By Ronda Fears
Nashville, Nov. 22 - NCO Group Inc.'s convertible is attractive for bond buyers, including crossover high-yield investors, due to the credit being misunderstood and resultant price levels, said Deutsche Bank Securities Inc. analysts.
"NCO Group Inc. is a poorly understood credit in the convertible bond market," said convertible analysts Jeremy Howard, Jonathan Cohen and Robert Barron in a report Friday.
"We also believe the NCOG 4.75% 2006 to be attractive to convertible bond buyers and crossover high yield bond buyers. NCOG's fundamentals do not warrant an implied credit spread of Libor + 1,200 bps."
Much of the mispricing for the NCO Group convert is due to discomfort with the credit.
"The implied credit spread is almost 1,000 bps wider than the most expensive possible pricing on the secured revolver (L+225 bps). We believe that the NCOG 4.75% 2006 should (conservatively) trade in the L+900 bps range (still 675 bps wider than the revolver).
At a spread of L+900 bps, theoretical value on the convert would be 85.777. Using a 50% stock volatility, that would make it 6 points undervalued at current levels.
The analysts also noted that NCO Group is a profitable company that generates free cash flow, is modestly levered and has been reducing debt this year.
"We find NCOG a company which generates a healthy margin (operating income and EBITDA), positive funds from operations as well as generating (albeit small) free cash from operations," the analysts said.
"We also find a moderately leveraged balance sheet (45% debt to total capital and 3.17 times debt to EBITDA full year 2002 est.)."
Because the convert was issued with a $32.92 conversion price and the current price of NCO Group stock is $13.98, the analysts noted it trades and behaves more like a high-yield bond than a balanced convertible.
The yield is "high enough to make it attractive to equity investors who know the NCOG story," the analysts said.
Deutsche Bank currently has a hold rating on the common stock with a $15.00 price target.
NCO Group 4.75% convertible due 2006
| Ask: | 80
|
| Equity price: | $13.98
|
| Parity: | 42.467
|
| Premium: | 88.38%
|
| Current yield: | 5.9%
|
| Yield to maturity: | 12.13%
|
| Conversion ratio: | 30.3767
|
| Conversion price: | 32.92
|
| Call: | April 22, 2004
|
| Call price: | 102
|
| Provisional call: | 120%
|
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