Chesapeake drops after earnings miss, more McClendon headlines; Charming Shoppes gains

By Rebecca Melvin

New York, May 2 - Chesapeake Energy Corp.'s convertibles fell outright and by as much as 2 to 3 points on a dollar-neutral, or hedged, basis Wednesday as the underlying shares of the Oklahoma City-based natural gas company swung to a 52-week low on poor quarterly results that missed estimates and more headlines calling into question the business dealings of chief executive officer Aubrey McClendon.

Chesapeake shares and bonds had jumped higher on Tuesday when the company's board announced that it had stripped McClendon of his chairmanship, but retained him as chief executive.

McClendon is the focus of management concerns plaguing investors right now. But management is only one of two problems facing the company - the other is weak fundamentals.

"There are two things: the background noise with management, and then the fundamentals of the business, and people are concerned about both," a New York-based convertibles analyst said.

Meritor Inc.'s 4.625% convertibles added outright and improved about 0.5 point on a dollar-neutral basis after the Troy, Mich.-based truck parts supplier reported quarterly earnings that beat expectations.

Charming Shoppes Inc.'s convertibles surged 5 points in heavy volume to about 99.5 on word that the Bensalem, Pa.-based retailer is getting taken over by Ascena Retail Group Inc. for about $890 million, or $7.35 per share in cash, which was a 25% premium to Charming Shoppes' closing share price Tuesday.

More M&A activity

The Charming Shoppes deal puts mergers and acquisitions in the spotlight again, highlighting the fact that the market is split between companies with a lot of cash on their balance sheets and many that are struggling.

"The market is split between winners flush with cash and losers with tiny market caps," a Connecticut-based convertibles analyst said, when asked if convertibles players should expect to see a continuing trend toward boosted M&A activity.

Another source said that he saw the potential for more "takeouts."

"Some stocks have done very well, and others are languishing," the New York-based convertibles strategist said, adding that the valuations often move to extremes because stocks that go up, get chased higher; and stocks that go down continue to get sold off.

"I would think we see more deals that are immediately accretive to earnings," the strategist said.

Between the M&A news and Chesapeake's ongoing story, convertibles saw a burst of trading activity. More than $35 million of round lot trades changed hands between the Chesapeake's 2.5% convertibles and Chesapeake 2.75% convertibles, and there was $25 million of Charming Shoppes round-lot trades.

In addition, typical names were active. Intel Inc. traded $23 million and Amgen Inc. and Gilead Sciences Inc. each traded $20 million, a New York-based trader reported, citing Trace data.

Equities ended mixed after early losses tied to the latest ADP report on private sector hiring, which showed a weak increase of just 119,000 jobs added in the United States in April, below expectations for 175,000 new jobs and sharply lower than the downwardly revised gain of 201,000 jobs in March.

In other economic data, factory orders in March slipped 1.5% from February, which was in line with expectations.

Chesapeake chops lower

Chesapeake Energy's 2.5% convertibles due 2037 ended the trading session at 84 versus the closing underlying share price of $16.74. That was down about 5 points outright and 2 to 3 points on a dollar-neutral basis, according to a New York-based analyst.

A second source said the Chesapeake convertibles, of which there are four bond issues outstanding and two preferred issues, were all down about a point dollar neutral.

Trade was not one sided, but there was definitely two-way flow, sources said.

A second series of the Chesapeake 2.5% convertibles due 2037, which is a newer exchanged issue that trades at a slight discount to the original convertible due to illiquidity, ended the session at 83 versus the $16.74 closing share price.

Between the two series, the 2.5% convertibles have about $1 billion outstanding.

Both issues are putable and callable in May 2017 and are considered five-year paper. As such, they trade on about a 40% delta theoretically.

But many players have put them on a heavier delta to hedge out credit risk, an analyst said.

Chesapeake's 2.75% convertibles ended the session wrapped around 90, having traded between 89.5 and 92 during the session.

Chesapeake shares slid $2.86, or 14.6%, to $16.74, and represented the first time the stock has traded below $17.00 in three years.

Market players complained that the Chesapeake story keeps unfolding in increments and blamed the company for not getting all the bombshells out at one time.

"I'm sure they are under a phenomenal amount of pressure, but it would have been better to get it all out in one shot," a convertibles source said.

The source was referring to news from the board early Tuesday that McClendon was no longer going to be chairman, news which sent shares higher, and the earnings report after the market close Tuesday, which sent shares lower on Wednesday.

Chesapeake reported a net loss of $71 million, or 11 cents a share, for the first three months of the year, which was a narrower loss than in the year-earlier period.

But on an adjusted basis, the company earned 18 cents a share, which was well below estimates for 28 cents a share for the quarter.

Revenue was $2.4 billion, which was below estimates, but higher from $1.6 billion in revenue reported in the year-earlier period.

"There is certainly some risk because of the poor fundamentals in the market," a market source said. But the company "has a lot of assets, so people are generally comfortable with the credit."

As for the management quagmire, Reuters reported on Wednesday that for at least four years, McClendon ran a private hedge fund that traded in contracts for oil and natural gas.

"The guy probably shouldn't be running a major company," a convertibles source said.

"There are headlines every day about something that creates conflicts of interest," he said.

Nevertheless, investors should have been somewhat aware about risky behavior by management, the source argued, because in 2008 when McClendon faced a margin call on levered stock he held, he had to sell "hundreds of millions, and it was very well documented. He has a high risk tolerance."

Meritor expands 0.5 point

Meritor's 4.625% convertibles due 2026 traded last around 92.37, which was up a couple of points outright and about 0.5 point on a dollar-neutral basis.

Meritor shares added 18 cents, or 2.7%, to $6.92 in trading volume that was more than double the three-month average.

There is a mix of hedged and outright interest in the issue.

On Tuesday, the Meritor 4.625% convertibles traded between 91 and 91.875.

"Valuations on this name seemingly change on the hour," a trader said early Wednesday.

Meritor said net income rose to $20 million, or 21 cents per share, from $17 million, or 18 cents per share, a year ago.

Excluding items, Meritor earned 33 cents per share, easily beating the 25 cents per share that analysts had expected.

Revenue fell 1.7% to $1.16 billion as sales declines in Europe offset strong sales in North America.

The company said its aftermarket and trailer segment sales rose 2% to $263 million.

Gross margins rose to $134 million from $118 million. The company also reaffirmed guidance for full-year revenue of $4.8 billion. Analysts were expecting revenue of $4.9 billion.

Meritor's 4% convertibles due 2027 weren't seen in trade, but Trace had them at 80 at the end of the session.

Charming Shoppes jumps

Charming Shoppes' 1.125% convertibles due 2014 traded actively on Wednesday, adding 5 points to 99.5 from about 94.5 previously.

"They are trading at 6% yield to the deal closing on June," a trader said, referring to the buyout of Charming Shoppes by Ascena.

Shares of the Bensalem, Pa.-based retailer surged $1.41, or 24%, to $7.31 in ultra-heavy volume.

"I'm not that surprised [by the takeover]. They have a niche that they have carved out," a convertibles strategist said.

Charming Shoppes owns Lane Bryant, which sells large-size women's closing, as well as Fashion Bug and Catherines Plus Sizes. Ascena owns Dressbarn, Maurices and Justice brands.

Mentioned in this article:

Charming Shoppes Inc. Nasdaq: CHRS

Chesapeake Energy Corp. NYSE: CHK

Meritor Inc. Nasdaq: MTOR

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