Level 3 gains 2 points on massive credit spread blowout; Adelphia whipsaws, ends in 40s

By Ronda Fears

Nashville, Feb. 25 - Buyers swooped into the convertible market Wednesday on the recent cheapening, with Level 3 Communications Inc. as one of the more eye-popping situations as the credit spread on its two 6% converts have widened in the neighborhood of 800 to 900 basis points in the past three weeks. Adelphia Communications Corp. was another big mover after filing a reorganization plan.

Meanwhile, in the primary market, Houston-based Veritas DGC Inc., an oil well servicing firm, launched a $125 million floating-rate convertible talked to yield three-month Libor minus 25 basis points to plus 25 basis points, with a 43% to 47% initial conversion premium.

At bat was MGI Pharma Inc. with $200 million in proceeds of 20-year discount cash-to-zero convertible notes with guidance for a yield to maturity of 2.0% to 2.5% and a 30% to 35% initial conversion premium. The issue was seen offered in the gray market at 0.125 point over issue price with no bid. The stock ended Wednesday down $1.02, or 2%, to $48.40.

Market sources also noted that an Israel newspaper reported Tuesday that Amdocs Ltd., a Chesterfield, Mo.-based firm that provides billing software for telephone companies, plans to sell $500 million in convertible bonds. Calls to the company were not returned by press time.

According to the news article, proceeds from the new issue would be used to roll over the convertible it sold in 2001, a $400 million issue that becomes putable on June 1, plus add to its cash coffers of about $1.2 billion. Amdocs shares closed Wednesday up 15 cents, or 0.54%, to $27.90. The 0% convertible due 2021, putable at par, was quoted at 99 bid, 101 offered.

Spread, vol, hedge ideas swirl

Convertible players have been scouring the market for opportunities, and research, or any ideas, has become a premium on The Street.

While new issues continue to price rather aggressively, according to buyside sources, traders had been commenting the past couple of days that convertible players seemed to be poised to pounce on several convertibles with declining stocks, once spreads widened notably.

Volatility also has been a closely watched area, and on Wednesday, Lehman Brothers launched a new, standing report on convertible volatility with a conference call. Venu Krishna, head of U.S. convertible research, and James Hosker, head of U.S. volatility research, teamed up on the call.

The Lehman analysts, however, don't see much of a pick up in volatility until the second half of this year. Owning volatility hasn't been very profitable yet, they said.

In a maverick line of thought, a source at another sellside shop on Wednesday mentioned investigating a reverse hedge strategy on certain convertible names, where one would be long the stock or calls and short the bond. But he said it was something still being mulled over, so there were no specific names to mention.

Level 3 gains

Level 3 produced an unmistakable reaction Wednesday on the spread expansion in the 6s, which widened to around 1,500 basis points from the 600 to 700 basis points area just about three weeks ago, on the stock's backtracking to nearly its 52-week low after reaching a new high in mid-January.

"The stock has been leaking badly," one source commented. "With the equity getting killed, the credit got pushed out."

A trader put it like this: "The spreads are getting whacked."

Level 3 shares closed Wednesday up a nickel, or 1.14%, to $4.45. The 52-week range is $4.12 to $7.90, the highest of which was hit about five weeks ago.

Some onlookers were speculating it was a delayed reaction to Warren Buffet of Berkshire Hathaway Inc., or better known as the Oracle of Omaha, cutting his stake in the high-speed communications network operator in recent months.

Others said it was just an over-reaction to the pullback taking place throughout the telecom sector.

In any event, a buyside trader said he's "glad finally to get paid for some risk."

The 6% convertibles, which fell 7 to 9 points on Tuesday, reversed course Wednesday, and each added around 2 points, on an outright position, to the low-60s. Level 3's new 2.875% convertibles were little changed at about 88.5.

Adelphia ends higher

Adelphia Communications Inc. was on a wild ride, too, as the Greenwood Village, Colo.-based cable company filed its long-awaited reorganization plan Wednesday.

Even though exact recovery levels were not laid out in the plan, the converts, which have been spiraling swiftly in the past two weeks, opened Wednesday with a bid in the low 30s - versus the late Tuesday offer of 44 - but settled out the day in the mid-40s area.

"They [Adelphia converts] had a huge runup, in the mid-60s and hit a wall," a convertible market source said.

The runup was almost entirely due to their being such a dearth of distressed paper, a trader said, noting that when Adelphia filed bankruptcy nearly two years ago "the best estimate was a 30-cent recovery level, and most people thought it would be slim to none."

A trader said the optimism that emerged stems from continuing market chatter that Adelphia or some of its assets might be an acquisition target for some company like Time Warner Inc.'s cable unit.

While recovery amounts are not known for each class of creditors, Adelphia said it has secured $8.8 billion in exit financing via J.P. Morgan Chase & Co., Citigroup Inc., Credit Suisse First Boston and Deutsche Bank.

Before the company filed bankruptcy in mid-2001, it had $9.37 billion in debt with some 15 series of subordinated notes or debentures, including the 6% and 3.25% convertible notes. The company also has three convertible preferred series.

Excluding amounts held by the Rigas family, as of March 31, 2001, the company showed on its balance sheet that there was $862.5 million outstanding on the 6s and $575 million on the 3.25s.

Entities controlled by the Rigas family own $167.4 million of a separate class of the 6% issue and $400 million of a separate class of the 3.25% issue, Adelphia said when filing the bankruptcy case, which will immediately be transferred to the company, thereby reducing balance sheet debt by $567.4 million.

The Rigas family will receive no payments for their claims in the bankruptcy, Adelphia said. Adelphia founder John Rigas, his sons Timothy and Michael, and Adelphia's former director of internal reporting, Michael Mulcahey, are charged with fraud and their trial began in New York earlier this week.

Early on in the Adelphia scandal, before the bankruptcy was filed, some convertible players and observers had been calculating that recovery for Adelphia convertible holders could be as high as 70%.

Moody's said that recovery levels indeed could be 75% to 80% for the straight debt but convertible holders - the notes as well as preferreds - would get much less, if anything.

"Convertible subordinated noteholders and preferred stock holders are not expected to fare nearly as well and may in fact recover very little, if anything, relative to the face value of their claims," a Moody's analyst said at the time. "The common equity on the company will almost certainly be wiped out in its entirety."

In mid-June, when two Adelphia units filed bankruptcy, only a couple of weeks before the parent took the plunge, the converts went into a freefall that sent the issues to single-digit levels.

Comtech issue up on forecast

Comtech Telecommunications Corp. also got a nice bounce after it boosted its guidance for second quarter due to better-than-expected mobile data sales. The new 2% convertible climbed about 3.25 points on the news, while the stock surged 14%

Comtech shares zoomed after the company raised its fiscal second-quarter earnings per share outlook to 31-33 cents from an earlier 24 -26 cents, which compares to the First Call average estimate by analysts of 25 cents. For fiscal 2004, the company is increasing its outlook to $1.09 to $1.14.

The Melville, N.Y.-based company, which makes telecom equipment such as mobile data communications and radio frequency microwave amplifiers, said its sales have been higher due to a shift in the timing of U.S. army orders and a better product mix in telecom transmission.

Comtech is scheduled to report fiscal second quarter earnings March 10.

The new 2% convertible senior notes due 2024 ended Wednesday at 93.25 bid, 93.75 offered, which a trader said was up from "around 90-ish" on Tuesday. The underlying stock soared $3.21, or 12.94%, to $28.01.

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