Lower credits gain ground while high grades slip on call repricing; Hilton deal slides in aftermarket

By Ronda Fears

Nashville, April 16 - It was still a thin market in convertibles Wednesday, but traders made noteworthy mention of lower credit quality names gaining steam for a variety of reasons, usually name specific, while several high-grade issues lost ground as players reprice them due to the widespread call alert in the convertible market.

Flow was really light and one dealer commented: "If you think it's bad today, wait until tomorrow."

El Paso Corp. and Charter Communications Inc. were having another good day, said traders who handle mostly high-yield names.

Conversely, high-grade credits like American International Group Inc., Pride International Inc. and Avon Products Inc. were down sharply due to increased anxiety over upcoming calls or puts, along with other factors like huge drops in the underlying stocks.

Desks that were already light got lighter due to Passover, which began late Wednesday. But many were looking forward to getting through Thursday and a long weekend due to the markets being closed on Good Friday.

Wednesday started with a bang of sorts as Hilton Hotels Corp. priced $500 million of new convertibles in another "breakfast deal" that priced before the open.

Hilton is using part of the proceeds to redeem its 5% convertibles due 2006, which are callable May 15 at par. Also Wednesday, Union Pacific Corp. announced it would redeem $500 million of its 6.25% convertible preferreds on May 16 - about a third of the issue.

But those are just the very latest of a string of redemptions. According to Citigroup convertible analyst Adrian Miller, there are 211 issues callable in 2003, including 148 convertible bonds and 60 preferreds or mandatories.

"The recent Hilton convertible continues a trend of companies refinancing existing straight and convertible debt by using the convertible market," Miller said.

"With rates being at their historic lows couple with an accommodating environment for bizarre pricing within the convertible market, an increased opportunity for companies to issue convertibles for the purpose of calling their typically higher coupon convertible is being presented."

The decision making process by the management of these companies can be and has been very different when determining whether the call a convertible bond versus a convertible preferred, Miller added, and investors can take into account the structure when trying to determine how aggressive companies may be in calling an issue.

Hilton picked a window and its bankers for the offering said it was a very good window, noting market response to the deal was upbeat in that it keeps a "key benchmark name" in the convertible universe, even though the Dow Jones Industrial Average ended down by 1.6%.

Deutsche Bank Securities Inc. and UBS Warburg were joint book-running lead managers for the deal.

It was opportunistic capital-raising, and many observed that the banks bent over backward to get it done, like several of the top convertible underwriters have done on recent deals.

Hilton sold the 20-year convertible senior unsecured notes at par with a 3.375% coupon and 73.08% initial conversion premium. It was re-priced by the underwriters at 98 to buyers, resulting in a yield to put of 3.821% and 69.6% conversion premium.

"It makes a great deal of sense to redeem an existing 5% note that is callable and to replace it with a significantly reduced interest expense, extended maturity and have the results be accretive to earnings," said a source who worked closely on the Hilton deal.

"The company really got themselves an awesome deal - low interest expense and, excluding deals that required additional warrant coverage, the highest conversion premium offered to market to date," which makes a convertible more appealing to issuers, although often times less appealing to buyers.

Indeed, many market participants have been surprised that new deal flow in converts has not been heavier, given the issuer-friendly terms that have evoked phrases like "free money" and "free-er money" from the buyside.

"I expect a torrent of new paper toward the end of April, early May," essentially after the earnings reporting season, said one market source.

"Who wouldn't?" he posed, with the terms issuers are getting these days. "Who wouldn't!" he added with emphasis.

But issuers will have to act quickly, others say, as something of a buyers strike is under way - evidenced by at least four deals, including the Hilton deal, getting re-priced by the bankers at a discount to buyers as potential investors have finally balked at the ever-shrinking yields and eye-popping premiums getting tacked to the new paper of late.

"The situation is, we haven't seen fee compression in the U.S. market really and now we're starting to see that," said another bank source working on the Hilton deal.

"At the moment, banks are willing to be more aggressive and give up some fee. They [the buyside] appear to be grateful, as it keeps the product alive. And it keeps valuations higher."

The banks effectively lower their fees by re-pricing the deals at a discount to buyers, as the issuer still gets the full amount of the deal.

Most market participants, hedge funds and outrights alike, agree that the terms on convertibles thus far in 2002 and the avant-guard structures have been designed by the bankers in order to lure issuers to the convertible market.

Ted Southworth, portfolio manager at Northern Trust Co., noted at this year's Goldman Sachs convertible conference he wanted to ask the banker making a presentation if there would ever be any more classic convertibles, because the banker made it sound like plain vanilla convertibles were altogether a thing of the past.

Another buyside source from the hedge fund community recently commented in reference to the new Photronics Inc. deal that at least it fits into a convertible model.

Even with the discounted price to buyers, sellside analysts put the new Hilton convertible anywhere from just 1.36% cheap to 2.29% rich.

"It looks like they were trying to get it close to fair value," said a buyside source on the West Coast.

"That helped swallow a 73% premium. The coupon was the best we've seen in a long while, too, and it is a name people have already made money on in convertibles.

Elsewhere there really was little trading going on, dealers said.

The junkier, or even distressed, credits continued to rally on hopes of refinancing or turnaround events, while several better credits were marked sharply lower as the market continues to re-evaluate levels based on upcoming call schedules.

Charter's converts "were off their highs, but had another good day," said Michael Vaughn, head convertible trader at CRT Capital Markets.

"We changed our recommendation on Charter from sell to hold, based on the Comcast deal adding value at the holding company level."

Charter's converts have been moving up all week, due to a deal between majority stakeholder Paul Allen's negotiations with Comcast Corp. whereby his investment vehicle, Vulcan Inc., essentially would give cable systems in Texas or New England to Comcast instead of the $725 million that it would cost to pay the put that Comcast can exercise for its stake in Charter acquired with AT&T Broadband.

Also, investors have gained encouragement from the $300 million loan to Charter from Allen, even though it was disclosed in Charter's 10-K filing on Tuesday that the Securities and Exchange Commission investigation into its accounting practices that began on an informal basis in November was made a formal investigation in January.

The Charter 5.75% due 2005 moved up another 1.125 points to 35.625 bid, 37.625 offered and the 4.75% due 2006 gained 2.125 points to 33.625 bid, 353.625 offered.

Charter shares ended unchanged on heavy volume at $1.25.

El Paso also had a nice day, Vaughn said, noting that CRT put a buy recommendation across the entire capital structure - bonds, preferreds and equity.

The El Paso 0% convertibles gained about 1 point to 40 bid, 40.5 offered. The 5.25% convertible preferreds added 0.5 point to 24.5 bid, 24.75 offered and the 9% mandatory gained 0.5 point to 27.5 bid, 27.75 offered.

El Paso shares closed up 7c, or 1.05%, to $6.75.

The market was pleased that El Paso had news on renewing its bank facilities, which has been anticipated for some time now but with increasing optimism as other energy companies like AES Corp. and CMS Energy have been able to renegotiate bank facilities.

El Paso said Wednesday that it has entered into a new $3 billion revolving credit facility that will push out the maturity date, and restructured $750 million in project interests into a term loan. The new revolver is due June 2005, replacing the previous $3 billion revolver that had a one-year term-out option to May 2004.

El Paso said its existing $1 billion revolving facility, which matures in August 2003, and some $1 billion of other bank facilities will remain in place with no change in maturity. However, key financial covenants have been conformed to the $3 billion facility and they will share in the collateral being provided to that facility.

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