Ohio Casualty deal 5% to 8% cheap, should have wide appeal

By Ronda Fears

Nashville, Tenn., March 12 - Ohio Casualty Corp.'s proposed $125 million of 20-year convertible notes, which are talked to price to yield 5.0% to 5.5% with a 22% to 27% initial conversion premium, are 5% to 8% cheap depending on how aggressive you are about the stock. Moreover, analysts said the deal should get broad participation from outright and hedged convertible investors.

Wachovia Securities convertible analyst Kimberlee Brody said the issue was 5.42% cheap, assuming a credit spread of 450 basis points over Treasuries and 20% volatility in the stock. While some onlookers might think that was not aggressive enough on the stock, Brody explained that she typically gives a slight haircut to the bid side of implied volatility on call options.

The 100-day historical volatility on Ohio Casualty shares is 41%, 10-year historical volatility is 33% and the implied volatility of Aug 20 calls is 26.5%.

Bear Stearns & Co. convertible analyst John Wright puts the deal about 5.08% cheap at the midpoint of guidance, assuming a credit spread of 450 basis points and 25% volatility in the stock. With a little more aggressive position on the stock with 30% volatility, he said it would be about 8.06% cheap.

"We found it challenging to find many comps with public debt outstanding for this company in their particular segment - property and casualty insurance sector company with a market cap of less than $1 billion," Wright said in a new issue report Tuesday.

"The best comp we could find was Presidential Life, which has a senior note due in 2009 trading at a 9.3% yield and an implied credit spread of 465bps to Treasuries. We used a spread of 450bps to model Ohio Casulaty, which reflects the slightly larger size as well as the shorter term of the proposed convertible."

Ohio Casualty shares could come under considerable pressure in the interim of pricing, Wright said, noting average daily volume is around 150,000 shares and assuming a 70% delta it would require around 4.2 million shares to hedge the deal, or about 28 times average volume. But, he added, that with a potential conversion premium below 25% the deal should attract considerable outright investors, which would alleviate some pressure on the stock.

Ohio Casualty shares closed down 82c to $18.10.

"This seems like an attractively priced short dated convertible note structure which offers investors a relatively high coupon (5% or higher) with a reasonably small conversion premium in the mid 20's," Wright said in the report.

"Given that the security is expected to be split-rated, investment grade by Moody's and speculative grade by S&P, the paper should be well received."

Standard & Poor's has assigned a BB rating to the new issue, noting Ohio Casualty's regional business position, good capitalization, and improved investment strategy. S&P also revised the outlook to stable from negative. Moody's is expected to rate the issue Baa2.

Salomon Smith Barney is lead manager of the Rule 144A deal, which is set to price after the close Wednesday. The 20-year notes will be non-callable for five years, then at par. There are puts in years five and 10, at par. The Fairfield, Ohio-based insurance holding company said proceeds will be used to repay bank debt.

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