EMC, ON Semiconductor climb on stock upgrades; Citigroup paints bright, front-loaded outlook for 2007

By Kenneth Lim

Boston, Jan. 8 - Analysts' upgrades boosted a couple of technology names early Monday, as the convertible bond market got off to a sluggish start for the week.

EMC Corp.'s two convertible series were higher outright, as the stock gained about 3.45% during the day after it was upgraded by UBS.

ON Semiconductor Corp. also improved slightly, getting a step up after Lehman Brothers upgraded the equity.

The rest of the convertible market was quiet, with a listless secondary market and a primary market that has yet to bring any new deals since the start of the year.

"Liquidity stinks right now," a sellside convertible bond trader said, adding that the market was unusually quiet for this time of the year. "Here's what I hope will happen: Some of this January effect doesn't happen, so...I hope the stocks start to crack and fall out, and the volatility on the underlying common picks up. That, combined with a real calendar to soak up some of the money out there."

The trader grumbled that the market was too rich at the moment.

"I don't like anything I see," the trader said. "I do understand why things are so rich, but it doesn't make sense to me. There's too much money floating around. If I look at something with an old credit spread, like what I was using six months ago, it models 4% to 5% rich. I then have to model it with an aggressive credit spread just to get it at fair value. Anything with my old model models out 4%-5% rich."

Strong start seen for 2007: Citigroup

Despite the relatively uneventful start for 2007, convertibles could return 10% to 11% outright and 8% hedged for the year with the first half of the year offering the best gains, said Citigroup's convertible research team in an outlook report.

New convertible issuance will continue to be robust and could reach $65 billion, and the net inflow into the market could improve by 20%, to $15 billion, the analysts wrote.

"We look for most of the positive developments that drove convertible performance and issuance in 2006 to remain in place as we head into 2007," wrote Citigroup analysts Adrian Miller and Stuart Novick in the report. "Generally rising stock prices, low interest rates, a continuation of the strong M&A activity in 2006 are all likely to drive returns and fuel demand for new issuance in 2007."

The analysts based their forecasts on expectations of a strong year for equities. Underlying the equity outlook are solid economic fundamentals entering into 2007, although concerns about a slowdown in economic growth is expected to gain bigger prominence in the second half of the year, the analysts wrote.

EMC rises on upgrade

EMC's 1.75% convertible due 2011 and its 1.75% convertible due 2013 rose about 2 points outright on Monday, pulled higher as the stock gained on an upgrade by broker UBS.

The 1.75% convertible due 2011 traded at 107.25 against a stock price of $14.10, while the 1.75% convertible due 2013 was 107.5 versus the same stock price. EMC stock (NYSE: EMC) gained 3.45% or 47 cents to close at $14.08.

"Those were slightly better in line with the stock," a buyside convertible bond trader said.

UBS equity analyst Benjamin Reitzes on Monday upgraded EMC stock to buy-1 from neutral, noting positive demand in the sector and potential for improved margins. EMC is "poised to benefit from solid storage demand as well as an ongoing mix shift to higher-margin software," Reitzes wrote in a note.

"With software sales increasing as a percentage of total sales, and benefits from restructuring, EMC is well positioned for margin expansion and mid-teens organic growth," the analyst wrote.

Reitzes has a $16 price target on the stock.

EMC is a Hopkinton, Mass.-based data storage company.

A buyside convertible bond analyst said the upgrade was not a big surprise.

"I think most analysts are neutral to positive on the stock," the buysider said, noting that the upgrade did not have any significant implications on EMC's credit. "This is a solid company, and their acquisitions and restructuring efforts on the whole have been positive...although just based on consensus the UBS estimate seems a little on the high side."

A sellside convertible analyst said the EMC convertibles have appeared more interesting as hedged investments than as outright holdings.

"I think EMC probably makes more sense from an arbitrage point of view," the analyst said. "Outright, I was always lukewarm, as a total return opportunity, on it, because the converts are fairly low coupon. The converts will probably do OK if you're hedged, outright I'm not so sure."

ON gets upgrade boost

ON Semiconductor's zero-coupon convertible due 2024 and its 2.625% convertible due 2026 gained outright on Monday, on the strength of a stock upgrade by Lehman Brothers.

The zero-coupon convertible was marked at 100.5 bid, 100.75 offered against a stock price of $8 on Monday, about 1.5 points higher. The newer 2.625% convertible was 102.5 bid, 102.75 offered versus the same stock price. ON stock (Nasdaq: ONNN) rose 7.32% or 55 cents to finish at $8.06.

"They didn't really trade much, but I know the stock was active because of the upgrade," a buyside convertible bond trader said.

ON common stock was trading at a 40% discount to its peers before Monday, and has remained flat despite have stronger cash flow, wrote Lehman's Romit Shah in a research note. Shah upgraded ON to overweight from equal weight and raised his price target for the stock to $10, from $8.

Shah noted that although ON has significantly reduced its interest expenses and improved its cash flow, the stock continues to hover near levels from three years ago and lags its peers. That gap should narrow, Shah wrote.

ON is a Phoenix, Ariz.-based maker of data management semiconductors and standard semiconductor components.

A buyside convertible bond analyst said ON's convertibles currently look fair on a hedged basis.

"The stock's run up today, the bonds are mostly in line," the analyst said. "I don't think it's that attractive at these prices. I saw the report, but I don't think there's a lot there that isn't already known. The interest expenses, stock buybacks, were all funded with the convertible last month, so you haven't really seen any improvement in credit."

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