Buyers emerge in many outright names; MF Global drifts lower after downgrade; Cemex gains

By Rebecca Melvin

New York, Oct. 27 - Buyers of convertible bonds came out of the woodwork on Thursday with offers being lifted in abundance as stock markets bounded higher following news of a European debt fix. A positive initial reading on the U.S. gross domestic product for the third quarter also helped markets.

"It's a lift-fest...guys are just lifting offers," a New York-based trader said during the session.

There was strong buying of a number of distressed, or high-yield, outright names; but also sector strength in areas like energy, in particular coal names, and industrials, a New York-based sellside analyst said.

MF Global Holdings Ltd. continued to dominate convertible trading as it has done for the past few days. Its three convertible bonds drifted lower after initially trading mixed following a rebound into the close Wednesday. A Fitch Ratings downgrade was blamed for the renewed weakness.

Also trading actively were Cemex SAB de CV's convertibles, which were higher outright in active trade. They were mixed on a premium-over-parity basis, with the newer Cemex issues expanding a couple of points, while the older issue contracted a couple of points. The underlying shares surged.

Also in the high-yield or distressed arena, DryShips Inc. and Clearwire Inc. were active in trade, with Clearwire ending the session in the mid-40s, after popping to 47 bid, 51 offered Wednesday. DryShips traded at 75 with the underlying share price at $2.75.

Iconix Brand Group Inc. traded higher and ended with a 1.125 point gain on a dollar-neutral basis after the New York-based branding company reported positive earnings.

Equities provide a lift

But the story of the day was the huge rally in equities.

"It was a pretty impressive rally," a convertibles analyst said, but whether it signals a genuine turn in the market was uncertain given that the fix for the Euro debt situation means "nothing definitive," he said.

"If they can kick the can far enough down the road, people are going to put risk back on, but a lot is yet to be determined," he said, allowing that investors appear to be getting more comfortable with the European situation.

As for what convertible arb players were up to, he said there appeared to be some unwinding. "People haven't done a good job of buying low and selling high," he said. "A lot of people are unwinding now."

In general, convertibles were higher outright and dollar neutral with much of the universe up 0.25 point to 3 points, depending on the sector.

The Euro Summit brings some clarity to the Greek debt crisis, calling on private investors to take a 50% haircut on debt held, and there was also agreement on recapitalizing European banks. There has been no talk of requiring haircuts on other sovereign debt in the euro zone.

The Euro Summit statement referred to Spain and Italy individually, saying that both were taking positive steps to restructure and reform. Italy plans to bring about a reduction in gross government debt to 113% of GDP in 2014.

In the United States, the government's initial read on third-quarter GDP showed that U.S. growth accelerated over the summer, rising at an inflation-adjusted annual rate of 2.5% from July through September. The gain was less than the 2.7% rate expected.

MF Global drifts lower

MF's 3.375% convertibles due 2018 drifted down to about 50 or a little lower after having jumped up to 65. The bonds went out on Wednesday at about 58.

MF's 1.875% convertibles due 2016 also moved down to about 50 from 65. They were 57 last on Wednesday.

MF's 9% convertibles due 2038 were more difficult to read at the end of the day, being a less liquid and smaller issue. They probably ended 55 bid, 70 offered, an analyst said. They had traded early at 78 bid, 79 offered, then moved up to 84.

The MF 9% paper is more subject to volatile price action. The issue is short dated, with a call/put in 2013. The current 20-point spread between the 9% convertibles and the two newer issues would collapse immediately if there were some sort of credit event, an analyst said.

Shares of the New York-based broker-dealer sank 27 cents, or 16%, on top of an 8.6% slip on Wednesday and a 42% slump on Tuesday.

Fitch downgraded MF Global on Thursday and placed it on Rating Watch negative, citing an increased risk-taking that has left the company "vulnerable to potential credit deterioration and/or significant margin calls."

The convertibles analyst pointed out Thursday that none of MF's European debt is Greek debt and there has been no talk about requiring haircuts on other sovereign debt like Italian debt; therefore, the company looks to be in pretty safe position.

But it's a matter of perception, too, the analyst said. His firm believes there is underlying asset value in the MF firm, but if customers decide not to do business with it anymore, a liquidity crisis can occur that precipitates a credit event or collapse.

Cemex rises

Cemex's newer 3.25% convertible A tranche due 2016, which priced in March, traded last at 60 versus the closing underlying share price of $4.45. Earlier in the session, the paper traded at 56.5 versus a $4.10 share price. That compared to 52.5 on Wednesday.

The Cemex's 3.25% B tranche due 2016 traded similarly.

Cemex's 4.875% convertibles due 2015, or the older tranche of Cemex convertibles, traded last at 61 having earlier traded at 58, and compared to 54 on Wednesday.

On Monday, the A and Bs were at 52.25 and the old tranche was at 54 versus a stock price of $3.75.

Shares of the cement maker based in Garza Garcia, Mexico, surged 74 cents, or 20%, to $4.45 on Thursday.

In research published Monday, Citigroup's convertibles trading and sales desk outlined three strategies involving Cemex convertible debt. The first strategy would be to buy the convertibles instead of the underlying equity given downside protection value they afford in the event of a potential default or bankruptcy. This also provides a step-up in yield and low dollar price implying "significant upside in the bonds if Cemex's fundamentals improve," Citi said.

A second strategy is to use options to hedge a long position in the convertibles, and a third plan would be to buy the convertibles on a full hedge versus buying the straight debt.

Despite a recent management presentation in which the company focused on expected positive developments, the stocks and bonds fell due to investor concerns over the potential for a credit facility covenant breach.

Cemex has said it will sell assets and deleverage to avert a breach. But Cemex isn't likely to take out the convertibles to help deleverage because its lenders don't include the sub debt in the leverage calculation.

Citi says the mostly likely outcome for Cemex is that the company's operating results will improve modestly over time.

If the company were to default, which Citi thinks is unlikely, but more likely in the short term than further out, the subordinated convertibles would only recover a small amount given Cemex's $17 billion of secured debt.

Given the possibility of a credit event in the near term, Citi prefers the Cemex 3.75% (B) bonds. It says that the credit risk is mitigated in the out years of the bond's life, plus the issue's remaining coupons are in excess of its point premium, or 24 points of coupons to the issue's 2018 maturity compared to a 17 point premium.

Iconix expands about a point

Iconix's 2.5% convertibles due 2016, a $300 million deal that priced in May, traded at 97 versus an underlying share price of $18.35 during the session. The paper closed at about 97.5, an analyst said.

Compared to the closing share price of $18.50, the bonds looked to have expanded about 1.125 points on a dollar-neutral basis, the analyst said.

Iconix's 1.875% convertibles due 2012, due in less than a year, were at 99.375, up from 99, during the session, according to Trace data.

Shares of the New York-based branding company jumped out of the gate but slipped back into the red before bouncing back for a 14 cent, or nearly 1%, gain on the day.

In conjunction with its third-quarter earnings report Thursday, Iconix announced that it inked a deal to buy Sharper Image for about $66 million. The deal represents the company's first foray into the consumer electronics market.

The company also announced that it is extending a share repurchasing program expiring Oct. 31, with authorization to buy back $200 million of stock over the next four years.

Third-quarter earnings were a little lower than the year-earlier quarter but beat consensus estimates by a penny. Slightly lower revenue also beat estimates.

Guidance was a mixed bag, however. The company, formerly known as Candie's, reaffirmed full-year revenue, earnings and free cash flow guidance but lowered its outlook for 2012.

The company has clothing brands like Mossimo and Mudd as well as home product brands such as Royal Velvet and, Fieldcrest. It expects Sharper Image to be earnings neutral in 2011.

Mentioned in this article:

Cemex SAB de CV NYSE: CX

Clearwire Inc. Nasdaq: CLWR

DryShips Inc. Nasdaq: DRYS

Iconix Brand Group Inc. Nasdaq: ICON

MF Global Holdings Ltd. NYSE: MF

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