Delta, JetBlue dive on oil, downgrades; Red Hat falls, Novell gains on Oracle CEO's comments

By Kenneth Lim

Boston, April 17 - Airline convertible bonds lost altitude in line with their stocks on Monday as oil prices rose and analysts dealt out a couple of stock downgrades.

Novell Inc. gained slightly outright after Oracle Corp.'s chief executive Larry Ellison said it had considered buying Novell and launching its own Linux operating system. Those comments and an analyst's downgrade sent Red Hat Inc.'s convertibles lower on fears of tougher competition from Oracle.

Market sources said the convertible bond market was generally slow on Monday.

"There's not a whole lot of activity," said a buy-side trader.

Ceradyne Inc.'s 2.875% convertible due 2035 was seen trading at about eight points better on an outright basis from the start of the month at 118.25 versus a stock price of $54.625 in reaction to the company's better-than-expected guidance from the previous week.

"They said their results were better than expected and raised guidance," said a sellsider. "The bonds are really just going to track the stock."

Ceradyne (Nasdaq: CRDN), a Costa Mesa, Calif.-based maker of technical ceramic products for the defense industry, saw its stock gain 9.93% on Wednesday last week after it said first-quarter profit would be 88 cents to 90 cents per share, better than Street estimates in the 75 cents region. The stock was up slightly by 0.73% or 40 cents on Monday for a $55.02 close.

Level 3 Communications Inc.'s 2.875% convertible due 2010 was better by about 3.25 points on an outright basis early Monday in line with a morning spike in the stock after the Broomfield, Colo.-based network provider announced a $163 million acquisition of privately held ICG Communications Inc.

The convertible changed hands at 88 against a $4.80 stock. Level 3 stock (Nasdaq: LVLT) was up 1.24% or 6 cents at $4.89 at the close, but rose by as much as 4.34% or 21 cents during the day.

Level 3 said Monday that it was buying ICG for $127 million in shares and $36 million in cash. ICG is an Englewood, Colo.-based network services provider.

JDS Uniphase Corp.'s zero-coupon convertible due 2010 was seen trading lower in line with its stock after competitor Bookham Inc. lowered its third-quarter guidance, said a buy-side trader. The convertible changed hands at 97 versus a stock price of $3.56. JDS stock (Nasdaq: JDSU) closed at $3.41, down by 27 cents or 7.34%.

"The stock got hit pretty good after some competitor, Bookham, pre-announced negative guidance, and it brought the whole sector down," the trader said.

Bookham cut its forecast third-quarter gross margin to between 10% and 12% from between 23% and 27%, and now guides for an EBITDA of negative $10 million to negative $12 million, from positive $1 million to negative $3 million previously. The San Jose, Calif.-based optical component maker cited a changing product mix and charges related to the closing of its British operations for the changes.

JDS provides optical products for telecommunications service providers, and is also based in San Jose.

The new Medtronic Inc. 1.5% convertible due 2011 and the 1.625% convertible due 2013 continued to see trading action, holding firm at 98.625 against a stock price of $49.75 on a dollar-neutral basis. Medtronic stock (NYSE: MDT) retreated 0.74% or 37 cents on Monday to close at $49.56. The stock has been sliding for three straight sessions on concerns that proposed changes to Medicare reimbursements could affect sales of the Minneapolis-based medical devices maker, market observers said.

Continental, JetBlue slip on oil, downgrades

Continental Airlines and JetBlue Airways Corp. convertibles were lower Monday on an outright basis after analysts downgraded their stock and high oil prices fueled concerns about industry earnings.

Continental's 5% convertible due 2023 traded about four points lower on an outright basis on Monday. The convertible was seen changing hands at 151.25 versus a stock price of $27.375 early in the day, but it was marked at 143.89 bid, 144.01 offered at another trading desk at the closing stock price of $24.42. Continental stock (NYSE: CAL) closed 10.78% or $2.95 lower.

"It's a survivor, and the overall valuation doesn't look stretched," said a New York-based convertible fund manager.

Continental's stock was hit Monday after Lehman Brothers cut its equity rating on the stock to underweight from equal-weight citing the Houston-based airline's "rising share price."

Crude oil prices also hit $70 a barrel, sending shares tumbling across the industry. Lehman analyst Gary Chase said in a report that fuel prices are "taking a big bite out of the earnings potential we had hoped for" in the industry.

JetBlue's 3.5% convertible due 2033 stayed firm on a hedged basis but was lower by under a point outright at 89.75 against a $10.40 stock price on Monday as JetBlue stock (Nasdaq: JBLU) fell 8.94% or 93 cents to close at $9.47.

In addition to the high oil prices, JetBlue investors were spooked by a research report by JP Morgan equity analyst Jamie Baker that predicted the Forest Hills, N.Y.-based budget carrier will try to sell some of its older aircraft or have to push back the delivery of new planes. Baker said those moves would be negative in the long term for the stock.

But the New York convertible fund manager said JetBlue was is in a "transition stage" and is "the reason to be in airlines." He added that he would continue to invest in the company if there is sufficient yield.

"The company is in an ideal position to raise fares, which will help itself and all airlines, and it's also at a stage where it ought to slow down its own expansion, which will also help itself and the other airlines," the fund manager said.

"The relative ease of turning JetBlue around will make it attractive at a price," said the fund manager, who declined to share that price. "No offense, but you could be CEO or CFO of JetBlue and you could turn it around. Raise the fares and stop buying more airplanes, and it's done. It's not like this is General Motors."

Novell up, Red Hat down on Oracle rumors

Novell's 0.5% convertible due 2024 "traded up a little bit," said a buy-side trader, while Red Hat slid on comments by Oracle chief executive Larry Ellison that Oracle had considered buying Novell and introducing its own Linux-based operating system.

Novell's convertible was seen at 92.375 against a stock of $7.75 on Monday, while Novell stock (Nasdaq: NOVL) gained 2.26% or 17 cents to close at $7.68. Red Hat's 0.5% convertible due 2024, which the trader said was "flattish around lunch," traded at 121.25 versus a $28.25 stock. Red Hat shares (Nasdaq: RHAT) closed at $28.51, lower by $2.04 or 6.68%.

Ellison told London's Financial Times in a Monday report that his company is considering launching its own Linux-based operating system, and has mulled an acquisition of Waltham, Mass.-based Novell, which is one of the largest distributors of the open-source system. That would boost Redwood Shores, Calif.-based Oracle's ability to defend against growing Linux vendor Red Hat, which said last week it was buying middle-ware software maker JBoss Inc. for $350 million.

"I don't think Oracle and Microsoft want another Microsoft in Red Hat," Ellison said.

Novell declined to comment on the report. Oracle representatives could not be reached.

Goldman Sachs equity analyst Rick Sherlund on Monday downgraded his recommendation on Raleigh, N.C.-based Red Hat to underperform from in-line.

"Red Hat's acquisition of JBoss begins Red Hat's migration up the infrastructure software stack and leads it in to direct competition with Oracle and IBM, two important partners of Red Hat," Sherlund wrote in a research note. "We suggest investors be more cautious on the stock near term as Oracle unveils its own open source stack initiative."

But a sell-side convertible analyst cautioned against reading too much into Ellison's comments on Novell.

"He always shoots his mouth off all the time," the convertible analyst said. "He's said he wanted to buy any number of companies any number of times. They're an acquisitive company...but is Novell the way to go so that they can counter Red Hat in Linux? Maybe, but it's conjecture and probably not much more at this point."

Novell could also be an unwieldy takeover target for Oracle, the convertible analyst said, citing Novell's networking, security and enterprise software businesses that Oracle may not be interested in. Those aspects of Novell may have kept Oracle at bay, and investors from reacting more strongly to Ellison's remarks. "I think that's why you didn't see the stock just fly up on that statement," the convertible analyst said.

But Oracle could still be on the look-out for takeover targets. "It think Oracle will always look to acquire additional companies that will give it better competitive footing against its rivals. But as to where it's going to strike, that's hard to say," the convertible analyst said.

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