Players eye utility mandatories for chances to boost cash flow

By Ronda Fears

Nashville, Tenn., Oct. 14 - It was a thin trading session on Columbus Day as many convertibles players joined the credit markets for a day off.

Moreover, traders described convertibles as slightly higher with the major stock indexes edging up.

"Some people were kind of jockeying around in these utility mandatories," said Stuart Novick, a convertible analyst at Salomon Smith Barney.

Players are scanning the deck of utility mandatories looking for those with huge yields on the common stock, trying to guess who will be next to cut the dividend. Then, they must guess what will happen to the common stock price if that happened and adjust hedges, or buy/sell the mandatory.

"There's some big assumptions that have to be made," Novick said.

"You have to figure out who's cutting, how much they're going to cut [the common dividend] and then what the reaction in the common will be."

A lot of these utility stocks are trading very low, too, and that further complicates the guesswork.

Also, several have plans to sell stock, or have recently sold stock, and that presents a dilution effect.

But there could be opportunities to boost your cash flow in the mandatory if you make the right guess, Novick said.

Like with TXU Corp.

TXU said Monday, under pressure from the rating agencies, that it would slash its common dividend to 12.5c from 60c, an 80% drop.

The company's TXU Europe Ltd. unit was cut to junk Monday by Moody's and S&P, the latter of which also cut the parent's corporate credit rating to BBB from BBB+.

The common dividend put took TXU's newest mandatory, the 8.125%, into a positive 1% cash flow from a negative 4%, Novick said.

The TXU 8.125% mandatory traded down 1.82 points to 23.55 on very heavy volume of 1.3 million shares versus the average 85,200. There was heavy selling in TXU's 8.75% mandatory, too, and it dropped 3.39 points to 22.9 with 4 million shares changing hands, compared with the average 192,000.

TXU shares fell another $5.81 to close at $12.94. It is the third straight session in which the stock dropped by around $5.

Teco Energy Inc. is another getting eyed, with the common yielding about 12% right now.

In a surprise move last week, Teco sold another 17 million shares for $11 each, and the stock closed Monday down 69c to $11.20.

The Teco 9.5% mandatory ended off 0.4 point to 15.2 but there was very little volume in the issue.

Midwest power giant American Electric Power Co. Inc. also was getting attention, traders said, as it comes under fire regarding its European operations and power trading activities. The company lowered its 2002 profit estimates by 11% last week and said it was cutting exposure to trading and Europe.

AEP shares are yielding about 11.35% after closing Monday down by $1.36 to $19.78 on high volume.

The 9.25% mandatory dropped 1.4 points to 30.45, also with heavy volume.

Lots of the utility names are still pressured by liquidity issues and general investor uneasiness with the sector.

Dominion Resources Inc. Monday sold another 26.5 million shares at $39.35 each to raise about $1 billion in proceeds earmarked to repay debt, and last week said it would eliminate $900 million in capital spending through 2005 to strengthen its balance sheet.

Dominion's newest mandatory, the 8.75% issue, was down 0.31 point to 25.36 and the 9.5% was off 0.25 point to 42.25. The common stock closed down 33c to $39.35.

Planned cuts to spending put common dividends in jeopardy because often times a utility has spending obligations related to power purchases or construction projects.

Dominion and AEP have expressed that they have no plans to cut their common dividends, however.

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