Shanda, Cell Genesys bid up in gray market; insurers pulverized by Spitzer suit

By Ronda Fears

Nashville, Oct. 14 - Convertible names were predominant in the charges leveled Thursday by New York Attorney General Eliot Spitzer against giant insurance broker Marsh & McLennan and a growing list of insurers that currently includes American International Group Inc., Ace Ltd., Chubb Corp., Hartford Financial and Munich Re's Munich American Risk Partners.

The Spitzer charges that contingent commissions, a common practice whereby insurance companies pay commissions similar to a finder's fee to brokers, amounts to kickbacks. Spitzer said other insurance companies are still under investigation and, as a result, St. Paul Travelers Cos. Inc. and Prudential Financial Inc. were lower. Aon Corp., another insurance broker, also fell sharply.

"Insurance issues were pulverized, across the board," a sellside trader said. "The credits just blew out like a volcano, anywhere from 40 to 50 basis points."

Ill feelings toward Marsh & McLennan were already brewing in the convertible market, stemming from its cash takeover of Kroll Inc. early in the summer as it crushed convertible arbitrage players and spurred a prevailing trend of cash takeover protection features in new issues.

Elsewhere in secondary dealings, there was pressure from the Spitzer headlines along with oil spiking to nearly $55 a barrel. The November contract for crude oil climbed $1.12 to settle at $54.76 on the New York Mercantile Exchange, another record.

But even as oil shot up, several airline issues were higher. Still, analysts were warning that cash tills at the carriers will be dwindling rapidly on higher fuel prices.

Delta Air Lines Inc. was buoyed by views that its sweetened and extended bond exchange offer would delay, if not altogether stave off, a bankruptcy filing while it negotiates pay concessions with pilots. Meanwhile, Northwest Airlines Corp. gained as a tentative agreement was inked with pilots on wage cuts.

Traders said in general that there still were yield shoppers in the market tossing out bids that were getting hits, despite the spike in oil and the Spitzer news. Fresh paper on the table was especially hot.

Shanda bid plus 1.375 points

In the gray market, buyside traders said bids were running about 1.375 points over issue price for Shanghai-based Shanda Interactive Entertainment Ltd.'s $150 million of 10-year senior convertible notes - talked to yield 0% to 0.5% with a 27.5% to 32.5% initial conversion premium.

Shanda shares fell $3.68, or 10.94%, to $29.96 on heavy volume, suggesting hedge funds will be big players in the deal.

The deal, on tap after the closing bell, was estimated by one sellside analyst at 3.5% cheap using a credit spread of 750 basis points over Libor and 50% volatility although a buyside market source said a 650 basis point spread also had been tagged to the Shanda credit.

Potential players in the deal were concerned about the limited public float in the underlying stock and takeover protection language, which was said to not be entirely defined in marketing materials. Takeover threats could be critical, some said, as the company could be vulnerable to consolidation in the online game industry.

But a sellside source said Shanda was more widely viewed as a suitor, noting that Shanda said proceeds also would be used for working capital and potential future acquisitions.

Shanda's major stakeholders are New York-based Skyline Multimedia Entertainment Inc., with 59.6%, and SB Asia Infrastructure Fund, with 18.7%. Shanda said it has been asked by SB Asia Infrastructure Fund to consider buying back a block of its ordinary shares, which was not specifically defined, and said some convertible proceeds may be used for that purpose.

Cell Genesys deal at bat, too

Cell Genesys Inc. also was at bat after the close with $100 million of seven-year convertible notes talked to yield 2.625% to 3.125% with a 30% to 35% initial conversion premium. Late afternoon, the issue showed up in the gray market, buyside traders said, with a bid of 0.375 points over issue price and an offer at 0.875 point over.

Cell Genesys shares closed down 42 cents, or 5.66%, to $7.00.

Sellside analysts away from the new deal put it anywhere from around fair value at par to nearly 4% cheap.

At the midpoint of price talk, Merrill Lynch analysts put it 3.76% cheap, using a credit spread of 800 basis points over Treasuries and 52% volatility. Another sellside analyst, away from the Goldman Sachs desk, put it just 0.5% cheap, using a credit spread of 650 basis points over Treasuries and 50% volatility.

"Given the scarcity of new deals, we anticipate that the issue could price at the middle of the price talk," said Merrill Lynch convertible analyst Tatyana Hube. "Due to the tough borrow on the common, we expect the deal to be bought predominantly on the outright basis."

Insurers slammed by charges

Spitzer's attack on the insurance industry sparked a lot of selling in the sector but also heavy buying in credit default swaps, traders said.

"The big deal was that there were criminal charges," one trader said. "The investigation had been going on and was to some degree priced in as something that could cause some write-offs, fines. This is a bigger deal."

Last April, Spitzer issued subpoenas to several insurance brokerage firms, including Marsh & McLennan and Aon, seeking information into compensation agreements between brokers and insurer companies.

Two AIG executives have pleaded guilty to charges in the suit, which also names ACE, Hartford and the Munich Re unit, among others.

AIG's convertible bonds were not heavily traded, dealers said, as the stock plunged $6.99, or 10.43%, to $60. Rather, mandatories linked to insurance companies saw the most action outside of the goings on in the CDS market, one trader said.

Hartford's mandatories plummeted about 3 points each with the 7% issue at 58.125 bid and the 6% issue at 56.75 bid, while the underlying stock plunged $3.78, or 6%, to $58.40. Chubb's mandatories each lost 1 point with the 7% due 2005 at 26.85 bid and 7% due 2006 at 27 bid, as the stock fell $4.09, or 5.86%, to $65.65.

St. Paul, Pru, Aon also plunge

As Spitzer inferred there could be additional defendants named by saying several insurance companies are still under investigation, virtually the entire insurance sector was hammered. Again, convertible names were predominant on the list.

St. Paul Travelers' 9% mandatory due 2005 dropped about 1.5 points to 61.125 bid, 61.625 offered, a sellside trader said. The stock dropped $1, or 2.94%, to $33. He said the St. Paul 4.5% convertible due 2032 also dropped by about a quarter-point to 22 bid, 22.5 offered.

Prudential's 6.75% mandatory due Nov. 15, 2004, lost 1.125 points, he said, to 68 as the stock dropped 91 cents, or 1.95%, to $45.71.

Aon's 3.5% convertible due 2012 plummeted 13 points or so, another sellside trader said, to 123 bid, 123.5 offered as the underlying stock fell $4.48, or 16.2%, to $23.18.

Delta buoyed by extension

Delta convertibles were buoyed by views that the exchange deadline extension, which also included several sweeteners, will delay if not altogether stave off bankruptcy. But, amid the spike in oil prices, credit analysts warned about a sharp cash drain.

"Essentially, this buys them [Delta] more time" in terms of filing bankruptcy, a convert trader said.

The Delta 8% convertible was lifted at 41, a 4.75-point gain from Wednesday, a buyside trader said. The 2.875% issue gained 3.5 points to 41 bid, 42 offered while Delta shares rose 41 cents, or 10.79%, to $4.21.

The biggest gain, though, was in the short-dated Delta junk bonds with the 7.7s due 2009 soaring 9 points to 64.

The amendment offers bondholders a larger amount of new securities, a limited amount of common stock for some bondholders and a higher coupon for some of the new bonds. The participation threshold also was lowered to 75% from 90%. And, the exchange deadline was extended to Nov. 18 from Thursday.

Exchange hinges on pilot pact

But there were grave signals in the extension and sweetener, a buyside trader said. Firstly, the exchange offer so far was grossly under the participation target of 90% originally sought so bondholders are a trouble spot, he said. He also noted that the exchange remains contingent on getting pilot concessions although so far no resolution has been reached in that area.

"There is trouble in both camps," he said. "How anyone can see anything positive out of this astounds me. It seems to me that it just cements the inevitability of bankruptcy."

To date, Delta said that a mere $24.2 million has been tendered. The company is offering to exchange $650 million of new debt for $1.56 billion. From pilots, Delta is seeking $1 billion of cuts in wages and other benefits, while the pilots have offered $750 million in reductions and are asking for some equity in the airline.

Some holders of the Delta convertibles had thought the pilot contract would hinge on results of the debt exchange, but now their anxiety levels are heightened.

"I thought the bond exchange would happen and then the pilots would make an offer that Delta could accept," said a holder of the Delta 8% convertibles. "Now, with no one, bondholders or the pilots, wanting to negotiate, it seems like Delta's choices are narrowing."

Oil spike accelerates cash drain

Standard & Poor's credit analysts Philip Baggaley said the exchange extension implies that Delta will not likely file bankruptcy before the new exchange deadline unless its parallel negotiations with pilots break down or external events such as high fuel prices or terrorism caused its cash reserves to erode faster than anticipated.

But, he also warned that the airline's cash is dwindling rapidly and rising fuel prices will accelerate the drain.

Liquidity, previously substantial, is dwindling rapidly, with $2 billion of unrestricted cash at June 30, down from $2.7 billion at Dec. 31. The company earlier indicated that it expects its cash position to decline at a similar rate during the second half of the year, which would imply year-end cash of $1.3 billion.

"However, fuel prices have risen significantly since then, which could deepen losses and accelerate the cash outflow," Baggaley said.

Delta is scheduled to release third-quarter results next Wednesday, and many speculate that if the airline's cash position is between $1 billion to $1.5 billion, the company may file bankruptcy.

Northwest garners pilot deal

Meanwhile, Northwest pilots said Thursday negotiations have produced a tentative agreement for $265 million in concessions from the pilots as well as $35 million in concessions from Northwest management.

Northwest has been seeking annual labor concessions of $950 million, which was critical in the airline's negotiations for a new $975 million revolving credit agreement.

Northwest's convertibles gained about 2 to 3 points each on the news, traders said, with the 6.625% issue at 82 bid and the 7.625% issue at 68 bid. Northwest shares climbed 67 cents on the day, or 8.84%, to $8.25.

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