Cephalon adds outright, flat on hedge after Teva bid; Teva adds too; International Coal up

By Rebecca Melvin

New York, May 2 - Cephalon Inc. traded a little higher outright and about in line, or flat, on a hedged basis on Monday after Teva Pharmaceuticals Industries Ltd. said it will buy the Frazer, Pa.-based biopharmaceutical company for $6.8 billion, a hefty premium over the Valeant Pharmaceuticals bid four weeks ago and 6% over Cephalon's closing share price on Friday.

"It was priced right for this kind of deal," a New York-based sellside trader said regarding Cephalon's two convertible bond issues, a good bit of which moved into hedged hands subsequent to the Valeant bid. Prior to the Valeant bid, they were held mostly by outright investors, market sources said.

Cephalon's 2% convertibles due 2015 and 2.5% convertibles due 2014 and Teva's series C convertibles, or the 0.25% convertibles of 2026, were the names of the day.

There were influences of a strong Merger Monday elsewhere, as well.

International Coal Group Inc. became the latest coal producer to be acquired as Arch Coal Inc. said it will pay $3.4 billion for International Coal in an all-cash deal to create the fourth-largest coal producer in the world and the second-largest metallurgical coal producer in the United States.

News related to a third tie up affected Tenet Healthcare Corp.'s convertible mandatory preferreds. But those preferreds weren't heard in trade after Community Health Systems Inc. raised its bid for Tenet by $1.75 per share to $7.25 per share. The underlying shares of both companies were lower as investors still weren't convinced about this deal.

Otherwise, trading volume was described as muted, a situation that has existed for several weeks in the convertible market, in tandem with very light new issuance.

"You've got $290 million of convertibles traded and $71.5 million of that is the takeover. So you've got barely over $200 million of bonds traded so far this afternoon; that's pitiful," the trader said.

Volume remained "fairly muted," a New York-based sellside convertibles analyst said, citing a "supply pipeline that is muted."

What May will bring remains difficult to say. "Last week we had a little bounce back from the week before," the analyst said. The analyst said that performance of the existing universe was decent. Outright return last week at 1.1% compared to the S&P 500 stock index's 2.1% return and a hedged return of 0%.

He cited an earnings tailwind as impetus for convertible bonds.

"April was a pretty solid month. Volume was muted, but performance was straight up. First-quarter results have been pretty strong, and we were slightly lower than the S&P," the analyst said.

The broader markets wavered and ended lower in the aftermath of news late Sunday that Al Qaeda leader Osama bin Laden had been killed in a firefight with U.S. forces.

The CBOE Volatility Index rose.

Cephalon flat on hedge

Cephalon's 2% convertibles due 2015 were up about 6 points outright to 174, but the jump was small compared to the 40-point leap subsequent to the unsolicited Valeant bid on March 29.

The Cephalon 2.5% convertibles due 2014 were up to 123 from 120.5.

Shares of the Frazer, Pa.-based biopharmaceutical company closed up $3.09, or 4%, to $80.11 on Monday.

"They moved in line," a New York-based trader said of the Cephalon convertibles. "People lost money when the first deal was announced."

Holders set up with the 2% bonds on an 85% delta and the 2.5% convertibles on a 75% delta "were roughly flat today," a New York-based sellside trader said.

Holders who were hedged a little less full would have done slightly better, he said.

Holders initially lost money, but there weren't that many hedged investors at the point when Valeant offered the rejected $73-per-share offer.

"Initially they lost money, but then [the convertibles] got priced to that or up a few points. It was priced for this kind of deal," the trader said.

The rejected Valeant offer was $73 a share when the stock was at $77. Valeant had said they would make a higher offer, but they didn't come through on that and stepped aside for Teva's $81.50-per-share offer.

"The main thing from the initial move was major compression on the 2.5%, but at the time they were almost entirely owned by outrights. Presumably a decent number had moved into swap hands, either arbs or dealers, between then and now," a second New York-based sellside trader said.

Teva said Monday it has agreed to buy Cephalon for $6.8 billion, which is 39% above Cephalon's share price on March 29, the last trading day before the unsolicited Valeant offer and 6% above the closing share price of Cephalon on Friday.

Teva expects $500 million in annual cost savings from the deal, which is says will be accretive to earnings immediately upon closing. The acquisition will expand Teva's presence in areas like oncology and the treatment of respiratory diseases, as well as pain management.

The combined company is expected to have $7 billion in annual sales of branded drugs. Cephalon had $2.8 billion revenue last year.

Last summer Teva bought German generic drugmaker Ratiopharm for €3.6 billion. Teva will finance the Cephalon deal using cash reserves, credit lines and bond issuance. It hired Credit Suisse as its financial adviser and Kirkland & Ellis as legal counsel.

Cephalon was advised by Deutsche Bank and Bank of America Merrill Lynch and Skadden Arps, Slate, Meagher & Flom.

"This was priced to an event; the game's over," a New York-based sellside trader said.

If one assumes the deal closes in five months, "that's breaking even right there, depending on the delta," the trader said, assuming a 65% delta on the 2.5% convertibles and an 85% to 90% delta on the 2% convertibles.

"The further out you go, the less stock you get," he said.

Teva adds a little, too

The equities of both Cephalon and Teva gained on Monday, indicating that investors think the deal is a good one for acquirer Teva, too.

Teva's 0.25% convertibles due 2026, or the series C convertibles, are the only significant issue that remains outstanding. Those bonds traded at 111.375, which was up 2.4 points on the day.

Teva shares gained $1.54, or 3.4%, to $47.27 on Monday.

International Coal rises

International Coal's 4% convertibles due 2017 were seen closing at 257.7 compared to 254.9 previously, according to a pricing source.

The International Coal 9% convertibles due 2012 were seen closing at 236.2, compared to 183.7 previously.

Shares of the Scott Depot, W.Va.-based International Coal surged $3.40, or 31%, to $14.43 in super heavy volume on Monday.

"This doesn't come as a surprise. This was touted as a highly possible takeover target in the coal sector," a New York-based sellside analyst said.

On an outright basis, the convertibles did fantastic, but with the bonds standing at nearly 200 prior to the deal with a 4% coupon, one has to assume that it has been shifting over to hedged players and not held outright, a sellside trader commented.

Mentioned in this article:

Cephalon Corp. Nasdaq: CEPH

International Coal Group Inc. NYSE: ICO

Tenet Healthcare Corp. NYSE: THC

Teva Pharmaceuticals Inc. Nasdaq: TEVA

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