American Axle surges on possible loophole; DOV Pharmaceuticals falls, Sepracor gains on drug's rejection

By Kenneth Lim

Boston, May 16 - Activity in the convertible bond market picked up on Tuesday with American Axle and Manufacturing Holdings Inc. turning the most heads as investors scrambled to take advantage of a possible loophole that pushed the value of its convertible near to par.

Meanwhile, DOV Pharmaceuticals Inc. dived about 10 points on an outright basis and slid slightly on a hedged basis as the stock crashed on news that an insomnia drug it licensed to Neurocrine Biosciences Inc. was rejected at a critical dosage by the U.S. Food and Drug Administration.

The same news sent rival insomnia drug maker Sepracor Inc.'s longer-dated convertible climbing about five points on an outright basis in line with a surge in the stock.

A couple of new deals in the pipeline also added to the buzz. Greenbrier Cos. announced plans to price on Monday next week $85 million of 20-year convertible bonds, while Enzon Pharmaceuticals Inc. expects to price $175 million of seven-year convertible senior notes on Wednesday after the market closes.

American Axle climbs on supposed loophole

American Axle burst into the spotlight on Tuesday, with its 2% convertible due 2024 opening at about 83.5 points in the morning and closing at about 94 despite a 3.94% decline in the stock. American Axle stock (NYSE: AXL) closed at $17.07, down by 70 cents.

"American Axle has been keeping me very busy today," a buy-side convertible bond trader said on Tuesday.

Most of the surge only came in the afternoon, when investors started to hear that they may be able to convert the 2% convertible bonds and get back their accreted principal in cash - a quick profit considering that the bonds were trading well below par and had an initial conversion ratio of 18.0421 shares per note.

The trigger for the contingent conversion option actually arrived two weeks ago, when credit rating agency Standard and Poor's cut American Axle's rating by two notches to BB from BBB-. After Moody's Investors Service lowered American Axle to below investment grade in December 2005, the S&P downgrade this month activated a contingency conversion option in the 2% convertibles that lets holders convert the notes if S&P rates them BB or lower and Moody's rates them Ba2 or lower, said Michael Knox. Knox runs Xtract Research, which keeps track of legal documents related to fixed-income securities.

But the catch that sent investors scurrying for the convertible on Tuesday was that instead of getting shares in a conversion, investors could get back their accreted principal amount. That reasoning stems from an irrevocable cash-settlement notice American Axle issued in October 2004, Knox said. In the notice, American Axle said it "elected to exercise its right under Section 11.02 of the [February 2004] Indenture to...deliver cash in an amount at least equal to the Accreted Principal Amount of the Securities converted" in the event of such a contingent conversion. Section 11.02 refers to American Axle's option to settle conversions in cash or stock.

The problem is that American Axle should have "elected to deliver cash in an amount equal to the lesser of the accreted principal amount or parity," and not "at least equal to the accreted principal amount," Knox reckoned.

"It's hard to say that they made a mistake...but they may have overlooked it," Knox said.

A staff member at American Axle's investor relations department said the company had received several calls on Tuesday regarding the company's convertible bonds, and executives were in a meeting to discuss the convertibles even after the market closed.

A number of market sources were surprised by the discovery of the supposed loophole, with one convertible fund manager remarking that "whoever discovered this needle-in-a-haystack deserves the quick gain!"

A sell-side convertible analyst said he had trouble finding the cash-settlement notice even after "scouring" the records, and quipped that the person who found the supposed loophole should get a fat bonus.

DOV falls, Sepracor gains on drug's failure

DOV Pharmaceuticals' 2.5% convertible due 2025 dropped about 10 points on an outright basis, closing around 62.3 versus a stock price of $3.02 on Tuesday after an insomnia drug it licensed to Neurocrine failed to get critical FDA approval.

A buy-side convertible bond trader said DOV convertibles were "a little heavier than market delta," but noted that not many people were affected by the drop because convertible was "a small issue" and was usually not quoted much.

Shares of Hackensack, N.J.-based DOV (Nasdaq: DOVP) closed at $3.02, down by 57.16% or $4.03.

Neurocrine said it had received FDA approval for lower doses of the insomnia drug Indiplon that it licensed from DOV, but a critical 15-milligram slow-release tablet form was rejected by the regulator. The lower doses simply induce patients to sleep, and are not seen as important sales generators because they will soon face generic drugs that can perform the same function. The higher dosage version, which keeps patients asleep, would have enabled the drug to compete against drugs such as Sepracor's Lunesta.

The news was particularly negative for DOV, a biotech company, because its other key product, the back pain drug bicifadine, also failed to perform better than a placebo in late-stage trial results released in April.

"Their two main candidates did not get approved, so where is the income coming?" a sell-side convertible analyst said.

DOV has "really big partners" in Pfizer - which is co-developing Indiplon with Neurocrine - and that could provide a sliver of hope, the analyst said. DOV could still find partners or buyers for its other products that are in the pipeline, although none are in very advanced stages of development, the analyst said.

The news was much better for Sepracor, whose Lunesta drug would have had to face new competition if Neurocrine's drug was approved.

Sepracor's zero-coupon convertible due 2024 was marked at 95.9375 bid, 96.3125 offered against a stock price of $50.88 on Tuesday, better by about four points outright and about a point on a dollar-neutral basis. Sepracor stock (Nasdaq: SEPR) closed at $51, up by 14.01% or $6.28.

"It's a pretty good move," a hedge fund trader said.

The convertible analyst said Marlborough, Mass.-based Sepracor benefited from the news because the market had been concerned about competition from Neurocrine's Indiplon. But the credit story was not significant for Sepracor, whose convertibles are mostly trading to fast-approaching maturity and call dates, the analyst said.

Greenbrier deal seen as cheap

Greenbrier's planned $85 million of 20-year convertible senior unsecured bonds was seen as cheap by sell-side analysts, but valuations differed depending on indications of the borrow investors could get on the deal.

The offering is expected to price on May 22, and price talk is for a coupon of 2.125% to 2.625% and an initial conversion premium of 27.5% to 32.5%.

There is a greenshoe option for a further $15 million.

Bear Stearns and Bank of America are the bookrunners of the Rule 144A deal.

Greenbrier is a Lake Oswego, Ore.-based maker of railcars. It will use the proceeds of the offering for general corporate purposes. Greenbrier stock (NYSE: GBX) closed at $36.96 on Tuesday, sliding 6.1% or $2.40 after the deal was announced.

A Connecticut-based convertible analyst said Greenbrier "seemed like a solid little company." The company has a small market capitalization and the coupon may be too low for some investors, but the analyst said the offer modeled about 4% cheap at the mid-point of talk using a credit spread of 300 basis points of treasuries and 40% volatility.

"They're coming in really cheap," the analyst said.

A New York-based analyst thought the deal was only about 2% cheap in the middle of price talk with a credit spread of 200 bps to 225 bps over Libor and a volatility of 42%, but noted that some "borrow penalty" had been worked in because there were suggestions on the Street that "the borrow is fair but not great."

Although credit spreads in Greenbrier's transport sector have tightened, "the credit on this company is OK, the debt to EBITDA and interest coverage ratios are, I would say, decent, but it's still a single-B company, so I'm reluctant to use anything tighter than 200 for this," the New York analyst said.

Enzon to price $175 million offering

Enzon Pharmaceuticals Inc. plans to price $175 million of seven-year convertible senior notes on Wednesday after the market closes, with price talk guiding for a coupon of 3.5% to 4% and an initial conversion premium of 25% to 30%.

The convertibles will be offered at par, and there is a greenshoe option for a further $50 million.

Goldman Sachs is the bookrunner of the Rule 144A deal.

Enzon, a Bridgewater, N.J.-based biopharmaceutical company, will use the proceeds of the offering to buy back its existing 4.5% convertible subordinated notes due 2008, of which $394 million is still outstanding. Investment advisory firm Franklin Advisors Inc. has agreed to sell $128 million of the 4.5% convertibles back to Enzon and to buy at least $75 million of the new convertibles.

"It is good that they are addressing the 2008 convert," said a biotech equity fund analyst. "If they chose they could retire all of the 2008 convert with the proceeds of the new convert along with cash on hand. I don't think they will use the cash for that purpose but they could. For today, anyway, the common is down but in the long run it should be a positive. With the company doing better, it's much cheaper doing a convert than straight debt. I think it is smart to start addressing this now. Unfortunately, the new conversion price will probably be around $11. I guess if it gets to $11 it will be good for all. Seems like a sweet deal for the new convert holders."

Enzon stock (Nasdaq: ENZN) fell 6.22% or 53 cents to close at $7.99 on Tuesday after the deal was announced. The 4.5% convertible due 2008 was last seen at 96.50 at the same stock level.

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