Level 3 takes off on earnings, cash flow outlook; Ambac tumbles on loss; AirTran fails to spark interest

By Kenneth Lim

Boston, April 23 - The convertible market remained soft Wednesday as mixed earnings news offered little respite from the bruising session on Tuesday.

Level 3 Communications Inc. jumped outright after the company reported a narrower loss and guided for an improved cash flow outlook.

Ambac Financial Group Inc.'s convertible mandatories fell with the stock after the bond insurer reported a larger-than-expected loss.

AirTran Holdings Inc.'s planned $65 million offering of convertible senior notes remained quiet in the gray market as airlines continued to struggle amid high fuel costs and poor earnings.

The convertible market remained weak on Wednesday, but the mood was better than on Tuesday, when stocks took a beating.

"It's a little better today," a sellside convertible trader said. "Yesterday was like you got hit in the back of the head with a baseball bat. Today it still hurts, and you're treading with caution, but at least the shock is over."

Huntington Bancshares Inc.'s recently priced 8.5% perpetual convertible preferreds slipped two points to close at 94 against a stock price of $9.15. Huntington common stock (Nasdaq: HBAN) dropped 4.6% or $0.44 to close at $9.12.

"Huntington was slightly better dollar neutral. The stock's falling victim to what's going on with the rest of the sector but I think the credit hasn't changed much," a desk analyst said.

Level 3 climbs on earnings

Level 3's three convertibles that mature in 2009 and 2010 rose on Wednesday after the company reported better-than-expected earnings and painted a rosy cash flow outlook.

Level 3's 6% convertible due September 2009 rose 2 points outright to trade at 91.75 against a stock price of $2.75. Its 6% convertible due March 2010 climbed 3 points to trade at 83 versus the same stock price, while its 2.875% convertible due July 2010 jumped 7 points outright to 77 against the same stock price.

Level 3 common stock (Nasdaq: LVLT) closed at $2.91, up by 22.78%, or $0.54.

Level 3 on Wednesday said it narrowed its first-quarter loss to $181 million, or 12 cents per share, from $647 million, or 44 cents per share, in the year-ago period. The company also said it expects to break even on a free cash flow basis in the remaining three quarters of the year.

"Our 2009 maturity of $362 million are due in September of 2009 and as we will be generating cash, we also feel comfortable that we can handle those maturities with cash on hand," Level 3 chief financial officer Sunit Patel told analysts. "As has been the case historically, we expect to refinance the roughly $900 million due in 2010 long before 2010. We have a proven track record of refinancing our debt well in advance for our maturity and feel confident that we will do so for the 2010 maturities."

A convertible analyst said Level 3, a Broomfield, Colo.-based internet backbone services provider, is a company in a compelling market but hampered by credit concerns.

"I've been an end-market proponent," the analyst said. "It's one of those great markets, bad capital structure kind of things. They had made a lot of acquisitions and they hadn't been achieving some of their debt-reduction targets. Around the end of last year they announced a really disastrous quarter because they had some provisioning problems, and things really collapsed."

"But last quarter they had a really good quarter," the analyst said. "It really reflects the fact that they really managed to fix the internal provisioning problems."

The analyst noted that management has stated its goal to achieve a sustainable, positive free cash flow and to increase sales. The company appears confident that its business outlook has improved and sees good demand.

The analyst said Level 3 will likely try to eventually take out its 2009-maturing convertibles as part of its debt-reduction goals.

"They've been buying those '09s back, so it wouldn't surprise me if they continue to pick those off," the analyst said. "The issue originally was $823 million, now it's $362 million. The bonds are in the low 90s, so they may continue to just buy them up with cash on hand...why wait for them to accrete?"

Level 3 may hold off refinancing the 2010 convertibles until prices in the market are better, the analyst said, noting remarks made by Patel.

Despite Level 3's apparently better outlooks, the analyst remained cautious about whether the company will be able to achieve its goals.

"It's still a very, very highly levered company," the analyst said. "They've had some management issues and changes, and clearly they stumbled internally but that was clearly a result of acquisitions...they've been trying to get to free cash flow positive, and if they achieve that, it would be great. But there's still a lot of execution risk here."

Whether the company will be able to refinance its maturing debt and how it does so is also uncertain.

"They claim they have access, but it depends on how this market goes," the analyst said.

Ambac falls on loss

Ambac's recently issued 9.5% convertible mandatories due 2011 fell 13.5 points outright on Wednesday after the bond insurer reported a larger-than-expected loss.

The convertible was last seen at 33.50 against a stock price of $3.46. Ambac common stock (NYSE: ABK) dropped 42.62% or $2.57 to close at $3.46.

"Another day, another piece of crap," a sellside trader said. "Everyday there's something new and these guys keep getting worse."

New York-based Ambac said it lost $1.66 billion in the first quarter of the year, an $11.69 per share loss, as it suffered from a drop in the value of its derivatives positions and provisions to cover losses on guarantees.

"Nobody has any idea now how strong their credit really is," the trader said. "People thought Ambac wasn't as affected as the others by the whole subprime mess, so when these first came out people were still OK with buying them. Now you know that they're not operating on a desert island. And people thought there's a chance some of the banks might bail them out, but now the banks are in trouble themselves so who's strong enough to bail them out?"

The trader said there was a significant concern that Ambac's credit would get downgraded, which would jeopardize its ability to perform its core business - insuring debt.

"They can't keep raising capital to keep their triple A," the trader said. "After a certain point, they're too highly leveraged, or their stock's too diluted. It's like a vicious cycle. The worse off you are, the harder it is to get someone to help you."

AirTran remains quiet

AirTran's planned $65 million offering of seven-year convertible senior notes continued to struggle on Wednesday with talk mounting that the deal will likely end in very few hands or even be scrapped.

The deal is talked at a coupon of 5% to 5.5% and an initial conversion premium of 20% to 25% and slated to price Thursday after the market closes. AirTran common stock (NYSE: AAI) closed at $3.25 on Wednesday, down by 9.97% or $0.36 cents.

"It's a small deal, they're on credit watch negative, the stock's taking a whack," a sellside analyst said. "Why would they do it now unless it's a desperate thing?"

AirTran is offering the convertibles at par. There is an over-allotment option for a further $9.75 million.

Morgan Stanley & Co. Inc. is the bookrunner of the registered shelf offering.

There is a concurrent common stock offering of 14.25 million common shares with a greenshoe for an additional 2.1375 million common shares.

AirTran, an Orlando, Fla.-based airline, said it will place part of the proceeds from the notes offering into an escrow account to fund the first six interest payment. The rest of the proceeds will be used for general corporate purposes, which may include working capital, capital expenditures, debt retirement and strategic investments.

The analyst said it was not even useful to figure out the company's credit spread and volatility.

"It is kind of pointless because they're currently trading at over 2,000 basis points spread, and that was like a three-year risk," the analyst said. "And the new one is seven-year risk."

There was speculation that the deal could be hedged, the analyst said.

"I have heard some people talking about over-hedging it...that means you hedge it with over 100% stock," the analyst said.

Part of the problem for AirTran is that the entire industry is reeling from high fuel prices.

"They were struggling at $65 fuel," the analyst said. "Capacity is coming out of the system, the planes are so full...you can't make at living at $118 oil. They can't unilaterally raise prices, but if the airlines do raise prices as a group and demand doesn't drop, there might be something. But everything else is just killing people, and if prices are so high, people might say, maybe we'll just drive somewhere, or maybe we won't take a vacation this year."

Even if investors are buying the convertibles for the yield and eventual redemption, doing so would take resilience, the analyst said.

"I think the company could be a survivor but I don't know how your bonds could possibly look good on a marked to market basis until it pays off," the analyst said. "You're hoping for 5.25% interest on a really risky airlines situation."

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