EDS slides on Navy contract write-off; Pegasus plunges 25 points as DirecTV talks end

By Ronda Fears

Nashville, Feb. 6 - Convertibles were firmer Friday, particularly in the tech and telecom groups, amid light trading volume. But blowups involving Pegasus Communications Corp. and Electronic Data Systems Corp. were the highlight of the session.

Pegasus's convertible preferred fell about 25 points, or nearly 50%, after Hughes Electronics Corp.'s DirecTV said it had immediately terminated talks with the smaller digital satellite television programmer over payments to provide rural service.

That, in turn, seemed to nix speculation that DirecTV would make a move to buy Pegasus, which had been screaming higher since December on that buzz. But Pegasus claimed it looked to be an attempt to drive its securities lower ahead of a takeover.

EDS also plunged - with the bonds down about 2.5 points and the mandatory losing 1.25 points - on a $600 million charge related to its Navy Marine intranet contract.

Primus Telecommunications Group Inc. was another big loser Friday on weak earnings. But Level 3 Communications Inc., a bigger communications service provider, bounced back slightly from a deep plunge Thursday on a less-than-rosy outlook for 2004.

Dealers said it was a slow session, partly due to the winter storm dousing the New York region.

"It's pretty messy with the ice, snow, sleet," said a buyside trader in New Jersey. "Some people were having trouble getting in."

New issues were doing well in the immediate aftermarket, but there was some trouble with the tiny LTC Properties Inc. deal. The Malibu, Calif., real estate investment trust said its $50 million perpetual convertible preferreds was postponed "because it appears that at this time the offering could not be completed at the terms initially proposed."

New paper higher with market

New issues put into circulation this week followed the broader convertible market higher Friday, despite the grumblings of many buyside players that the new paper was too expensive.

American Axle & Manufacturing Holdings Inc. sold $130 million of 20-year cash-to-zero convertible notes at par to yield 2.0% with a 40% initial conversion premium - aggressively outside of guidance for a yield of 2.125% to 2.615% and at the middle of premium talk of 37.5% to 42.5%. The company used $63 million of proceeds to repurchase stock, a bit more than the $40 million estimated before pricing.

American Axle also sold $250 million straight 10-year senior notes to yield 5.25%.

At the middle of price talk, sellside analysts put the American Axle convertible 0.42% cheap, but it gained 2.875 points from par in the first day of trading.

Merrill Lynch & Co., one of the lead managers, closed the new American Axle convertible at 102.875 bid, 103.375 offered. The underlying stock ended up $1.31, or 3.31%, to $40.90.

Equinix Inc. sold $75 million of 20-year convertibles at par to yield 2.5% with a 34% initial conversion premium - cheaply outside yield talk of 1.75% to 2.25% but aggressively outside premium guidance of 28% to 32%. At the midpoint of guidance, sellside analysts had put it 3.175% cheap.

Citigroup Global Markets Inc., bookrunner on the Equinix deal, closed it at 102.5 bid, 103.5 offered - up 2.5 points from issue price and 1.5 points higher than gray market levels before it priced. Equinix shares ended up a nickel, or 0.17%, to $29.55.

Delta Air Lines Inc.'s new convertible also gained some ground, although it had been hit rather hard immediately after pricing earlier this week at a reoffer level of 97. The 2.875% convertible gained about 2 points to 96 bid, 97 offered. The stock rose 17 cents, or 1.76%, to close at $9.83.

Looking forward, the only deal firmly on the calendar is Citadel's $300 million of seven-year convertible notes, which are talked to yield 1.5% to 2.0% with a 30% to 35% initial conversion premium. Pricing is set for after the close Wednesday.

Pegasus off on failed talks

Pegasus' 6.5% convertible preferred is not among the most liquid issues, but it was the biggest loser in the convertible market Friday as it plunged about 25 points to the mid-30s area, a dealer said. In the junk bond market, traders said Pegasus bonds got "clobbered," losing some 11.5 to 17.5 points.

The dive was in reaction to DirecTV suddenly cutting off court-ordered talks between the two parties that began in January 2003. The dispute involves a $150 per subscriber payment DirecTV agreed to make to members of the National Rural Telecommunications Cooperative, to which Pegasus belongs.

Market buzz that DirecTV or its parent Hughes would simply buy Pegasus to resolve the matter came to a crashing halt on the news. For several weeks, such speculation had driven Pegasus securities up sharply.

"This was a complete surprise to the market," one convertible dealer said. "Everybody really figured it was a done deal, DirecTV would buy Pegasus and it was all over. The bets had been placed, and they went bust."

Chase Carey, chief executive of Hughes Electronics, suggested in a statement that the market speculation about a takeover of Pegasus gravely overvalued its assets in relation to DirecTV's footprint, noting that Pegasus' customer base amounted to just 8% of all U.S. households.

"While we would have expected the securities markets to reflect this reality, in our view, the current equity and bond trading levels are fundamentally disconnected both from the company's limited rights and its financial position, as well as its potential value to DirectTV," Chase said.

"We believe that the only basis for these valuations is the belief that the new management of Hughes and DirectTV are impatient and will overpay in order to quickly resolve this situation. That simply isn't the case.

"DirectTV has demonstrated an ability to aggressively grow our subscriber base without - and, quite frankly, despite - Pegasus. At or anywhere near current trading levels for Pegasus, we believe our capital is better deployed growing our subscriber base in high-growth markets rather than overpaying for the declining Pegasus subscriber base."

Pegasus also surprised

The move by DirecTV also caught Pegasus by surprise, according to Pegasus Chairman Marshall Pagon, who expressed strong disagreement with what he referred to as "a misleading and improperly motivated" news release by DirecTV.

Pagon said DirecTV's "timing appeared intended to interfere with our recently announced financing" and seemed to attempt to drive down Pegasus' equity and bond values.

Just last week, Pegasus sold $100 million of its 11.25% senior notes.

"Based upon the two-page press release that was issued this afternoon by DirecTV, which bears no relationship whatsoever to the matters discussed by Mr. Carey and me [Thursday morning], I can only conclude that DirecTV is seeking to intentionally damage the value of our equity and debt securities and thereby interfere with the successful completion of our recently announced financing," Pagon said.

"Indeed, it would appear from their press release that DirecTV's larger purpose is to seek to acquire our DirecTV business at a substantial discount to the value that our bondholders and preferred equity holders are legally entitled to."

Pegasus' 9.75% bonds dropped 11.5 points to 86.5 bid, the 11.25s lost 17.5 points to 85.5 bid and the 0s fell 15 points to 77.

EDS sinks on write-off

EDS recorded a $354 million net loss for fourth quarter, in large part due to a $599 million write-off of its Navy Marine Corps Intranet contract. In addition, the company guided its free cash flow estimates for 2004 downward. That news also prompted all three credit rating agencies to put EDS debt in jeopardy of downgrades.

And it gave many convertible investors who had already been looking for an exit point to sell EDS, a dealer said.

"A lot of people were just looking to move out of this," the trader said.

As a result, the EDS 3.375% convertible due 2023 lost 2.5 points to 101 bid, 102 offered, and the 7.625% mandatory convertible due 2004 plummeted 1.25 points to 20.

EDS shares dropped $1.39, or 5.97%, to close at $21.90.

Late Thursday, EDS reported a fourth quarter net loss of $354 million, or 74 cents per share, after the $559 million in deferred costs related to the Navy Marine program. Without the write-down and other charges, EDS said it posted fourth quarter income of $59 million, or 12 cents per share. In fourth quarter 2002, the company reported income of $194 million, or 40 cents per share, excluding extraordinary items.

Also, EDS revised the range for free cash flow guidance, defined as cash flow from operations less capital expenditures, for 2004 to a range of $500 million to $600 million from prior guidance of $600 million to $800 million. Also, the company reduced 2004 through 2007 Navy Marine contract free cash flow to around $900 million from prior guidance of $1.9 billion.

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