Mills higher on project financing deal; Developers REIT offer draws poor reviews; Scottish Re widens

By Kenneth Lim

Boston, Aug. 22 - The convertible bond market had another slow session on Tuesday, with Mills Corp. marked higher after the company said it managed to shift the financing burden of building the Meadowlands Xanadu entertainment complex in New Jersey, raising hopes that the company will now be easier to buy out.

Meanwhile, Developers Diversified Realty Corp.'s planned $250 million of five-year convertibles, expected to price Tuesday after the market's close, failed to garner any interest in the gray market after investors panned the deal as too aggressive even at the reoffered price of 98.5.

The convertible market in general saw little in the way of trading on Tuesday.

"I don't think there were any big movers," a buyside convertible bond trader said.

The buysider attributed the lack of activity to the usual summer slack.

"It's the last two weeks of August," a buyside convertible bond trader said. "Nothing's going to happen around this time."

Gateway Inc.'s 2% convertible due 2011 slipped about a quarter point outright on Tuesday despite a sharp jump in the stock after a hedge fund said that it has acquired a 10.2% stake in the company. The convertible eased slightly from week-ago levels to 71.75 against a stock price of $1.70. Gateway stock (NYSE: GTW) climbed 12.42% or 19 cents to close at $1.72.

"It doesn't usually trade," a sellside convertible bond trader said. "It came in a little today. I think guys still aren't very sure what the new investor wants to do."

Shares of Irvine, Calif.-based Gateway stock shot up on Tuesday after hedge fund Harbert Management Corp. and Firebrand Partners said they bought 10.2% of the common stock and released a letter to the company suggesting that they will take an active interest in helping the personal computer retailer restructure itself. The investors did not provide details on their plans, but expressed confidence in Gateway's position in the personal computers sector.

Scottish Re Group Ltd.'s 4.5% convertible due 2022 also widened, declining by about a quarter point outright after a third credit ratings agency cut its view on the Bermuda-headquartered reinsurer. The convertible, which may be put in December 2006, changed hands at 96.50 versus a stock price of $7.20 on Tuesday. Scottish Re stock (NYSE: SCT) gained 1.84% or 13 cents to close at $7.19.

Fitch Ratings on Tuesday reduced Scottish Re's issuer default rating by two notches to BB from BBB-, citing concerns about liquidity. Moody's Investors Service and Standard and Poor's recently also cut Scottish Re's rating after the company reported a surprisingly poor quarter and said it may try to sell itself.

"At this date, Fitch does not believe that Scottish Re has sufficient liquidity, without concessions from its bank group, to fund the repayment of the $115 million in convertible notes in December 2006," Fitch said.

Oscient Pharmaceuticals Corp. was flat to slightly better outright on the back of a morning rally. The drug maker's 3.5% convertible due 2011 traded at 68.25 against a stock price of $1.375, while Oscient stock (Nasdaq: OSCI) gained 0.75% or 1 cents to close at $1.35.

The stock rally came a day after Oscient said it had completed its purchase of the U.S. rights to the cardiovascular drug Antara. Oscient paid Reliant Pharmaceuticals $78 million for the rights plus a further $4 million in existing inventory.

Mills higher on buyout hopes

Mills Corp.'s 6.75% convertible preferred was marked higher on Tuesday after the company said Colony Capital Acquisitions and Kan Am USA Management XXII agreed to relieve Mills' financing burden on the Xanadu project.

The convertible was quoted at 81 bid, 82.5 offered against a stock price of $19.30 on Tuesday. Mills stock (NYSE: MLS) closed at $19.26, a 15.19% or $2.54 gain.

Under the non-binding agreement, Colony will invest as much as $500 million and arrange financing for the project in exchange for 4.5 million shares of Mills LP. Those shares will be distributed between Colony and Kan Am, a real estate syndicator. The deal will also make Mills' investment in the project subordinate to Colony and Kan Am's investment, which means will not be able to realize the profits from Xanadu. Arlington, Va.-based Mills is a real estate investment trust that focuses on retail properties.

"This deal basically takes a load of the company's balance sheet, so the chances of a takeout are higher," a sellside convertible bond analyst said.

Developers REIT deal panned

Developers Diversified's planned $250 million of five-year convertible senior notes saw no bids on the gray market on Tuesday amid sentiment that the deal was too aggressively talked even at the reoffered price of 98.5.

"I looked at it and I dismissed it," a buyside convertible bond trader said.

Developers planned to price the deal Tuesday after the market closed, with talk for a coupon of 3% to 3.5% and an initial conversion premium of 22.5%.

There is a greenshoe option for a further $37.5 million.

JP Morgan and Banc of America were the bookrunners of the Rule 144A deal.

Developers Diversified, a Beachwood, Ohio-based real estate investment trust that develops and manages shopping centers in the United States, said it will use part of the proceeds for convertible note hedge transaction and about $50 million to repurchase shares. The rest of the proceeds will be used to repay outstanding debt under the company's senior unsecured credit facility and for general purposes.

Developers Diversified stock (NYSE: DDR) closed at $53.15 on Tuesday, up by 0.15% or 8 cents, after the deal was announced.

An outright buyside convertible bond analyst said the company had a solid BBB credit.

"They are the second-largest shopping center REIT, they are a good operator with a good history," the analyst said. "It's just the segment of the market that we don't really want to be in right now."

REIT stocks are currently trading at historically high levels, and shopping centers are comparatively less attractive than office apartment REITs, which have seen more rent increases and may be more resilient, the analyst said.

"So from an outright perspective they're not too interested in that area," the analyst said.

The buyside convertible trader said the deal did not seem like it could be sold at the reoffered price of 98.5.

"My guess is that they're going to have to reoffer it [again], at 97.5 or so," the trader said. "At 98.5 there's not going to be a single guy out there who will take it. The common dividend has a pretty high yield, so there's a fairly large yield differential between the convert and the common. And the volatility [the bookrunners were offering] is just too high."

The trader said price talk suggested an implied volatility of around 21%, while Developers Diversified's volatility should be closer to around 17% to 18%.

Even marketing of the deal seemed quiet, the trader said.

"Normally the underwriters will call you in the day...but we haven't heard from them, maybe they know it's no good and don't want to waste a phone call," the trader said.

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