ExpressJet stands firm on lost business; Gilead deal priced cheaper than talk; Cephalon gains on new data

By Kenneth Lim

Boston, April 19 - ExpressJet Holdings Inc. convertible bonds had a roller-coaster ride early Wednesday but firmed later in the day against a weakened stock after major customer Continental Airlines decided to switch vendors for its regional routes.

Meanwhile, Gilead Sciences Inc. priced a $1.2 billion dual-tranche offering of convertible bonds cheaper than talk amid grumblings in the market that the volatility on the common stock was not enough to justify the originally intended premiums.

Faring better, Cephalon Inc. gained on a dollar-neutral basis after the company said it had found new data to suggest that its attention deficit hyperactivity drug did not cause a rare skin condition. Concerns about the drug's safety led the Food and Drug Administration last month to reject approving the drug's usage in children.

ExpressJet flies steady in storm

ExpressJet's 4.25% convertible bond due 2023 ended Wednesday stronger against its stock, but was slightly weaker earlier in the day as the shares plummeted on news that the airline was losing its Continental contract business.

"The stock was down big on the news, the bonds were kind of all over the place," said a sell-side market source. "They were sold off in the morning but bounced back later in the day. I heard there was somebody out there putting a strong buy on the credit."

The ExpressJet convertible was seen closing at 87.5 bid, 88.5 offered versus the last stock price of $6.11 on Wednesday. ExpressJet stock (NYSE: XJT) dived 11.83% or 82 cents over the day.

Continental said late Tuesday that it is withdrawing the 69 regional jets currently operated on contract by ExpressJet and giving the business to Chautauqua Airlines. Houston-based ExpressJet has until Sept. 28 to decide if it will return the aircraft, which it currently leases from Continental. Continental is ExpressJet's main customer.

But the sellsider said he was optimistic about the ExpressJet convertibles.

"I really like the credit," the sellsider said. "They have a put in just over two years, so the converts are pretty much money-good. The news is going to pressure the equity, so you will see analysts cut their recommendations, but this will be good for the convert arb guys. The converts should improve over time, and the equity is going to be pretty volatile."

A buysider whose convertible fund owns the ExpressJet convertible said "the irony of the relationship is that ExpressJet has been much more profitable than Continental, so one can understand why Continental would want to squeeze them."

The fact that ExpressJet has been profitable creates an exciting opportunity in the convertibles, the buysider said.

"The intriguing thing is the 10% yield-to-put, with a put on Aug. 1, 2008," the buysider said. "That's only a little over two years."

And ExpressJet is in no real danger of defaulting on its obligations, the buysider explained. The company had about $172 million in debt in the latest quarter, $137 million of which came from the convertibles. The company had $227 million in cash and is cashflow positive. And even though Continental has said it wants out from the relationship, the contract will have to be phased out gradually, giving ExpressJet breathing room to restructure its business, the buysider said. If it had to be liquidated it would be liquidated at a profit, the buysider said.

"Even if Continental takes away all this business, this thing is in fantastically healthy financial conditions," the buysider said. "It could be liquidated at a profit, it's going to be cashflow positive. Continental may be taking away three-quarters of its business...but it would be extremely difficult to conclude that this name is distressed.

"I repeat, if they do go out of business, they are hugely cashflow positive," the buysider stressed. "To make this bond anything other than money-good, one has to presume that the ExpressJet directors approve something really stupid."

Gilead's deal cheaper than talk

After the close Wednesday, Gilead Sciences priced an upsized $1.2 billion dual-tranche offering of convertible senior notes beyond the cheap end of initial talk as market observers grumbled that stock's low volatility did not support the premiums originally guided for.

"I just don't see how they can get it done at the mids," said a sell-side convertible analyst, speaking ahead of the pricing. "They'll have to come at the cheap end. You need a level of volatility that I think is hard to swallow."

Gilead's five-year paper was priced at a coupon of 0.5% on an initial conversion premium of 19%, while the seven-year paper was priced at a coupon of 0.625% with an initial conversion premium of 17%. The five-year convertibles were initially talked at a coupon of 0% to 0.5% with an initial conversion premium between 20% and 25%. The seven-years were initially guided at a coupon of 0.125% to 0.625% with an initial conversion premium between 19% and 24%.

All the convertibles were offered at par, and Gilead will be obtaining convertible note hedge and warrant transactions alongside the issue.

The size of each tranche was upsized to $600 million from $550 million, but the over-allotment options shrank to $50 million per tranche from $100 million previously. That kept the total deal size at a potential $1.4 billion if greenshoes are counted.

Morgan Stanley, Merrill Lynch & Co. and Banc of America were the bookrunners of the Rule 144A deal.

The sellsider said the main problem with the issue was that Gilead stock was not really volatile, and volatility is not expected to improve in the future.

"The company doesn't have too many late-stage trial data points coming out later in the year, so the volatility is likely to be kept low."

Another convertible analyst said Gilead is a strong credit with a spread of around 30 basis points over Libor. So for investors, "it comes to volatility."

"I would not be paying 30% vol here," the analyst said, noting that there was no interest in the gray market on Tuesday.

Also speaking ahead of the pricing, a buysider said the premium was too high "for yet another large deal like this, for a company that really isn't volatile."

"The stock itself isn't in vogue right now, so they may have to cheapen it," the buysider said. "I don't think we're going to participate."

Gilead, a Foster City, Calif.-based biopharmaceutical company, said it will use the proceeds of the deal to buy back about $500 million of its stock and to fund the convertible note hedge transactions. Any remaining proceeds will be used for general corporate purposes.

Gilead stock (Nasdaq: GILD) closed at $65.13 on Wednesday.

Cephalon gains on renewed hopes

Cephalon's convertible bonds were seen better on a dollar-neutral basis on Tuesday after the company said it has new data to suggest that its drug Sparlon did not cause a rare skin disease as previously feared.

Cephalon's A tranche zero-coupon convertible due 2033 was marked higher by about four points outright at 121.1 bid, 121.6 offered against a stock price of $67.43 on Wednesday. The B tranche zero-coupon convertible also due 2033 was marked at 125.5 bid, 126 offered versus the same stock price. The 2% convertible due 2015 was marked at 154.4 bid, 154.9 offered at the same stock level.

Cephalon, a Frazer, Pa.-based biotech company, said late Tuesday that it had new data showing that Sparlon, an attention deficit hyperactivity drug currently used to treat sleep disorders, did not cause the skin disease known as Steven-Johnson syndrome. It said a child suspected of having the disease may not have contracted the syndrome based on discussions with medical experts.

Concerns about links between Sparlon and the disease led the Food and Drug Administration last month to reject Sparlon as a treatment for ADHD in children, a move that led to a sell-down in Cephalon stock and rating downgrades from analysts.

"This could definitely turn out to be a big positive for Cephalon," said a sellsider.

The FDA is expected to meet again next month to deliberate on Sparlon, and investors could be buying in anticipation that the FDA could reverse its earlier decision, the sellsider said.

"Things could change in the event that the FDA could be persuaded to change their minds," the sellsider said.

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