock after the company missed earnings estimates in its fourth quarter, although some analysts remained positive on the company's prospects.

Meanwhile, Hart Woodson, the new managing director at convertible bond specialist Advent Capital Management, says the convertible bond market is looking attractive again.

Barclays Capital convertible analysts have also published a report noting that the cost of issuing convertible bonds in Europe fell by 11 basis points in February, although they expect coupon rate in the continent to bounce back in March.

HealthSouth deal heads north

HealthSouth's newly launched 6.5% perpetual preferreds were well received on Wednesday, with market sources noting that it was 106.25 bid, 107 offered versus a stock price of $5 mid-day.

The stock, which trades on the Pink Sheets under the ticker HLSH, rose 12 cents to close at $5 on Wednesday.

"They upsized the deal, which is nice, and it came so cheap," an analyst said.

HealthSouth originally planned to offer $300 million of the preferreds to help reduce its indebtedness, but the deal was increased to $400 million late Tuesday with an initial conversion premium of 25%. Talk guided for a dividend of 6.5% to 7% and an initial conversion premium between 20% and 25%.

The preferred were sold in a private Section 4(2) placement, which led a trader to remark that the group of investors who got to benefit the most from the increase was smaller than usual.

HealthSouth, a Birmingham, Ala.-based provider of outpatient surgery, diagnostic imaging and rehabilitative health care services.

ArvinMeritor upsizes offer

ArvinMeritor priced an upsized $260 million of 20-year convertible bonds on the rich end of talk late Wednesday to yield 4.625% with an initial conversion premium of 35%, syndicate sources confirmed.

UBS Investment Bank, which is running the books, has a greenshoe option of $40 million.

The size of the deal was originally set at $200 million, with a greenshoe of $30 million. Price talk guided for a coupon of 4.625% to 5.125% and an initial conversion premium of 30% to 35%.

The market was excited about the deal when talk was still going on. A trading source noted that the gray market bid the new bonds half a point above par in the morning. By the afternoon, one million units were bid at 2.5 points above par and offered at 3.25 points above par.

"It's a pretty cheap piece of paper, I think demand is going to be very high for this, but I don't like that it's a 10-year piece of paper," a buy-side source said.

"It has no puts before 10 years, I just prefer to stay within seven years, ideally within five years. Too much can happen to a company over 10 years."

He thought that a credit spread of 450 basis points, assigned by another buy-side analyst, should be tighter, but both agreed on a volatility of about 40%.

The new notes, which mature on March 1, 2026, are non-callable for 10 years, and have puts in years 10, 12, 14, 16 and 18. There is a contingent conversion feature with a 120% threshold, and the securities have net share settlement. After March 1, 2016, the cash coupon will step down to zero.

ArvinMeritor said will use the funds to partially finance a planned buyback of up to $450 million of its outstanding straight bonds. The Troy, Mich.-based car and truck parts has made a tender offer for its 6.625% notes due 2007, its 6.75% bonds due 2008, the 6.8% bonds due 2009 and the 7.125% notes due 2009.

ArvinMeritor stock (NYSE: ARM) fell $1.20, or 7.17%, to close at $15.54 on Wednesday.

Conexant offers new 20-year bonds

Conexant Systems late Wednesday said it was offering $200 million of 20-year convertible notes at a 4% coupon and an initial conversion premium of 50%.

The notes, which mature in 2026, will be reoffered below par, market sources said. Talk puts the reoffer price 98.5% to 99% - the exact level was not available at press time. At the conversion price of $4.92, each note can be converted into 203.25 shares.

Lehman Brothers is the bookrunner of the Rule 144A deal.

There is also a greenshoe option of $50 million.

Conexant said in a statement that it will use proceeds from the issue to reduce its outstanding debt. Market sources said the company plans to use the proceeds to retire its 4.25% and 5.25% convertibles due May. Newport Beach, Calif.-based Conexant designs, develops and sells semiconductor system solutions.

Conexant stock (Nasdaq: CNXT) rose 10.07%, or 30 cents, to close at $3.28 on Wednesday, but fell 3.66%, or 12 cents, to $3.16 in after-market trading.

Nektar Therapeutics earnings slide

Nektar Therapeutics convertibles slid slightly in line with the stock on Wednesday after the company reported the night before that its fourth-quarter loss grew fivefold to $108.2 million, or $1.23 per share, from $19.3 million, or 23 cents per share, in the year-ago period.

An analyst said its 3.25% convertibles due 2012 traded at about 116.792 versus a stock price of $20.55 on Wednesday. A major trading desk marked the company's 3.5% convertibles due 2007 at 96.01 bid, 97.01 offered against the closing stock price of $2.053. The 5% convertibles due 2007 were marked at 100.02 bid, 101.02 offered at the same stock price. Nektar (Nasdaq: NKTR) shares ended at $20.41 on Wednesday, 2.39% or 50 cents lower.

"They missed earnings estimates, that's why the stock's down," the analyst said.

But other analysts said they continued to be upbeat about the company's prospects.

"EPS [earnings per share] is a non-issue for these guys," said a sell-side analyst who covers the sector. "The stock is down little bit because they guided a little higher for loss for the year, but they're investing in more and more products in the line for trials."

He added that Nektar's prospects were dependent on the success of its diabetes drug Exubera, an inhalation form of insulin co-developed with Pfizer.

"I think Exubera is going to be a very strong drug for Pfizer and therefore for Nektar," he said. "I think the credit is going to get better over the next year, there's a 100 basis point improvement potential this year. I think so far nothing in yesterday's [Tuesday's] call will make me doubt the prospects of the company."

Convertible market coming back, says Woodson

New Advent Capital Management managing director Hart Woodson says the cheapness of some new convertible bond issues is "like walking into a candy store," and is a signal that the convertible market and the convertible arbitrage strategy is due for a comeback.

"It makes sense, because every article and report you see says convertible arbitrage is dead, but if you have a contrarian way of thinking, you see the building blocks of why it should improve," said the former senior vice president at Gamco Investors Inc. "The declining volatility, it's now starting to turn up again because it is cyclical, there is more M&A activity and rising interest rates."

Besides the cheap deals found in the primary market, the secondary market is also seeing that "clearly the relative value between high-yield and convertibles have come back into line," he said. Convertibles continue to offer opportunities that straight bonds do not, he added.

Convertible arbitrage still has a place in investment strategies, he said, but the days of gamma-type volatility trading are gone.

"It's never going to be a return to the good old days, where gamma-type volatility trading was what people practiced," he said. "If you're a hedge fund you have to take more of a view on credit and equity and volatility."

Woodson joined Advent on Wednesday, and said he will help to develop a "dedicated product in the global space" as the firm makes a push for greater global exposure.

European issuance costs down in February: Barclays

A Barclays Capital index measuring the cost of issuing convertible bonds in Europe fell by 11 bps in February on the back of higher long-term option-implied volatility, but coupon levels could rise again in March as swap rates increase, said the bank's convertible research group.

The Convertible Cost Index - an implied coupon on a hypothetical five-year, non-callable, no-put, euro BBB convertible bond with a 40% conversion premium - fell to 2.97% at the end of February, wrote analysts Luke Olsen, Haidjie Rustau and Heather Beattie in a research note.

"The CCI peaked briefly at 3.16% on 1 February...its highest level since May 2005. However, since the start of February, long-term implied volatility has increased, offsetting wider euro BBB credit spreads and higher five-year swap rates, pushing the CCI down," the analysts wrote.

The analysts expect the index to bounce back in March by 10 bps to 3.07% despite predicting that volatility levels will continue climbing to 20.5% by end-March. Offsetting the volatility increase will be rising five-year swap rates, which are forecast to reach 3.6%, and event risks that see investment-grade credit spreads at fair value, the analysts said.

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