Bear Stearns recommends Office Depot for volatility, safety

By Ronda Fears

Nashville, Tenn., July 16 - Bear Stearns & Co. convertible analysts are recommending Office Depot, Inc.'s 0% convertible due 2007 for outright and hedge funds, noting a nice combination of volatility and safety as well as an upcoming put.

For arbitrage investors the analysts suggest a 70% delta hedge.

Office Depot equity has sold off 40% over the past three months and the 0% convertible issue due 2007 is off 17% over the same time period, noted analysts Rao Aisola, Sarah Gallagher, Matt Hempel and Thomas Sugiura in a report.

"Despite the lackluster business climate, comparable store sales for the quarter are expected to be flat to mildly positive for second quarter," the analysts said in the report.

"Although we see some possibility of lightness in our revenue estimates when ODP releases earnings Wednesday, we feel the company can meet our EPS [20c] given the operating margin improvements. The conference call should provide good color on the important back-to-school quarter."

The back-to-school quarter is continuing to start earlier each year, as some regions in the U.S. are starting school as early as late July. International is weak too, with local currency same-store sales expected to come in low to mid single digit range.

The Office Depot convertible "offers a great combination of volatility and safety, based on their solid credit profile, discounted volatility and the upcoming put," the analysts said.

Using a credit spread of 500 basis points and a current bond price of 73.5, the implied volatility is negligible. Office Depot's straight senior subordinated notes trade 450 basis points off the comparable Treasury note.

The company has an upcoming soft put on Dec. 11, which at current levels is offering a yield to put of 15.49% with the put only 5 months away, the analysts pointed out.

"We do recognize that the ODP 0s of 2007 are not the most liquid securities," the analysts said.

"However, the ODP 0s of 2008 do not offer a compelling enough valuation for us to recommend them."

With cash and investments of over $845 million, free cash flow of an estimated $428 million for 2002 and EBITDA of an estimated $731.5 million for 2002, the analysts do not see any liquidity issue.

Office Depot Inc.

Subordinated notes due 2007

Convertible Price: 73.5

Stock Price: $12.73

Conversion Premium: 31.8%

Conversion Price: $10.861

Current Yield: 0%

Delta: 70%

Market Hedge: 85%

Yield-to-Maturity: 5.75%

100-Day Volatility: 42%

Put Price: 78.119

Years to First Put: 0.4

Spread: 500 bps over Treasury

Credit Ratings: BB+/Ba1

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