CSG Systems gains to 102.75 bid; Digital River, Headwaters gain; Cendant 3.875s seen vulnerable

By Ronda Fears

Nashville, May 27 - New paper was the focus of the market Thursday, convertible traders said, and even with five new issues in the mix it was a slow afternoon as the market began to wind down for the upcoming three-day weekend.

Otherwise, traders said the market was a tad higher but feeling a little soft in spots, like energy issues and several telecoms such as Corning Inc.

Buyside sources are mixed on whether the convertible market has cheapened adequately to stimulate much buying. New-issue terms that seem aggressive in the face of a rising interest rate climate also send a perplexing signal.

"New deal terms are worsening again, versus our perception that the convertible market is looking cheaper," said a portfolio manager in New York, who is involved with multiple convertible strategies.

"Premiums have come in and, since April 2, we have seen some interest rate increases, in essence. But credit spreads did not tighten when Treasury yields began to rise. Investment values tended to decline.

"This was dire for those riding the [convertible] bonds down, but good for those looking to reinvest interest income."

Another market source said pain for the hedge funds doesn't appear to have reached a plateau yet, but could see some easing once the Federal Reserve moves to raise interest rates, possibly in June.

Despite several surprise calls and a generally elevated level of convertibles getting called away a market source on the West Coast said Cendant Corp.'s 3.875% issue is very susceptible to a big drop ahead of the approaching call date in November.

New paper mostly higher

The latest new convertible came from CSG Systems International Inc., and traders said it gained nicely in the immediate aftermarket.

CSG Systems sold the $200 million issue to yield 2.5% with a 43% initial conversion premium.

Bookrunner Lehman Brothers closed the CSG Systems convertible, which priced at the middle of yield talk for a 2.25% to 2.75% coupon and at the cheap end of premium guidance of 43% to 47%, at 102.75 bid, 103.25 offered. The underlying stock rose 85 cents, or 4.54%, to end at $19.57.

Englewood, Colo.-based CSG Systems provides next-generation billing and customer services for the cable television, satellite, advanced internet protocol services, next-generation mobile and fixed wireline markets.

Digital River Inc.'s 1.25% issue edged up 0.25 with bookrunner Credit Suisse First Boston closing it at 100.25 bid, 100.75 offered. The stock gained 26 cents, or 0.83%, to $31.60.

Headwaters Inc.'s 2.875% issue added 0.625 point to 99.375 bid, 100.375 offered with the stock up 24 cents, or 1.17%, to $20.83.

Cendant 3.375s due sharp drop

A sellside market source who declined to be identified said holders of the Cendant 3.375% convertible should consider taking profits now as the issue is trading some 6 points over the call price.

The 3.875% issue, at 106.5, has a current yield of 3.64%, 11.36% conversion premium and 40% delta. The call price is 100, on Nov. 27 later this year.

"These bonds are going to be taken out. The company has previously bought back one third of the issue and has indicated intent to redeem the balance when they come callable in November," he said.

"They have plenty of cash and, as can be seen [in the company's 10-Q filing], have bought the 24.5-28.5 call spread expiring in November and December to insure that when they call these there is no stock dilution. This call trades around 25.5 vol and is very liquid, with an open interest of over 20,000 contracts. The stock historically moves on an even lower volatility.

Levels imply expensive volatility

The Cendant bonds look rich, he said, particularly due to the low volatility in the stock.

"Despite these considerations and the public information regarding the company's intent to retire this debt, the converts currently imply 30 vol," the sellside analyst said.

"This valuation is difficult to justify, as capturing the 5.5 points these trade above bond floor seems very unlikely.

"I believe that the company calling these bonds will even further dampen volatility as people will be forced to buy in the stock they are short against the converts if [the] stock is below the strike price, and sell stock against their converts if [the] stock is above the strike price.

"With $800 million outstanding this will be significant influence to pin the stock. If you use 26 vol these converts look 1 point rich, and I think a slow summer could bring these in even more than that."

The convertible on Thursday was down by about 0.75 point to 105.9375 bid, 106.0625 offered, while Cendant shares ended up 2 cents, or 0.09%, to $22.97.

"The pain is not over yet," he said. The convertibles "have plenty of room to come in."

Cendant preps for call

In its 10-Q, Cendant outlines several measures it has taken to call the 3.375% convertibles on the call date in November.

In connection with such redemption, holders may elect to convert into 41.58 shares, and the company said it estimates that, as of Nov. 27, this conversion rate will be equivalent to a conversion price of around $24.50 per share.

To offset a portion of the dilution that would occur if the holders elect to convert in connection with the company's anticipated redemption, the company said in the 10-Q that it had purchased call spread options on April 30 covering 16.3 million of the 33.4 million shares issuable upon conversion.

The call spread options have a lower strike price of $24.50 and a higher strike price of $28.50, settling in November and December, the company said.

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