HealthSouth converts trade in the 20s but more downside expected; Liberty/AOL prices at discount

By Ronda Fears

Nashville, March 21 - As U.S. and British troops stormed through southern Iraq, heavily bombing Baghdad and seizing critical oil fields, the markets interpreted it as a sign the war could be won swiftly.

Airline and leisure issues were immediate beneficiaries of the stock rally sparked by the so-called "shock and awe" military strategy employed against Iraq and unconfirmed reports that Saddam Hussein may have been killed or critically injured in the attacks.

Mandalay Resort Group, Carnival Corp. and Continental Airlines Inc. were marked sharply higher on the day.

The session was described as rather busy for a Friday. Traders said there were more sellers, however, and noted tighter credit spreads.

It was a long day for some traders, too, especially those who started at midnight trading HealthSouth Corp. convertibles.

HealthSouth converts opened, at midnight, in the 26-29 neighborhood, traders said. By around midday the 3.25% issue had dropped around 3 points to 23.5 bid, 25.5 asked, and nothing much was traded in the afternoon.

"After noon, everybody was watching the bombing [in Baghdad], or went out and got bombed themselves," said Chris Denton, a trader at Mesirow Financial.

But a good many traders had been at it since midnight, and trading in HealthSouth was described as brisk for several hours.

For some bankers it was a long day, too, pricing before the open Liberty Media Corp.'s $1.5 billion exchangeable, which at Liberty's discretion converts into AOL Time Warner Inc. shares, Liberty Class A common stock, cash or a combination.

The drive-by issue priced at 98.5 for a yield-to-maturity of 0.82% and 52% initial conversion premium, via joint lead managers Banc of America and JPMorgan.

The 0.75% issue sold at the cheap end of indicative terms.

It was quoted at Banc of America closing at 99 bid, 100 asked. AOL shares closed off 1c to $11.45. Liberty shares ended up 49c, or 5%, at $10.25.

In convertibles, it is uncommon, outside of original issue discount notes, to price new issues below par. The deal was first re-priced to be issued at 99, then in the final analysis was issued at 98.5, according to sources close to the deal.

Buyside sources said buyers who had placed orders began to complain to the underwriters when the issue started trading below par in the gray market. One hedge fund trader said it traded at 98, or 2 points below issue price, which was originally planned at par.

Traders are careful to quote new issues in the gray market in relation to "issue price" rather than par for this very reason - in case a deal is re-priced and sold at a discount.

First the issue was re-priced to be issued at 99, but in the end it priced at 98.5.

"Given the premium and what they were paying, it was to be expected," said John Siebel, head of trading at Silverado Capital Management.

"The bond market tanking today probably had something to do with it, too.

"At this point, with the bond market where it is, even if AOL shares strengthen, these bonds are going to lose value."

Treasuries plunged as investors pulled money from the safe haven area of the markets on optimism that the war would be short-lived.

Corporate spreads, however, narrowed.

AOL 5-year credit default swaps were quoted at 200/205 basis points over Libor by a Commerzbank derivatives trader, who said, "everything was moving in today."

While the Liberty/AOL issue price would suggest some difficulty in placing the issue, a source working close to the deal said the entire $1.5 billion issue was sold and the $250 million greenshoe has a good shot at getting exercised.

And there were willing buyers for HealthSouth paper.

The early trades in HealthSouth were the best for sellers, though, traders said, noting "fairly decent" two-way activity.

Many expect HealthSouth paper will continue to weaken, taking it as an ill omen that the stock was still halted on Friday.

"The stock still isn't trading and that can't be good," said a dealer at a high-yield/distressed boutique.

"There's more bad news coming, I think. There's more to it if they still wouldn't let the stock trade."

Some sellers were still fuming about having to unwind trades from Wednesday, too.

On hearing people speculate that the Securities and Exchange Commission will make it a practice henceforth to suspend trading securities of companies under the circumstance of alleged fraud, one buyside trader said: "It's just postponing the inevitable.

"It doesn't make any sense. This paper was going to hell in a hand-basket any way you look at. And halting the bonds was unusual, at best, if not unprecedented," the trader continued.

"All this [trading moratorium] did was erase some 20 to 30 points that could have been made [by sellers on Wednesday]."

HealthSouth converts opened, at midnight, in the 26-29 neighborhood, traders said, and by mid-morning the 3.25% issue had dropped around 3 points to 23.5 bid, 25.5 asked.

The convertible also was said to have traded in the teens, according to a buyside source.

HealthSouth senior bonds opened in the 40s flat, traders said, and continued to drift lower all morning.

"The converts traded at midnight, that was wild," said Jeremy Howard, head of U.S. convertible research at Deutsche Bank Securities.

"We had buyers and sellers, it wasn't all one-way."

Howard said about $100 million of HealthSouth paper - the convertibles and straight debt - moved on the Deutsche distressed desk.

Moreover, he said the HealthSouth situation, compounded by the reaction in bonds and stocks to the war and economic data, has put some pressure on the convertibles market.

"It really does underline the danger in picking up nickels in front of the steamroller," Howard said, referring to the HealthSouth convertible being less than two weeks from maturity.

"This is a huge wake-up call to re-evaluate your portfolio and short-term risk."

As one fund manager put it: "You can't count your money until you get paid."

Deutsche analysts in a report Friday said the probable value of the HealthSouth convertibles is zero, due to the uncertainty surrounding its balance sheet created by the fraud charges, but could be as high as 30 cents on the dollar under a liquidation scenario and not much more as a going concern. (See full report on page 1 of this issue)

Elan Corp. plc is a good example of the reverberations in the market, Howard said.

The re-evaluation of short-term paper in the convertibles market largely began with the recent surprise that Costco Wholesale Corp. was considering paying an upcoming call in cash.

"Those [Elan] bonds went to 59. And there is until December [the put] for something to go awry," Howard said.

"Then they dropped back to 46-49. That's reasonable."

The overall effect of the events of late on the convertibles market is really a matter of bringing it into balance, though, Howard said.

"The mood in the market is a little bit under pressure," he said.

"But we've really only knocked some of the euphoria out of the market."

Convertible participants, indeed, were more solemn on whole this week, and the reaction in the financial markets to the prospects that the war in Iraq will be over soon may intensify the squeeze being felt by hedgers as stocks rise sharply and bonds fall.

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