PDL BioPharma falls 3 points outright; Qwest active on extended tender; Cephalon improves

By Rebecca Melvin

New York, Aug. 13 - A good amount of event-driven trading kept convertible market players at their desks through most of the session Friday, although overall volume remained light given the summer vacation period underway.

Among convertibles trading, PDL BioPharma Inc.'s bonds fell 3 points outright but were called higher on a hedged basis by one sellsider, as shares of the Incline Village, Nev.-based biopharmaceutical company plunged on word of a royalty dispute between it and Genentech.

Qwest Communications International Inc. was very active in trade after the Denver-based provider of data, internet, video and voice services extended its tender offer for the $1.265 billion of 3.5% convertible senior notes. Qwest stock is trading right at the break-even point for the tender, a New York-based sellside analyst said.

Cephalon Inc. saw its 2% convertibles - the more equity sensitive of its issues - improve in the last couple of days as convertible arbitrage players bet on the prospects of that stock going higher.

Overall, the convertible secondary market was quiet, typical of a summer Friday.

"A lot of dealers were changing inventory in the Street," a New York-based sellside trader said.

Stocks slid for the fourth day, falling nearly 4% for the week as the latest batch of economic data doused investor sentiment. But the move in equities wasn't considered a big factor in terms of the strength or weakness of the convert market.

"It's summer, and people are taking days off. It's normal that volume would be getting light. It will be quiet for the next couple of weeks, into September, and then hopefully there will be a new issue calendar," a New York-based sellside analyst said.

"There are a lot of accounts doing maintenance stuff," the sellsider said.

Nevertheless, he warned, if there isn't an upswing in new issuance in September, the market risks fund outflows.

Extended volatility seen

"It's not a very exciting market right now with very low new supplies," the analyst said. "If this keeps going, you will see some money flowing out of the convert space."

Still, given the volatility, which isn't supposed to degrade into a Draconian, double dip-type situation, according to the analyst, it's a favorable market for convert arb players.

"The market is volatile, and we expect it will remain like this for an extended period. But we don't expect a double dip or that credit spreads will blow out," the analyst said.

He suggested that the markets rallied too strongly into earnings season, and given the latest employment and jobless claims data, which weren't as good as expected, the three days of correction was to be expected.

"It's not a directional market," the analyst said.

PDL down 3 points outright

PDL's 2% convertible senior notes due 2012 traded at 95.5 versus a stock price of $5.15 on Friday, compared to 98.5 versus a share price of $5.65 on Thursday.

Shares of PDL fell $1.02, or 16.5%, to $5.18, plunging after PDL said it received a letter from Genentech asserting that it doesn't think four Genentech drugs - Avastin, Herceptin, Lucentis and Xilair - infringe on patents held by PDL in Europe.

How convertibles valuation was affected given the stock plunge depended on the hedge used. One sellsider said the bonds gained 2 points on a hedged basis. But another sellsider said that the theoretical delta on the bonds is only 5%, or almost nothing.

Given that it's currently callable, an arb player wouldn't put too much delta on it because the conversion price is higher than the current stock price, and if they are called, premium would be lost, the second sellsider said.

It's likely to be an outright play, he argued, because the bond is not subject to equity volatility, it's trading close to par, and on top of that, PDL pays a special dividend from time to time to debt holders.

There was no positive spin to the news, he added.

Genentech licensed antibody technology from PDL in 1998, and it pays royalties to PDL on sales of its cancer drugs Herceptin and Avastin, macular degeneration drug Lucentis, and asthma drug Xolair.

PDL said Genentech plans to keep making royalty payments on the drugs when they are made, used, or sold in the United States. PDL said 30% of its revenue in the first half of 2010 came from royalties on sales of those four drugs that are made and sold outside the United States.

Genentech does not state what actions, if any, it intends to take with respect to its assertions and specifically stated that the letter is not "intended to comment on the validity of PDL's SPCs in Europe."

Qwest extends tender

Qwest's 3.5% convertibles due 2025 traded higher at 118.25 late in the session, which was up from 17.25 on Thursday ahead of what was expected to be tender expiration.

But Qwest announced early Friday that it was extending the tender to Aug. 26, and one source suggested that the company could keep extending the tender for the next several months until the bonds become callable.

Only 7% of the bonds were successfully tendered by the tender's Aug. 12 expiration.

The break-even price is $5.67, and the shares closed Friday at $5.69.

"The tender doesn't make sense," a sellsider said. "You're not getting any premium by taking the tender."

Qwest offered to purchase for cash any and all of its $1.265 billion outstanding 3.5% convertibles for a fixed cash amount of $1,170, which was the maximum consideration payable in the offer. Accrued interest to, but excluding the settlement date, was also paid.

The speculation is that they won't sweeten the deal because they can call it shortly, the sellsider said.

More than $70 million of Qwest bonds changed hands on Friday.

Cephalon 2s lift

Cephalon's 2% convertibles due 2014 traded at 135.188 late Friday, according to Trace data.

On Thursday, the Cephalon 2% bonds traded at 135.02 bid, 135.189 offered, versus a share price of $59.05.

"That was about 8.68 points after trading the prior day at 8.25 points versus $58.13," according to a New York-based trader regarding Thursday's trades.

Shares of the Frazer, Pa.-based biotechnology company settled down 49 cents, or 0.8%, to $58.33 on Friday, and the stock has gone down since the beginning of the month because the overall market is not doing that well.

The Cephalon 2s were recommended as a convert arb idea by Bank of America Merrill Lynch on Tuesday. And the paper traded better on Wednesday and Thursday.

Bank of America Merrill Lynch equity research upgraded the stock last week, and they might be encouraging convert arb accounts to swap out of the Cephalon 2.5% convertibles into the Cephalon 2% convertibles to try to take advantage of the higher equity sensitivity of the 2s.

"The bonds gained about 0.5 point on a hedged basis in the last two days. So on a hedged basis, it's working out pretty well," a sellsider said.

"The Cephalon 2% convertibles are the cheapest health care convert in the space," a sellside analyst said.

Mentioned in this article:

Cephalon Inc. Nasdaq: CEPH

PDL BioPharma Inc. Nasdaq: PDLI

Qwest Communications International Inc. NYSE: Q

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