Gap bonds gap up on improved sales; junk funds see $1.1 billion of inflows

By Paul Deckelman and Paul A. Harris

New York, Nov. 7 - The Gap Inc. did something in October that it hasn't done in well over two years - show a year-over-year increase in monthly same-store sales totals. The underperforming retailer's bonds firmed smartly on the news Thursday, and its shares rose as well.

High yield players who put in a little extra time at their desks Thursday in anticipation of Friday's shortened session also learned that junk bond mutual funds - considered a reliable measure of overall liquidity trends in the speculative grade bond market - showed a mammoth $1.104 billion inflow in the week ended Wednesday, according to statistics released by AMG Data Services of Arcata, Calif.

Market sources reported that number late in the day, after trading wound down for the session. While the number is huge - the biggest inflow since a record-breaking $1.556 billion seen in the week ended Aug. 28 - its impact on market trading may be limited, with an abbreviated session slated ahead of Monday's Veterans' Day holiday. The Bond Market Association has recommended a 2 p.m. ET close for the debt markets on Friday and a complete shutdown on Monday, although the equity marts will be in session.

The latest week's big inflow was the fourth in a row, coming on the heels of last week's nearly $684 million of inflow money. Inflows have now been seen in 26 weeks out of the 45 since the start of the year, according to an analysis of the AMG figures by Prospect News, with cumulative year-to-date net inflows totaling $5.784 billion, counting only those funds which report on a weekly basis, and excluding distributions.

Approximately $2.41 billion more has flowed into the high yield funds over the past four weeks than has left them, clearly establishing a positive liquidity trend and pointing the way toward both the likely appearance of primary issuers hoping to opportunistically take advantage of the easy liquidity conditions in the market as well as a continuation of the recent secondary market trend that has seen prices bid up - as the relative shortage of recent new-deal paper has run up against the need of portfolio managers to put their cash to work.

The standout performer in the secondary market on Thursday was The Gap, basking in the glow of the company's first monthly same-store sales increase from year-earlier levels in two-and-a-half years.

When a trader was asked whether Gap bonds had gone anywhere in the wake of the positive numbers, he exclaimed: "Boy, did they ever!" He quoted the Gap's 8.80% notes due 2008 as "the bond of choice today" in terms of market activity, noting that the notes had opened around 102.5 bid/104.5 offered, had pushed as high as 106 bid/108 bid, and then had eased a bit off those peaks to close at 104.5 bid/105.5 offered.

Other Gap paper was likewise firmer, with the company's 6.90% notes due 2007, which had opened at 91 bid/93 offered, rising to 95 bid/97 offered. They closed at 93 bid/95 offered.

Gap's 5 5/8% notes due 2003 were not much changed in quiet dealings, firming half a point to bid levels around par.

Gap shares meanwhile rose 65 cents (5.09%) in New York Stock Exchange dealings, to close at $13.42 on volume of 16.2 million shares, about three times the norm.

The San Francisco-based apparel retailer - which owns the eponymous Gap clothing store chain, as well as the well-known Old Navy and Banana Republic clothing outlets, reported that sales at those stores open at least a year increased 11% in October from year-earlier levels - almost double the 6% increase analysts had been expecting.

The Gap had been on a 30-month losing streak, but the size of the same-store sales declines had been steadily going down over the past few months, leading analysts to believe that it would finally manage to post a gain.

"Prior to today, everyone was expecting stronger numbers for The Gap," said Debra Anne Downey, senior vice president for high yield research at Miller Tabak Roberts, "but no one expected it to be up by 11%."

It looks like The Gap, she noted, "has been going back to basics" to try to pump up sales and end its losing streak. The merchandise mix at the company's flagship store chain has recently tended more toward more traditional basic offerings in khaki and denim - a change from what Gap stores were carrying a year ago, when they went in for more cutting-edge style fashions - a costly gamble which failed to ignite sales.

But do the surprisingly strong numbers posted by the Gap in October point the way to a lucrative November-December holiday selling season? Not necessarily, said Downey, noting that "unfortunately, October is not a strong [predictive] month in the retail industry - it's a clearance month," as retailers try to move as much inventory as possible and thus clear out space for merchandise they'll be selling over the next two months, particularly in the month long shopping season that kicks off the day after Thanksgiving.

"The fact that The Gap's numbers were positive - I think that was expected. That they were so strongly positive - that was a surprise. However, before you can say that The Gap is out of the woods, you have to put it in perspective - that October is not a very important month when it comes to forecasting. It's definitely a more of a positive than it's been - but you want to see a trend [of rising year-over-year sales] in November and definitely December" before pronouncing that Gap has turned the corner, the analyst said.

Gap's turnaround could be blunted, she cautioned, by the lingering effects of the recent West Coast dock labor troubles, which curbed the flow of apparel made in Asia to U.S. retailers. Although the dockers have gone back to work during an 80-day cooling-off period ordered by the White House while the port operators and the union try to resolve their dispute, "there's still a big traffic block there of getting the goods out" and on the shelves of U.S. store chains in time for the holiday season.

Downey also noted that Gap's year-ago figures were particularly low in the wake of the Sept. 11 terrorist attacks against the U.S.; the company had a large and busy Banana Republic outlet, as well as one of its flagship Gap stores right in the underground shopping concourse at the World Trade Center; both were destroyed in the attacks, which helped bring down the sales figures for last September and the subsequent months. "You would expect the comps [comparable store sales figures] to be better this year," she said.

The company said in a news release that it expected per-share earnings for the just-completed quarter to come in around 12 to 14 cents - double the six cents per share Wall Street is looking for.

Doubling anticipated earnings from what the investment community expects seems to be kind of a stretch, Downey observed, "especially in this kind of environment"

Downey further noted that retailers in general had been helped by "the cold weather which came in unexpectedly" in many parts of the U.S. last month, which helped spurt sales of outerwear. She said another high-yield retailer whose recent numbers have been "horrible" - but which turned in strong October results - was J. Crew, which said that sales had really picked up over the last three weeks of the month "when the cold weather really began to kick in."

Downey opined that given the impact of cold weather on this year's earlier-than-usual sales of outerwear and the retailers' low numbers from a year ago in the wake of 9/11, "an easier comp to beat, any of these [October] numbers have to be taken with a grain of salt."

J. Crew bonds, meantime, moved up the same way the Gap paper had on the better sales data, a trader said, pushing up to the mid-70s from the lower 70s.

A trader said bankrupt Kmart Corp. bonds were "well bid for" at levels around 21-23. "There were buyers around, but with very few bonds to be found."

Outside of retailing, Nextel Communications Inc. bonds were firmer on unsubstantiated market rumors - reported by Internet investment websites - that regional phone giant Verizon Communications had expressed interest in Nextel as a possible acquisition target. "Yeah, there were rumors going around," a trader said in quoting Nextel's benchmark 9 3/8% notes due 2009 up about three-quarters of a point, at 87.5 bid/88.5 offered.

He also quoted United Airlines bonds - which had risen strongly over the past several sessions on news of a debt restructuring deal that eases its immediate liquidity concerns - off a few points on apparent profit-taking on the gains; United's 10.67% notes due 2004 dipped to 37 bid/39 offered from prior levels around 41.

United "just got up there and kind of stalled out," another trader said in noting Thursday's dip. He also saw American Airlines paper holding steady around 50 bid.

The trader saw bankrupt WorldCom Inc. bonds firmer, in the 19-19.25 bid range, all trading on top of one another. Those bonds had firmed from depths as low as around 12-13 over the past two weeks of so after the troubled phone giant reported positive cash-flow numbers for July and August.

During Thursday's session, the high-yield market seemed to be standing off watching equities descend in the wake of the Federal Reserve's 50 basis points cut in the Fed Funds rate on Wednesday.

"People interpret what the Fed did in different ways," one official from the sell-side told Prospect News late Thursday.

"The equity market didn't seem to like it too much," the sell-sider added, alluding to the 185-point drop in the Dow Jones Industrial Average (2.11%).

"However we've seen 10-year Treasuries rally by 18 basis points today," the source said. "So we could have a very interesting year-end because I think that investors probably remain under-invested for the year; we know, certainly, that private placement investors are under-invested.

"I think that's probably an indicator that the market at large is not fully invested. That's why you saw Owens upsize. You saw Dex get done after some tweaking. And I think Donnelley is going to do okay," the source added regarding the market's expectation that R.H. Donnelley Corp., the Purchase, N.Y. yellow pages advertising marketer, will bring a two-tranche $750 million notes offering via Salomon Smith Barney, Bear Stearns & Co. and Deutsche Bank Securities Inc., to help finance its $2.23 billion acquisition of Sprint's directory publishing business.

Market sources say the Rule 144A deal could launch during the week of Nov. 11.

"It's a healthy amount of yellow pages publishing," the above-quoted sell-side official said, regarding the aggregate amount of the three-quarters of a billion from Donnelley and the $975 million Dex Media East LLC/Dex Media Finance Co. that priced in late October.

The source also stated the expectation that the Kohlberg Kravis Roberts & Co. LBO of the Bell Canada directories business would produce additional bonds from the sector.

"There have been mixed reports," the high yield sell-sider said. "I heard that they were going to try to do a bank deal and just a big B loan. But I don't know how you do that deal without having a layer of subordinated debt. I don't think you do an all-senior deal. So unless they are trying to put in a bunch of equity or have some other mezzanine sources lined up I wouldn't be surprised if we see a bond out of that deal."

Dex then Donnelley then BCE: it adds up to a substantial burst of issuance from the directories business, the official conceded. However, the sell-sider stipulated, when you look at the directories issuance as a percentage of the high-yield market "it's still a pretty insignificant percentage.

"There's no danger of overexposure, but the percentage could ramp up quicker just because there is a flurry of activity."

No deals priced Thursday, and no word of new launches was heard.

Early in the session Diageo, which had announced in July the proposed sale of Burger King Corp. to a buyer group composed of Texas Pacific Group, Bain Capital and Goldman Sachs Capital Partners, stated in a press release that in the light of the conditions existing in Burger King's markets relative to performance targets the buyers were seeking to renegotiate the deal. Financing for LBO was heard to include $500 million of notes in dollars, pounds and euros via JP Morgan and Salomon Smith Barney.

"The performance at BK since July 1 has not been as promising as the year prior, which ended in June," a spokesman for Diageo told Prospect News Thursday.

"As a result the buyer is now renegotiating on the price," the source added, declining to comment specifically on the financing.

The press release stated that the negotiation could be carried on over the course of the "the next few weeks."

Finally Thursday, although some sources told Prospect News that they anticipated hearing terms on Constar International, Inc.'s $200 million of 10-year senior subordinated notes (B3/B) via Salomon Smith Barney and Deutsche Bank, late in the session no terms had been heard.

The deal, to help fund the spin-off of Constar from Crown Cork & Seal and to repay debt to Crown Cork & Seal, was talked Wednesday at 10¾%-11%.

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