By Ronda Fears
Nashville, Tenn., Oct. 15 - Following Network Associates Inc.'s better-than-expected earnings announcement last week, Wachovia Securities, Inc. convertible analysts are maintaining a buy rating on the convertibles.
Network Associates has two issues out, a 0% convertible due 2018 and a 5.25% convertible due 2006.
"With a YTP of 5.85% and plenty of cash on the balance sheet, [the] zero converts represent a good defensive instrument," said analysts Henry Voskoboynik and Dmitry Melnick in a report Tuesday.
"The 5.25% converts are fairly valued but offer decent upside participation on a lighter hedge."
In addition to better results, the analysts noted all business segments posted year-over-year growth and returned to profitability and that the balance sheet continues to improve with cash at $1.0 billion against debt at $530 million.
The company's fiscal 2003 guidance for earnings per share of 70c to 75c on revenue of $1 billion to $1.03 billion matches expectations, the analysts added.
Network Associates posted EPS of 15c for the third quarter, 3c ahead of the consensus estimate. Revenue was flat sequentially but increased 9.5% year-over-year and slightly exceeded estimates. The analysts noted that results exclude the impact from McAfee.com, which was re-integrated into Network Associates recently.
Demand for antivirus software remains strong in a weak IT spending environment, the analysts said, noting that Network Associates' overall gross margin improved 40 basis points sequentially to 84%.
"Although NET lost some market share to Symantec in this market over the past couple of quarters, Network Associates remains a solid No. 2 player in an incredibly resilient antivirus market," the analysts said.
"Strict expense management helps improve operating results. Network Associates is doing a great job in reducing its operating expenses."
Total operating expenses declined $8 million sequentially in third quarter as a result of a $10 million reduction in sales and marketing expenses, and the operating margin improved to 12.5% from 8.8% sequentially on relatively flat sales.
During a conference call Monday, Network Associates announced additional cost cuts and said it expects continued operating margin improvement next year to 16% for fiscal 2003 from 12% in fiscal 2002.
"Given balance sheet strength and solid positive operating cash flow, the company said it is on the lookout for potential acquisitions of private and public companies that would strengthen its competitive position and complement its product offerings," the analysts noted.
The 0% converts are trading at 48.5, with a yield to put of 5.85% and a premium of 416%.
"The company has repurchased a significant portion of these [0%] bonds to date and should not have any difficulties meeting the put given the cash position," the analysts said.
"We believe these bonds represent a defensive instrument for risk-averse outright investors."
The 5.25% converts are trading at 100.16 with a 5.24% current yield, 5.2% yield to maturity and 68.21% premium.
Assuming 50% volatility and a 700 basis points credit spread, the notes are trading at an implied credit spread of 744 basis points and are fairly valued to slightly cheap at 0.62% cheap, the analyst said.
On a 50% hedge, a 25% upside movement in the common would likely result in the convert trading up to 107.6 for a total return of 12.69%, or 50.7% upside participation, the analysts said.
On a 25% downside movement in the common, the bond would likely trade down to 92.71, for a total loss of 2.2%, or 8.8% downside participation, the analysts said.
If the common stock reached the analysts' 12-month price target of $16, the convert would likely trade up to 114.66 for a total return of 19.75%.
Network Associates 0% convertible due 2018
| Price: | 48.5
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| Common price: | $10.50
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| Current yield: | NA
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| Yield to maturity: | 5.85%
|
| Premium: | 416.41%
|
| Ratio: | 8.538
|
| Issue size: | $770 million
|
| Call: | Feb. 13, 2003 at $49.45
|
|
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| Network Associates 5.25% convertible due 2006
|
| Price: | 101.5
|
| Common price: | $10.50
|
| Current yield: | 5.17%
|
| Yield to maturity: | 4.81%
|
| Premium: | 66.74%
|
| Ratio: | 55.34
|
| Issue size: | $300 million
|
| Call: | Aug. 20, 2004 at $101.31
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