Players taking a reality check in wake of Mandalay upset find the market discounted considerably

By Ronda Fears

Nashville, June 8 - Trading remained thin Tuesday, convertible dealers said, but inquiries were heavy as a wave of aftershocks from the Mandalay Resort Group upset rippled through the market. Many players were trying to grasp where a real market for the convertibles in their portfolios stood versus where they had them marked on Friday before the turmoil.

Mandalay's convertible was steadying, traders said, but the rest of the gaming pack continued to slide along with most of the convertible market. Stocks slipped and Treasuries were slightly higher amid a stronger tone of higher interest rates from Federal Reserve chairman Alan Greenspan.

On Monday, shockwaves reverberated throughout the convertible market in the wake of the surprise takeover bid for Mandalay Resort Group by MGM Mirage. Mandalay's convertibles, which lack takeover protection in the event of an all-cash transaction, initially plummeted, causing the broader convertibles market to decline.

"We're seeing names that had been buried float to the top, making their way to the Street," said a convertible trader at a sellside shop. "People are trying to figure out where [the] market really is for some of this stuff."

Queries were made about Wynn Resorts Ltd., Keane Inc., ExpressJet Holdings Inc., Quanex Corp., Wild Oats Markets Inc. and Maxtor Corp. to name a few of the more illiquid convertible names mentioned.

Dealers said that while they were extremely busy with calls, most of those did not result in a great deal of flow. Even the Great Plains Energy Inc. deal at bat after the close was nowhere to be seen in the gray market, according to buyside traders. The small $150 million deal priced at the middle of guidance with an 8% dividend and 18% initial conversion premium.

Sympathy lacking from some

Some onlookers who were spared the pain of the Mandalay whiplash were not very sympathetic.

"Too many guys bet on Smarty Pants and got caught with their pants down," said a fund manager in New York, who is involved in several convertible strategies, including arbitrage.

Like the Smarty Jones 5-to-1 bet in the Belmont Stakes over the weekend that resulted in an upset by Birdstone, which paid 36-to-1, he added, "Smarty Pants, which was a typical institutional bet - seemingly low risk, seemingly low return - but it didn't work.

"As one of our analysts observed, Mandalay [expletive] our market once, now they've [expletive] it again. No surprise."

While the situation has caused lots of demoralization, he said, perhaps it is a good sign of better days ahead.

"I take no joy or solace in any of this, but as we have discussed ad infinitum, you CANNOT set up the new issues which have come to market over the past three years and not eventually pay the piper," said another fund manager focused on convertible arbitrage for a hedge fund in New Jersey.

"The terms have been ludicrous, and it has been a disaster waiting to happen...Maybe, I'm not holding my breath, new issue terms will be more reasonable going forward.

"I liken the convert arbs to the baseball owners and free agency; they complain how much they cost but they still bid for them. As long as guys buy these bonds, companies will issue them until sanity returns and we just say NO."

Waiting for other shoe to drop

Other players are waiting for the other shoe to drop - at least among hedge fund players - when interest rates rise and carrying costs soar. Meanwhile, hedge fund returns for last month may be worse than some had thought, and worsening.

While credit spreads were said to be steady as June started, Merrill Lynch reported last week that its convertible hedge index for May was down 1.25% net of a 2% annual management and a 20% performance fee, taking the year-to-date net return to zero before hedging out interest rates.

At the time that was thought to be low by several onlookers, even from within the hedge fund community, and there is some evidence that is the case indeed.

Van Global Fund Advisors International on Tuesday, at the request of Prospect News, ran a special preliminary tally of its convertible arbitrage index, finding the average net return in the strategy stands at a loss of 1.7% for May. That will change somewhat as many more May returns are received throughout June, a Van Global spokesperson pointed out.

The preliminary net loss of 1.7% for May would compare to a net gain of 1.3% for May 2003 and a 0.4% net gain for May 2002, according to Van Global.

Also, on the preliminary May statistics, the Van Global convertible arb index would show a year-to-date net return of 0.6%.

Biotech "correction" foretold

Many of the inquiries made on the heels of the surprise bid for Mandalay by MGM Mirage Inc. were focused on the biotech group. Although several traders, sellside as well as buyside, predict there will be an ongoing "correction" in those converts, there probably is less of a threat from all-cash takeovers than some fear.

"These [biotech convertibles] have made a big run and they likely will lead the market correction, which by all indications has already begun," said a sellside convertible trader at one of the big Wall Street firms.

But as for risk to takeovers, cash or any sort, there may be no real case.

"If you look back at biotechnology, you never see the waves of acquisitions that people always talk about," said a sellside market source on the West Coast.

"The guys that run these biotech companies, in general, want to see if they can turn these little names into the next Amgen, Chiron, Genentech" but those aspirations typically fail due to the lack of financial muscle.

When it comes to targets in the biotech field, he said people ask most frequently about Celgene Corp, Alkermes Inc. and NPS Pharmaceuticals Inc.

"I have heard Nektar Therapeutics was being looked at closely by Pfizer Inc.," he added. "That could be cash - they bought Esperion for $1.2 billion in cash - and have a partnership already" with Nektar.

Oscient Pharmaceuticals Corp., which tapped the convertible market in early May, also was mentioned by a sellside trader. The Oscient convertible was marked down about 2 points on Tuesday, the trader said.

Great Plains prices at mids

According to market buzz late last week, there were several new deals coming to market this week. But the commotion caused by the Mandalay event apparently nixed those plans, so far. Thus far, just the Great Plains Energy deal that was launched Friday is on the table.

Although there was no pre-market activity noted in the deal by buyside traders, sellside sources said the Great Plains Energy deal priced without a hitch after the market close Tuesday.

Great Plains Energy sold the $150 million of 2.6-year mandatory convertibles in the Feline Prides structure with a dividend of 8% and an 18% initial conversion premium - at the middle of guidance for a dividend of 7.75% to 8.25% with a 16% to 20% initial conversion premium.

The deal was priced concurrently with 5 million shares of common stock sold at $30 each.

Great Plains Energy shares closed Tuesday up 54 cents, or 1.83%, to $30.02.

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