Retreat in broader markets thwarts gains in new paper

By Ronda Fears

Nashville, Jan. 24 - As the broader markets fell back sharply, convertibles lost ground and even new paper recently injected into the market struggled during trading Friday.

"Everything was marked lower but there was not any flow to speak of," said a convertible dealer.

Intensified war fears, compounded by weaker outlooks in 2003 for the U.S. economy, delivered a severe blow to stocks. The Dow fell 2.85% and the S&P 500 similarly while the Nasdaq plunged 3.32%.

While the tech and telecom groups lost ground in large part, Nortel Networks Corp. and Lucent Technology Inc. continued to gain to the surprise of some onlookers.

This week's new deals suffered as the result of the market's backlash, as well as expensive terms, traders said.

International Game Technology's deal was upsized to $500 million in proceeds of 30-year 0% convertible senior notes and a source familiar with the Rule 144A overnighter said final terms also were cheapened early Friday.

Late Thursday, the market thought final terms were set at an issue price of 63.87 for a 1.5% yield-to-maturity and 47.5% initial conversion premium - at the middle of guidance. But early Friday a decision was made to cheapen it, lowering the issue price to 59.29 to yield 1.75%, up 45% - at the cheap end of price talk.

While it was not entirely unusual to change the terms so close to the wire, the source said the market did think that terms had been decided Thursday night.

Still, the new IGT convert had trouble advancing in the immediate aftermarket. It was quoted ending at 59.75 bid, 60 asked - up 0.5 point from the issue price but flat with gray market quotes on it from late Thursday.

Oneok Inc.'s new 8.5% mandatory slipped, chiefly due to the company's announcement right after pricing it that it would increase its common stock dividend by 10%, which cuts into the yield on the convert. But analysts still see it priced cheap to theoretical fair value. (See full story elsewhere in this issue.)

The Oneok mandatory closed off 0.2 point at 25.15 while the common stock ended off 17c to $17.02.

CMS Energy Corp. and American Electric Power Co. Inc. both are moving to cut dividends, which will boost the value of their mandatories, but troubles at those utilities resulted in drastically different reactions in the market. (See full story elsewhere in this issue.)

CMS decided to suspend its common dividends immediately, saving over $100 million a year.

AEP approved its 60c quarterly dividend for first quarter but plans cut it by 42% beginning in second quarter to save $340 million annually.

Both CMS and AEP, however, also lowered earnings outlooks and AEP reported a net loss amid huge write-offs.

S&P put AEP on watch due to the write-offs and said CMS' move was positive but alone did not do much to improve its credit quality.

The AEP mandatory (Baa2/BBB+) lost 0.7 point on the day, or 1.8%, to close at 37.95. An hour before the close, the issue was down 1.79 points. The common ended down $1.29, or 4.8%, to $25.60.

The CMS mandatory (Ca) fell 3.35 points on the day, or 20.6%, to end at 12.9. The common closed down $2.47, or 29%, to $6.07. CMS' junk bonds were said to be down about 2.75 points on Friday.

Arch Coal Inc.'s shares dropped sharply, due to some positioning for the new deal as well as the general negative tone in the market and for energy names.

Arch Coal shares fell $2.32 to close at $18.19.

Arch Coal is pitching $150 million of perpetual cumulative convertible preferreds with guidance for a dividend of 5.25% to 5.75% and initial conversion premium between 22.5% and 27.5%.

Deutsche Bank Securities convertible analysts put the deal 2.65% cheap at the midpoint price talk using a credit spread of 700 basis points over Libor and 42.5% volatility in the stock.

Wachovia Securities put it 0.87% cheap at the midpoint price talk using a spread of 800 basis points over Treasuries and 40% volatility.

Both valuations also account for a 1.12% current yield on the common.

The perpetual preferred structure on the Arch Coal deal may see some benefit from the proposed elimination of double taxation on dividends under consideration, a buyside source said, but that can't be factored into a valuation because it is uncertain how the legislation will look in the final analysis.

It was a bleak picture in the secondary market, as a majority of the market was in the "red zone," but Lucent and Nortel continued to surprise to the upside.

Nortel's 4.25% convertible due 2008 was quoted up 5.875 points to 70.375 bid, 70.875 asked and the 7% mandatory rose 3,890 points to 50,000 bid. The stock closed up 18c to $2.58.

Lucent's 8s (Caa2/CCC+) were quoted up 2 points to 79.5 bid, 80.5 asked. The stock ended up 6c to $1.98.

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