Mandalay prices at record premium among flurry of new deals; secondary players in hiding

By Ronda Fears

Nashville, March 18 - New issues were the focus of the convertibles market Tuesday as three overnighters totaling $610 million were put into circulation, including Mandalay Resort Group's deal which came with a record 100% premium.

Alaska Air Group Inc. and Zenith National Insurance Corp. also priced deals.

The News Corp. exchangeable into British Sky Broadcasting Group plc shares priced, and was even boosted to $1.5 billion, but did not free to trade on Tuesday. In the gray market, however, it traded 0.25 point over par and was last seen bid 0.5 point over par.

Other than trading in the new issues, the broader secondary market for convertibles was described as thin by major dealers and buyside sources, as stocks stalled after a strong war rally on Monday.

Convertible traders in the junkier issues appeared to see more action than the bulge bracket firms, moving Elan Corp. plc on negative news and Continental Airlines Inc. on hopes of a government aid package for the sector.

But new paper took center stage.

While the market in general is welcoming new paper with open arms, some buyers are a bit unnerved by the manner in which they are coming to market.

"From a convertibles perspective, there's a way to arbitrage each of these deals, even if the terms at issuance are relatively unattractive to outright accounts," said a convertible fund manager at a hedge fund based in New York.

"From a market perspective, we're seeing complicated deals rushed to market. This suggests to me that the issuing companies, and possibly the investment bankers as well, are bearish.

"There's a rush to jump through the window of opportunity before it slams shut. Such attitudes often mark key market turns. I'm feeling more bullish."

Even some arbs, though, are concerned about the expensive terms seen lately.

"All I can say about these deals today is, ugh, it's more of the same," said John Siebel, head of trading at Silverado Capital Management.

He's still looking for demand to get sated enough that more palatable terms emerge, but the $610 million from three deals is not enough to get excited about. The News/BSkyB deal, on the other hand, was a nice addition, and from a high-grade credit.

Lehman Brothers convertible analysts said that terms on convertible new issues year-to-date have averaged 1.07% cheap and cash-paying converts have been issued on average 1.16% cheap.

Several deals of late - including the Mandalay, Zenith and News/BSkyB deals Tuesday - have come to market as much as 1.5% to 3.5% rich, at least in some sellside analysts' view.

Zenith's new 5.75% issue was the only new deal Tuesday that gained from par. The Mandalay and Alaska Air floaters, which each priced as floaters that revert to 0% after five years, both lost ground out of the gate.

Mandalay Resort Group sold $350 million of 30-year convertible floaters to yield three-month Libor plus 0.75%, with cash coupon payments in the first five years and a record 100% initial conversion premium. The previous record was 77.79%, set by Affiliated Managers Group Inc. in February.

The Mandalay deal sold at the cheaper end of guidance, but that doesn't mean it was cheap.

Salomon Smith Barney convertible analysts put the deal 3% rich, using a credit spread of 450 basis points over Treasuries and a 45% stock volatility.

"This deal is structured very similar to the recent [Affiliated Managers Group] deal, where they tack on additional warrants to the conversion value if the stock gets above the conversion price," said Salomon convertible analyst Adrian Miller.

"However, as was the case with AMG, we don't put much value in the warrant kicker."

The conversion price of $57.30 is adjusted to $68.76 by the 120% contingent conversion feature.

Working it up on the five-year call date, to reach the initial conversion price Mandalay shares would have to advance around 14.8% a year, compounded. If you factor in the contingent conversion feature, the stock would have to advance about 19.1% a year before a holder can convert this issue.

"The only way for holders to truly realize added value to the warrant kicker is for the issue to remain outstanding after the call date while in the money," Miller said.

"Of course, a number of derivative trades could be put on in conjunction with being long this issue, which may help facilitate attractive returns over a shorter duration. However, short of these sophisticated complementary trades, holders won't benefit much with this kicker."

Mandalay's convert closed at 99.75 bid, 100 asked. The stock ended down $1.53, or 5.34%, to $27.12.

Alaska Air's deal was in a similar structure, sans the additional warrants offer.

The airline sold an upsized $150 million of 20-year convertible floaters to yield three-month Libor plus 250 basis points with a 35.4% initial conversion premium - at the cheaper end of guidance.

Standard & Poor's put Alaska Air, along with 11 other airlines, on negative watch Tuesday due to the impending war with Iraq. S&P noted, however, that Alaska Air's lease-adjusted debt to capital was among the lowest in the industry at 77% at Dec. 31, and a relatively healthy cash position of $636 million.

Alaska Air's new convert ended at 99.75 bid, 100 asked. The stock closed down $2.05, or 10.68%, to $17.15.

Zenith also boosted its deal, selling $110 million of 20-year convertible notes with a 5.75% coupon and 29.3% initial conversion premium - smack in the middle of yield talk but at the aggressive end of premium guidance. It was upsized from $105 million.

Salomon put it 3.5% rich, using a spread of 500 bps over Treasuries and 27% stock volatility.

"I don't get it," Salomon's Miller said.

"The common yields a whopping 5.2%, [and] large common yields significantly hurt convert valuations. Also, the issue's put is 7 years out, not a more attractive 5 years. Also, this is a $360 million [market cap] property and casualty insurance company," Miller continued.

"There was some rumors about the company cutting the common dividend, so perhaps some people where factoring in some kind cut. However, even if you assume a 3% common dividend this issue is still 0.8% rich."

Lehman estimated the Zenith deal 0.38% cheap, using a spread of 700 bps over Treasuries and 35% stock volatility.

The new Zenith convert closed at 101.375 bid, 101.875 asked. The stock ended up 6c, or 0.3%, to $19.39.

In London, News Corp. Finance Trust II sold an upsized $1.5 billion of 20-year exchangeables that convert into shares of British Sky Broadcasting Group plc at par to yield 0.75% with a 36% initial conversion premium.

Traders said the secondary market otherwise was quiet, following the strong rally in stocks Monday.

Stocks closed slightly higher Tuesday.

Transportation issues were notably stronger, traders said, despite the S&P watch on the airline industry.

Continental Airlines Inc. was included in S&P's negative watch, and the agency pointed out that the weak point in the credit profile is still liquidity, with $1.34 billion of cash at Dec. 31, no bank line availability and no unsecured aircraft.

Airline shares, however, were propped up with optimism that the U.S. government would come to the aid of the flagging airline industry, as it did after the Sept. 11, 2001, terrorist attacks.

Continental Air's 4.5% convertible notes edged up 0.75 point to 37.75 bid, 40.75 asked. The stock closed up 11c, or 2.14%, to $5.25.

Elan moved lower on the troubled $850 million asset sale to King Pharmaceuticals Inc.

"This was going to go a ways toward filling a funding gap and now it's in jeopardy," one trader said.

She said the market's concern is centered on the roughly $750 million put on the Elan 0% due 2018 in December.

The 2018 issue dropped 1.5 points to 46 bid, 49 asked while the stock closed up 10c, or 4.3%, to $2.43.

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