Level 3 jumps, Broadwing trips on buyout; ICOS gains on Eli Lilly offer; Home Properties launches deal

By Kenneth Lim

Boston, Oct. 17 - Corporate takeovers dominated trading in the convertible bond market on Tuesday, with Level 3 Communications Inc. climbing several points after it announced plans to buy Broadwing Corp. for $1.4 billion in cash and stock.

Broadwing, however, fell on a dollar-neutral basis over concerns that the make-whole premium would not be enough for hedged investors.

ICOS Corp. shot up to just a touch short of par after its larger drug partner, Eli Lilly and Co., agreed to buy the company for $2.1 billion in cash, which would trigger the change of control put.

From the primary market, Home Properties Inc. said it plans to sell $175 million of 20-year exchangeable senior notes. Pricing is expected Wednesday after the market closes.

Level 3 gains, Broadwing falters

Level 3 and Broadwing improved outright on Tuesday after Level 3 said it was buying the smaller company, but Broadwing's convertible fell about 5 points on a dollar-neutral basis on concerns that the paper could be taken out of the market.

Level 3's 3.5% convertible due 2012 gained about 5 points outright, trading at 122 against a stock price of $5.55 early in the day. The 5.25% convertible due 2011 quoted about 6 points higher outright at 162 versus a $5.82 stock price, while the 10% convertible due 2011 also rose to 188.25 against a stock price of $5.82.

Level 3 stock (Nasdaq: LVLT) closed at $6.02, up by 13.16% or 70 cents.

"The Level 3 converts did OK," a buyside convertible bond trader said. "If anything, it was a slightly positive credit event."

The deal did not rub off as well on Broadwing's 3.125% convertible due 2026, which came in about 5 points on a dollar-neutral basis despite an outright gain. The Broadwing convertible was marked at 114.375 versus a stock price of $15.50.

Broadwing stock (Nasdaq: BWNG) jumped 19.73% or $2.62 to close at $15.90.

Broomfield, Colo.-based Level 3 on Tuesday said it is offering $8.18 in cash and 1.3411 Level 3 shares per share of Broadwing common stock. Based on the Level 3's closing stock price on Monday, the deal was worth about $1.4 billion, of which $744 million would be in cash. Austin-based Broadwing's directors have agreed to the offer, but it still needs the approval of Broadwing shareholders.

Broadwing and Level 3 provide communications and network services to communications providers and corporate customers.

"I'd say I was surprised," the buyside trader said of the news.

A sellside convertible bond analyst said Broadwing chief executive Stephen E. Courter, who was appointed in July 2006, "had a history of going into companies and turning them around...and selling them."

"I don't think that Broadwing being sold was that big of a surprise, but them being sold so soon was definitely unexpected," the analyst said. "I don't think people were expecting them to be sold so soon."

The deal makes sense strategically for both companies, the analyst said. Level 3, which has been an aggressive acquirer this year, will further expand its network, while Broadwing benefits from the resources of the larger company.

"It's a great deal strategically," the analyst said. "Level 3 is really turning around, and it gives them a lot more access to the entire market. Broadwing was a little small, so they did need to find a bigger partner."

Broadwing's credit quality is also better than Level 3's, so the deal will actually be better for the credit profile of the acquirer. Broadwing, unfortunately, receives no such benefit. "Level 3 pretty much crushes their credit," the analyst said.

Hedged holders of Broadwing's convertible are now awaiting the companies' decision on how they will handle their takeover options on the convertibles. A make-whole premium may be applied to the bonds, or Level 3 can exercise its public-acquirer change of control option to assume the debt.

The buyside trader said the make-whole premium will not be enough for hedged investors, which was the main reason the Broadwing convertibles fell on a dollar-neutral basis.

"It is protected for a cash takeout, but at this lower level the protection isn't enough," the trader said. "If the convertible continues trading, it will be slightly better for the Broadwing holders."

ICOS jumps on buyout

ICOS's 2% convertible due 2023 shot up about 14 points to just shy of par after the company agreed to be bought by Eli Lilly, its partner in the erectile dysfunction drug Cialis.

The convertible traded at 98.5 against a stock price of $31.50, while ICOS stock (Nasdaq: ICOS) rose 16.15% or $4.38 to close at $31.50.

"It was up about 10 points on a dollar neutral basis," a buyside convertible bond trader said.

Bothell, Wash.-based ICOS said Tuesday it had agreed to be bought by Eli Lilly at $32 in cash per ICOS share, valuing the drug maker at about $2.1 billion. ICOS expects the deal to be completed near the end of 2006.

Shareholder approval is required, but a sellside convertible bond analyst reckoned that the deal will easily cross any hurdles.

"They're being taken over by their partner on the drug, so it's what everyone was kind of hoping would happen," the analyst said. "It's all very much like it's a done deal."

The offer will let convertible bond holders put the paper back at par. With ICOS's convertible trading around 81 at the start of the year and never passing 90 this year, the benefit of the deal was obvious for bondholders, the analyst said.

"It's a homerun for anyone holding the convertibles," the analyst said. "If only all of them could be like this one."

Home Properties plans deal

Home Properties plans to price on Wednesday a $175 million offering of 20-year exchangeable senior notes, talked at a coupon of 3.875% to 4.125% and an initial exchange premium of 18% to 22%.

The exchangeables, which will be offered at par, are slated to price after the market closes.

The notes will be issued by operating partnership Home Properties LP and exchangeable into common stock of the listed company.

There is an over-allotment option for a further $25 million.

Merrill Lynch is the bookrunner of the Rule 144A offering.

Home Properties, a Rochester, N.Y.-based real estate investment trust that focuses on residential apartment communities in the United States, said it will use about $58 million of the proceeds to concurrently buy back stock, and another $70 million to repay an outstanding revolving loan. The rest of the proceeds will be used for general corporate purposes.

Home Properties stock (NYSE: HME) slipped 0.13% or 8 cents in after-market trading to $62 after the deal was announced.

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