Energy, power issues active; HealthSouth troubles mount; Allied Waste seen next week

By Ronda Fears

Nashville, March 27 - It was another rather uneventful session in convertibles Thursday with distressed power names remaining active on the California refund case while HealthSouth Corp. sank into the low teens - and some think that is optimistic - as it became official that the convertible will not get paid when it matures next Tuesday.

There are pockets of "random noise" going on, said Rao Aisola, head of convertible research at Bear Stearns & Co., but no major events clearly moving the market Thursday.

Late in the day Allied Waste Industries Inc. announced a $4 billion refinancing package - $3 billion of bank facilities, $300 million of mandatory convertibles, $300 million of high-yield notes, $100 million of common stock, $150 million of accounts receivables securitization and $300 million of divestitures.

The convertible deal, at least, is not expected to emerge with details until next week.

"Based on yesterday's FERC [Federal Energy Regulatory Commission] ruling, all the energy power producers were active traders today," said a convertible dealer.

The regulators in Washington ruled that 37 electricity suppliers should refund $3.3 billion to California as a result of alleged price-gouging and market manipulation in the 2000-2001 power crisis. It's a third of the $9 billion sought by California, but nearly twice as much as a FERC administrative judge set last fall.

There weren't sharp price swings in the power names Thursday as had been seen the day before but the trader said activity was brisk in the power names.

She noted that even some that weren't part of the ruling were active, such as AES Corp. AES has been firming up, though, on its own news of an asset sale earlier in the week. El Paso Corp., too, has been gaining on a stepped-up asset sale plan.

Mirant Corp. and Calpine Corp. were both named in the refund case.

Mirant's 2.5% convertible edged up about 0.625 point to 63 bid, 65 asked. The newer 5.75s were off by about the same amount, traders said. Mirant shares closed down 5c, or 3.2%, to $1.51.

Calpine's 4% convertible gained around 0.25 point to 65.5 bid, 66.5 asked. The stock closed up 14c, or 4.4%, to $3.35.

News continued to spew forth on HealthSouth Corp. and the converts traded as low as 10.5 before closing the day at 11.5 bid, 12.5 asked. The stock, which has been trading over the counter since Tuesday, ended down 0.016c, or 14.5%, to 0.094 cents.

On Thursday, HealthSouth's banks put an official stop on the convertible getting paid after having frozen the bank lines shortly after the headlines hit last week. Also during the day, the company's current chief financial officer was fired after pleading guilty to fraud along with his predecessor.

JPMorgan Chase Bank, the lead bank for HealthSouth's $1.25 billion credit facility, informed the company that it is prohibited from making the $17.2 million interest payment to holders of its 10.75% senior subordinated notes and a $349.8 million payment of principal and interest to holders of its 3.25% convertible subordinated debentures since the bank facility was deemed in default because of the charges pending against the company.

HealthSouth also fired its chief financial officer, William Owens, who pleaded guilty to fraud and has agreed to cooperate with prosecutors. Former CFO Weston Smith pleaded guilty to similar charges last week as the case emerged.

A buyside trader said the HealthSouth 10.75% notes were seen at 9 bid, which "leads me to think that the converts have more [downside] to go."

"The banks blocking payment on the converts was no surprise," the trader said.

"It's just that the real numbers haven't come out and when you see these guys pleading guilty you just can't think the worst is over. I don't think there's much doubt this company files bankruptcy soon."

Analysts estimate recovery levels for the converts could be as much as 30%, or - increasingly widely speculated - "worthless." (See story elsewhere in this issue.)

Moody's downgraded HealthSouth senior notes to Caa2 from Caa1 and kept them on review for possible further downgrade. The subordinated notes, including the convertible, were lowered to C from Caa3.

"The C ratings on the subordinated notes reflect Moody's view that recovery prospects for the subordinated bondholders are extremely poor," the rating agency said.

With all the bad headlines and the war dominating news, many convertible players are sitting on the sidelines.

Not only because of the events, but because it is difficult to nail down a strategy under current market conditions.

"I'm having to do a lot of work to find one or two ideas that pass muster," said Ted Southworth, a senior portfolio manager at Northern Trust Co.

"I don't see a lot of reasons to jump into the market.

"It used to be that in a time like this there would be considerable buying on weakness. People are not so quick to do that now because it may mean there's just more weakness to come due to the landmines like HealthSouth etc.

"I think that is keeping a lot of buyers from stepping in on a day like today," Southworth said.

With volatility coming in and the squeeze getting put on premiums, he hopes for more balance in the convertible market. The situation is causing some pain for the hedgers but it brings the convertible market profile more in line with the outright strategy.

Onlookers like Aisola at Bear Stearns, however, have noted that many of the hedge strategies - capital structure trades, for example - are not working for the arbs these days either.

Bottom line: there needs to be convertibles that fit the traditional convertible strategy.

"At the Goldman conference there was one of the banker types speaking, talking about the new structures," Southworth said.

"I wanted to ask if we were ever going to see a plain vanilla convertible deal again because he made it sound like that was a thing of the past."

It would help guide the market back toward valuation levels more in line with reality if there were more plain converts mixed in with the new-fangled contingent converts, many say.

"It's a long process of getting everyone back to reality," Southworth said.

Trading desks at some of the bulge bracket firms are trying to revive some names to move around in the secondary market, he said, but "there's nothing that really jumps out. I'm not seeing a lot of trends in leadership."

It's not a very forgiving market, either, and many times the baby gets thrown out with the dirty water, so to speak.

The short put/call strategy is being re-thought, for example.

Southworth said he's not buying anything because of a short-dated put or call, but noted it can cause the premium to compress and can make some of these bonds more attractive from an outright perspective - quite the opposite for arbs.

"One of the CCU bonds [2.625s] were offered a couple of days ago at 99 7/8 with the settlement date just ahead of the maturity [April 1] and I thought, 'who wants to take that risk?'" Southworth said.

"On another day I might have, but not now,"

Another market source also was talking about the call risk alert in the market, specifically a JPMorgan report from Wednesday on Avon Products' convert that perhaps had something to do with the bonds cheapening 0.5625 on the bid side and 0.8125 on the offer side.

The Avon converts are callable and putable on July 12 at 53.174. They were trading at about 54.5 earlier in the week, which would put the conversion premium at 18.7% with a yield-to-maturity of 3.5%.

Some market watchers think Avon may be planning to refinance the 0% convertible with a new convertible at better terms, as the newer contingent convertibles have tax and accounting advantages for issuers.

Avon senior management members are hosting an investor meeting in New York on Friday from 9 a.m. ET to provide an update on the company's strategies and outlook. It will be webcast as well.

By a long shot, the Avon issue isn't the only example of heightened call risk in the convertible market. Roughly 75 convertibles become callable in 2003.

The scare stems largely from the Costco Wholesale Corp. conference call a few weeks ago, when management mentioned it might call its 0% convert for cash.

Deutsche Bank Securities convertible analysts explored the big picture in a recent report, also noting the market's re-evaluation of issues with short-term puts or calls.

What the call risk has done, market sources say, is bring into question the traditional parity plus 20% call assumption made in calculating the valuation for convertibles.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.