Century Aluminum ends at 100.875; telecoms mixed, Delta leads airlines lower

By Ronda Fears

Nashville, July 30 - As crude oil hit a fresh high of $43.80 a barrel, the transportation sector was impacted hard and none more than the already-beleaguered airline industry. Delta Air Lines Inc., the current poster child for financial woes among carriers, led the dive in airline paper Friday with its convertibles tumbling more than 3 points.

Telecom paper was widely mixed on the heels of AT&T Corp. credit getting cut to junk status. Corning Inc. and Lucent Technologies Inc. were both sharply lower along with Western Wireless Corp., which was speculated as a takeover target. But, market sources noted increased interest in European telecoms, such as Deutsche Telekom AG and Colt Telecom Group plc.

Overall it was a typical summer Friday session, however.

"I had the feeling there were lots of sellers earlier, but lately it seems there's better two-way action with the big and liquid stuff - Ford, GM, Tyco, Nortel, Lucent, et cetera," said a buyside market source on the West Coast.

Another buyside source said, though, that optimism about market recovery has diminished.

"The market doesn't feel like it has any legs, yet. Even companies with stellar earnings are dropping 10 to 30% when they announce," the trader said. "We see a buying surge for a day and then selling for two or three, so it's one step forward and then two steps back."

Jeff Seidel, head of U.S. convertible research at Credit Suisse First Boston, said there are no themes standing out right now, but convertible players in general are looking for high-delta setups in order to limit the impact of rising interest rates.

"We need a [new issue] calendar. That would be nice," Seidel said. "I just don't see it happening" perhaps for the rest of the year.

New deal activity has been very disappointing lately.

The latest among just a handful of deals this month, Century Aluminum Co.'s small $150 million overnighter, which priced at the cheap end of price talk at 1.75%, up 23%, edged a bit higher in the immediate aftermarket. The lead underwriter closed it at 100.875 bid, 101.375 offered while the stock dropped $1.37, or 5.5%, to $23.55.

In fact, July's total of $980 million, with only five deals, was the smallest monthly volume since $960 million came to market in September 2002, and it was particularly lame versus the $11.3 billion of new deals in July 2003.Year-to-date issuance is running behind last year by 46% at $33.42 billion compared with $72.63 billion at the same point in 2003.

Delta leads airline paper's dive

Among the most prominent declines in the convertible universe Friday, even amid thin trading, was that in the airline paper.

"I think we had some capitulation in all the airline paper after Yukos [Russia's largest oil company] was thought to be permanently shut down," said a convertible fund manager.

Oil prices skyrocketed in reaction to the OAO Yukos Oil Co. debacle, centered on a $3.4 billion tax bill in arrears which erupted onto the markets midweek, and the impact was compounded by attacks on oil infrastructure in Saudi Arabia and Iraq plus civil unrest in major OPEC producer Venezuela.

Crude oil futures rose to a new high of $43.85 a barrel on Friday before the September contract settled at an all-time record of $43.80, up $1.05, on the New York Mercantile Exchange.

The BBC reported Friday that Yukos, which produces an estimated 2% of the world's oil supply, has been given a month to settle a $3.4 billion tax bill, easing fears it might be forced into bankruptcy, but then new fears hit the markets on the possible constriction in OPEC oil supplies.

All the airlines have been crushed by rising fuel costs, and acutely at Delta where the company "went naked" without any hedges on fuel contracts early this year.

Delta's 2.875% convertibles dropped about 3.25 points to 49.25 bid, 50.25 offered and the 8s fell about 3.75 points to 46 bid, 46.875 offered, according to a sellside trader.

AMR Corp., parent to American Airlines Inc., convertibles dropped around a half-point with the new 4.5s at 67.5 bid, 68.5 offered and the 4.25s at 74 bid, 75 offered.

Northwest Airlines Corp. and Continental Airlines Inc. both saw their converts lose ground, as did the smaller regional carriers like JetBlue Airways Corp. and others.

Telecoms mixed on AT&T cut

The telecom group was reeling on Moody's cutting AT&T debt to junk, but there wasn't the wholesale selloff that had been feared. There was some selling, indeed, but traders also noted strong buying interest in European telecoms.

Among the high-profile, more liquid convertibles in the United States, Lucent's issues dropped about 1.5 points and Corning's lost about 0.5 to 1 point.

In the smaller issues, Primus Telecommunications Group Inc. and Western Wireless Corp. were standouts. Primus' converts and junk bonds tumbled sharply along with the stock on an unexpected second-quarter loss, while Western Wireless was getting pressure on a $500 million shelf registration filing Friday and speculation that it was a leading takeover target.

Regarding Western Wireless, traders said there weren't any surprises, but the timetable seems to be narrowing.

"The [Western Wireless] stock has run up nice for some time now so I think most everyone was expecting the company to raise money with a stock offering to pay off debt," a buyside trader said. "It just looks like maybe it's coming sooner than expected."

Western Wireless is also seen as "a prime takeover target as soon as the AT&T/Cingular deal is done."

Sellside convertible dealers noted strong interest in telecoms abroad, somewhat attributed to the selling in U.S. telecom paper.

Deutsche Telekom was mentioned specifically, as Moody's has put the credit on review for possible upgrade, with the 6.5% euro convertible up about a quarter-point to 110.625 bid, 110.875 offered. But Colt Telecom also was named, at least with interest shown in its longer-dated convertibles. The Colt Telecom 2% euro convertible due 2007 also was up about a quarter-point to 110.25 bid, 111 offered.

"DT is the major player in a sector that has become extremely competitive," said one dealer. "Some of this [interest] is from people who can look overseas for opportunities, because there's just not a lot of places [in the U.S.] to park your money."

Issuance seen slow rest of year

Lackluster convertible issuance, blamed perhaps ironically in part on strong corporate balance sheets, is not expected to get much better for the remainder of the year, according to market sources on the buyside as well as sellside, save those on the capital markets desks.

"Yes, [issuance will pick up]. It is light due to the equity market's choppiness, but deals are around, though small like Century Aluminum," said one top convertible underwriter.

"You won't get large cap if interest rates keep rising. Both high-yield and investment-grade markets are significantly down," the origination official continued. "Also, small caps are dependent on the equity market, [so] the Dow at 10,000 means very light issuance, the Dow at 11,000 would be a great calendar."

Potential buyers complain that the small issues have no lingering presence in the market, trading actively for a week at best. But moreover, buyside sources are not expecting much action for the remainder of 2004.

"If we can measure issuance with need to refinance and need for capex, I think we will have some mediocre issuance," said convertible market veteran Mike Revy.

"The amount of cash on balance sheets and the lack of corporate capex spending tells me issuance will be mediocre. Even if capex picks up, it seems like companies have generated enough money to get started on projects without needing any help from the financial markets."

CoCo ruling might be good

The market's initial reaction to a proposed new accounting rule requiring issuers of convertibles with contingent conversion features to estimate potential dilution to reported earnings per share was negative, but Revy said it may turn out to be something positive in the long run.

The proposal from the Emerging Issues Task Force, an arm of the Financial Accounting Standards Board, is scheduled to be discussed Sept. 29 and 30 by the panel, and numerous convertible market participants are preparing comments to submit.

"This is just a little pothole in the vast highway we're building for convertible securities and more efficient capital structures," Richard Ng-Yow, co-head of convertible origination at UBS Investment Bank, told Prospect News earlier this month when the topic surfaced.

"First we will fight the change because it is not justified," Ng-Yow said. "Second, if approved, we will take corrective actions [which, he added, would be a matter of wait and see]. Third, if approved, we adjust and customize just as the convertible market always has."

Venu Krishna, head of U.S. convertible research at Lehman Brothers, said that as long as the convertible market is competitively priced, it will remain active and healthy, particularly for smaller, non-investment-grade companies - the historical mainstay of issuers in the convertible market.

"I see the ruling against contingent conversion as a short-term negative for issuance, but long-term positive as issues coming from companies might really be trying to add shareholder value, not obfuscate EPS reports," Revy said. "Okay, that's a little harsh. What I mean is companies may do less financial engineering using converts and when/if they bring a convert they might be funding something interesting."

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