Continental Airlines strengthen mildly in the gray; AMR strong; SunPower, solar names dip

By Rebecca Melvin

New York, Dec. 7 - Convertibles players Monday were looking over a new issue from Continental Airlines Inc., which launched a $200 million deal before the open and was expected to price after the close. They were up a point or two in the gray market.

The new Continental deal was seen only about 1% cheap, using a credit spread of 1,350 basis points over Libor and a 45% volatility, which is less-cheap than a typical new deal, a New York-based sellside analyst said.

"That's because there hasn't been that many new issues and issuers are trying to take advantage of demand with more aggressive terms," the analyst said.

Continental's existing 5% convertibles due 2023 were seen little changed at about 105 versus a share price of $16.75 in the early going.

AMR Corp. convertibles changed hands at 101 versus a share price of $7.25.

"It's a more interesting convert now right around par with less credit risk" than other airline convertibles, a Connecticut-based sellside trader said.

The solar space was also in focus Monday, although not overly active after an upgrade by Barclays Capital to "overweight" from "equalweight" on SunPower Corp., Suntech Power Holdings Co. Ltd. and JA Solar Holdings Co. Ltd.

The upgrade caused underlying shares to run, but the convertibles didn't do much; and SunPower convertibles were weaker as their underlying shares added 9.5%.

Suntech Power was mildly active and a little better compared to SunPower, a sellsider said, and Evergreen Solar Inc. had "a nice run," up about 3 points in good volume.

Take-Two Interactive Software Inc. continued in trade, moving up a little, after it fell Friday - but held in on a hedged basis - as its underlying shares plunged upon word that the video game publisher would see lower revenue and earnings for its just completed fiscal fourth quarter and in 2010.

Otherwise, trading in the secondary market was dominated by the usual suspects, which included Medtronic Inc.'s 1.625% convertibles and Advanced Micro Devices Inc.'s 5.75% convertibles.

Also among top traders were Savvis Inc.'s 3% convertibles and Omnicom Group Inc.

Continental up mildly in gray

Continental's new issue was seen in the gray market at plus 1 bid, plus 2 offered.

"It doesn't model cheap and is pretty uninteresting," a sellside trader said. "I'm not real impressed with it."

But the stock borrow for Continental is "pretty good," a New York-based sellside trader said. "Short interest isn't that low. It's about 10%, but there are more shares available to borrow. It's not as closely held as some stock, and there is a lot of volatility," the sellsider said.

The Houston-based commercial airline planned to price $200 million of five-year convertible senior notes after the market close Monday to yield 4.25% to 4.75% with an initial conversion premium of 22.5% to 27.5%, according to a market source.

The registered offering, which has a $30 million, or 15%, greenshoe, is being sold via joint bookrunners Morgan Stanley & Co., Citigroup Global Markets Inc., Credit Suisse Securities, Goldman Sachs & Co. and UBS Securities LLC, with Morgan Stanley handling stabilization, billing and delivery.

Proceeds are earmarked for general corporate purposes.

The bonds will be non-callable for life.

Continental's existing 5% convertibles were seen 104.5 bid, 105.5 offered. The paper, which is callable/putable in six months on June 15, 2010, is very short term.

The new one was modeling about 1% cheap, based on one sellside shop's valuation, which was based on Continental's five-year credit default swaps before the market opening.

Five-year CDS before the open was 1,400 basis points over Libor.

Airlines moving up

Airlines in general have been moving up, especially since last week when there was some positive economic news, and after Morgan Stanley upgraded AMR and UAL. Since then the stocks and converts have posted strong returns, a sellsider said.

Bank of America Merrill Lynch put out some research saying its favorite trade idea in the sector is to buy Continental Airlines' 5% 2023 convertible and overwrite the Continental June 2010 $20 call options to monetize the convert's cheap implied vol, which is at a 10 vol points discount to the option vol.

The trade provides an annualized yield of 12%, Bank of America Merrill Lynch convertibles analysts Yichao (Alan) Yu, Tatyana Hube and equity analysts Michael Linenberg and Alexander Loanzon wrote in their report.

"We recommend higher hedge ratio (than theoretical delta) for arbitrage positions in UAL's 6% '2029 and AMR's 6.25% '2014 converts. We prefer the UAL 6s for a lower credit exposure and more attractive carry. We think both converts could rally on a hedged basis should an economic recovery materialize in 2010 and solidify airline fundamentals," the analysts wrote.

"We think the nine points of pricing gap (490 basis points of basis) between the UAL 5s and UAL 4.5s is unjustified, and swapping from the 5s to the 4.5s makes sense," they wrote.

"Given that UAL's liquidity sufficiency might still be subject to swings in fuel prices, we think going long the 4.5s and buying Jan 2010 UAUA low strike puts provide a much more attractive risk/reward than buying the convertible outright."

Another sellsider said the airlines are really a "bellwether for economic growth," particularly after they faced the perfect storm of challenges last year, including lower revenue and financing obstacles.

Still he thought the capturing of 10 points of vol and selling calls on the recommended trade wasn't as interesting as the AMR convertible paper.

AMR's 6.25% convertibles due 2014 traded at 101 versus a share price of $7.35, compared to just over par versus a share price of $7.37 on Friday and 96.75 on Thursday.

Shares of the Fort Worth-based airline closed down 12 cents, or 1.6%, at $7.25 on Monday.

Solar names weaker versus stocks

Solar convertibles didn't reflect the enthusiasm that their underlying shares did possibly due to the fact that convertible players have already marked their positions and are riding out the balance of the year after huge gains in 2009, according to a Connecticut-based sellsider.

SunPower "came in" versus its shares Monday but was trading mostly odd lots, he said.

"The stock is notoriously volatile," he said. It was up on Monday on a Barclays Capital recommendation.

The space as a whole was more active than usual, but still not as active as its shares may have pointed to. SunPower's 1.25% convertibles due 2027 were at 86.5 at the close, which was up 1.75 points on the day. But shares of the San Jose, Calif.-based maker of solar cells and panels jumped $2.14, or 9.6%, to $24.45.

SunPower's newer 4.75% convertibles due 2014 traded at 115.875.

"The stock was up the biggest. The convertibles were active in odd lots. There weren't round lots trading, and they didn't move up with the stock," a sellsider said.

Suntech was "mildly active and a little bit better. Those were pretty much up in line," the sellsider said. While Evergreen, a busted convertible, trading like a bond, moved up 3 points in good volume, he said.

Mentioned in this article:

Advanced Micro Devices Inc. NYSE: AMD

AMR Corp. NYSE: AMR

Continental Airlines Inc. NYSE: CAL

JA Solar Holdings Co. Ltd. Nasdaq: JASO

Medtronic Inc. NYSE: MDT

SunPower Corp. Nasdaq: SPWRA

Suntech power Holdings Co. Ltd. NYSE: STP

Take-Two Interactive Software Inc. Nasdaq: TTWO

UAL Corp. Nasdaq: UAUA

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