Citigroup analyst looks at potential trades for convertibles in chip sector

By Ronda Fears

Nashville, Dec. 9 - For exposure in the semiconductor sector, convertibles investors should consider the credit but also the potential gains as the stocks recover.

Lynn S. Hambright, convertible analyst at Citigroup Global Markets, studied 18 semiconductor companies that have 26 convertibles in play. She compared them by looking at three years of financial data. In general, she said she likes convertibles that are equity sensitive and are in that "sweet spot" where credit improvement coincides with lots of trading alternatives from the equity angle.

"Given the dynamic nature of our industry, we realize things change quickly. As such, we view our work as an ongoing process," Hambright said in the resulting report that was released Tuesday. "The impact of credit spreads gapping tighter was extremely apparent to us throughout this process. In fact, we re-priced this piece three times."

The greatest surprise, she said, was the tightness in the lower delta and lower quality credit names.

In the report, the universe of chip convertibles was segmented by type using delta, premium over parity and gamma, and then each bond was analyzed relative to similar bonds.

Included were Agere Systems Inc., Advanced Micro Devices Inc., Atmel Corp., Conexant Systems Inc., Cypress Semiconductor Corp., Fairchild Semiconductor Corp., GlobespanVirata Inc., International rectifier Corp., Lattice Semiconductor Corp., LSI Logic Corp., Micron Technology Inc., PMC-Sierra Inc., RF Micro Devices Inc., Skyworks Solutions Inc., Triquint Semiconductor Inc., Transwitch Corp., Vishay Intertechnology Inc. and Vitesse Semiconductor Corp.

The analyst ended up splitting the group into five segments: fixed income, fixed income - lotto ticket, equity exposure, hedged equity sensitive and equity sensitive - sweet spot.

Hambright described the equity sensitive sweet spot as where a higher delta, more reasonable premium over parity and high gamma characterize this group.

"Generally speaking this [equity sensitive - sweet spot] is our favorite space for trading opportunities - credit spread improvement, equity sensitivity, altering hedge ratios and gamma trading," Hambright said.

"We note maturities are a little longer and call protection is more of a factor."

She ended up interested in the Fairchild 5% due 2008, Lattice 0% due 2010, Micron 2.5% due 2010, LSI 4% due 2010. She was "fair" on the Skyworks 4.75% due 2007 and found the Agere 6.5% due 2009, Vishay 3.625% due 2023 "a tad rich."

Hambright described the fixed income - lotto ticket group as a fixed income play offering a chance at equity sensitivity.

"We focused on credit but given these companies are more established, we didn't need as big of a protective cash balance to make us comfortable," Hambright said.

She offered that 236 basis points over Treasuries "seems fair" for the remaining Cypress 3.75% due 2005, noting the potential for the company to be virtually debt free. She found the LSI 4% due 2006 "a tad ahead of itself" and offered a 345 basis points spread is more reasonable, while the ATML 0% due 2021 credit spread seemed wide and she preferred 490 basis points. PMC-Sierra's 3.75% due 2006 was in the group, also.

"Overall, we preferred this group [fixed income - lotto ticket] to the fixed income group - maturities weren't too different, business models seemed more established and the lotto ticket seemed free," Hambright said.

For the fixed income group, she considered the current cash balance and preservation of cash to assets, as well as the likelihood of bond retirement via redemption or repurchase as most important.

As the best credit in this group, she said, the RF Micro Devices 3.75% due 2005 at 220 basis points over Treasuries "gave us a starting point." From there she decided 405 basis points was more appropriate for both the Conexant 4.25% due 2006 and 4% due 2007, put the GlobespanVirata 5.25% due 2006 at 360 basis points and the Triquint 4% due 2007 at 375 basis points. Vitesse's 4% due 2005 was in the group, as well.

"But for the RF Micro Devices 3.75% due 2005, we found credit spreads in this group have moved too tight for our tastes - relative to each other and relative to bonds in our other groups," Hambright said.

In the equity exposure group, with higher delta and reasonable premium over parity group, "we're focused on credit but looking for more than just the preservation of assets," Hambright said. The solid credit International Rectifier 4.25% due 2007 was the starting point, she noted, adding that the Vishay 0% due 2021 was fairly priced while traditional Advanced Micro Devices' 4.75% due 2022 at 148 basis points "was way too tight." Transwitch's 5.45% due 2007 was in this group, too.

The equity sensitive group hedged with stock plus a put is the most efficiently traded group, and thus, the toughest area to make money, Hambright said. She offered that the RF Micro Devices 1.5% due 2010 "provides an opportunity to lower the hedge ratio as did straddle-like AMD 4.5% due 2007 and we punted on efficiently priced Cypress 1.25% due 2008."

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