Shorter-dated, high-grade names in focus; Verigy trades well out of the gate; NetApp steady

By Rebecca Melvin

New York, July 10 - Shorter-dated, investment-grade paper was in favor in the convertibles market on Friday, maintaining a trend that dominated much of the week.

Pricing was firm, although the market was described as "very quiet" or "dead." Trading desks seemed to have emptied out early ahead of what was expected to be a nice, summer weather weekend.

"I think you and I are the only ones here," a New York-based sellside trader said toward the end of the session.

The newly priced Verigy Ltd. 5.25% convertibles jumped out of the gate early Friday to 104 bid, 105 offered but were not very active late in the session.

"They traded well," a sellsider said.

NetApp Inc.'s convertibles were steady as the view on the data storage company shifted from potential acquirer to potential takeover target after EMC Corp. won the bidding over Data Domain Inc.

The Regis Corp. 5% convertibles were seen steady as their underlying shares closed unchanged on the day. The paper closed at 100.5 bid, 101 offered versus a stock price of $12.23 on its debut Thursday.

Advanced Micro Devices Inc. was a name in trade for much of the week, strengthening after several weeks of weakness. The paper was off slightly on Friday from Thursday.

Verigy trades well

The newly priced Verigy 5.25% convertibles were last seen at 104, having been quoted early at 104 bid, 105 offered.

"I saw it wrapped around 104. Optically, it looked pretty cheap to me," a Connecticut-based sellside trader said.

Shares of the Singapore-based semiconductor test company ended up 31 cents, or nearly 3%, at $10.80.

The company priced an upsized $120 million of five-year convertibles after the market close Thursday to yield 5.25% with an initial conversion premium of 25%, according to a syndicate source.

Initially the deal size was $110 million of notes.

The Rule 144A offering priced beyond the tight end of the talked range on the coupon, which was 5.5% to 6%, and at the tight end of the talk for the premium, which was 20% to 25%.

NetApp steady at 89

NetApp's 1.75% convertibles due 2013 were seen steady at about 89 on Friday. On June 11, they were at 86.75.

After losing out in a bidding war with EMC to acquire Data Domain, the Sunnyvale, Calif.-based data storage company might now itself become a potential takeover target, according to Barclays equity linked strategies and convertibles research.

Its options are to grow internally or acquire private vendors, according to other views.

The Barclays analysts said that given the takeover potential, the bond's convex profile makes it an attractive arbitrage play.

For outrights, the analysts Manoj Shivdasani, Venu Krishna and Peng Cheng recommend that equity investors consider swapping into the convertibles, which have a superior risk-reward profile and represent a more defensive position in the capital structure.

The company has solid operating fundamentals, especially since NetApp's convertibles are its only debt on the balance sheet.

Its operating metrics are strong, with estimated 2010 free cash flow of $670 million (26% margin), operating profit of $451 million (17% margin) and net income of $393 million (15% margin), the Barclays analysts wrote.

NetApp's credit profile and liquidity position is healthy, with debt to total capitalization of 28%, and debt to free cash flow of 2.1x.

Notwithstanding macro economic weakness, NetApp operates in the storage industry, which is a longer-term growth industry given demand for digital storage.

The convertible's risk-reward is attractive with an upside/downside of 46%/16%, assuming a plus or minus 10% spread change, and the bonds have a very low premium over bond floor.

The convertible is at 89 while the bond floor is 82.1, and risk-premium is 8.4%.

"We have considered two scenarios: One where a change of control is triggered and another where the convert remains outstanding (greater than 90% stock)," the analysts wrote in research published Friday.

"Our analysis shows that if the takeover premium is 20% under the first scenario the outright expected return is 11 points and fully hedged return is 5.59 points, and under the second scenario the outright and fully hedged expected returns are 10.69 points and 5.28 points, respectively," they said.

"On the downside, if there is no acquisition and the stock declines 20%, assuming a spread of Libor plus 539 basis points and a vol of 35, the convert would likely lose 5.07 points outright, but still return +0.34 points fully hedged," the analysts wrote.

Data Domain accepted EMC's offer of $2.1 billion, or $33.50 a share, in cash after the market closed on Wednesday.

Santa Clara, Calif.-based Data Domain, a data network storage developer, had first struck a $30.00-a-share cash-and-stock deal with NetApp but was outbid by EMC, a Hopkinton, Mass.-based information technology firm.

A researcher with Jefferies & Co. told Prospect News on Thursday that NetApp might find other transactions, but none as good as what Data Domain could provide.

AMD strengthens

AMD's 6% convertibles due 2015 traded at 48.25 and were later seen at 47.75 bid, 48.375 offered, according to a sellside trader, compared to 48 bid, 49 offered on Thursday.

AMD's 5.75% convertibles due 2012, which bounced Thursday to 62, were seen at about that level on Friday.

Shares of the Sunnyvale, Calif.-based company settled essentially flat, or up a cent, at $3.49, after a 3.6% gain on Thursday.

"They've been active all week, and better," a sellside trader said. The 5.75s had been weak up until yesterday, when it bounced and caught up with its sister paper, he said.

Mentioned in this article:

Advanced Micro Devices Inc. NYSE: AMD

NetApp Inc. NYSE: NTAP

Regis Corp. NYSE: RGS

Verigy Ltd. Nasdaq: VRGY

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