By Ronda Fears
Nashville, Nov. 20 - After an upgrade to OSI Pharmaceuticals Inc. stock, Lehman Brothers head of U.S. convertible research Venu Krishna said the drugmaker's 3.25% convertible due 2023 is a more defensive means of gaining exposure to the stock than its 4% convertible due 2009, plus is cheaper.
"Both converts are busted, though not significantly," Krishna said in a research bulletin, on the heels of a report Thursday by Lehman stock analyst Jim Birchenough.
"Despite a higher coupon on the 4s, we prefer the 3.25s."
The attractiveness of the 3.25s over the 4s is driven by better valuation; he said, noting the 3.25s are 3.3% cheap versus the 4s being 1.76% cheap. Also, the 3.25% convertible has a better risk/reward profile, he said, and greater upside equity participation at 14.6% versus 11.6% for the older issue.
In addition, coupons on the 3.25% issue are collateralized for three years with U.S. Treasuries.
The 3.25% notes, putable in five years at par, were quoted at 90.5 with the stock at $25.25, which he said translates into a 5.5% yield-to-put and premium of around 79%.
On a valuation basis, the 3.25s appear 3.3% cheap, Krishna said, conceding the credit spread of 550 basis points over Treasuries is "arguably aggressive given the high cash burn rate" of the company - roughly $130 million for the last 12 months at June 30.
"Yet, our spread assumption reflects comparable spreads for other pharma converts with similar profiles," such as the CV Therapeutics Inc. 2% convertible due 2023, he added. He noted the option adjusted spread was 650 basis points and the implied volatility was 39% - attractive relative to listed and historical volatility.
On a risk/reward basis, the 3.25s look attractive, too. Relative to a 25% move in the common stock over the next year, the 3.25% is estimated at a total return of 14.6% on the upside and minus 5.8% on the downside. In other words, the 3.25s are expected to provide a 2.5-to-1 risk/reward profile.
The 4% issue, which has provisional call protection for life with a make-whole feature through February 2005, has a similarly busted profile, quoted at 90 bid versus the stock at $25.25, suggesting a 6.2% yield to maturity and 79.2% premium.
Using similar assumptions, the 4% convertible was estimated 1.76% cheap on a valuation basis. Relative to a 25% move in the common stock, the convertible is estimated to provide a total return of 11.6% on the upside and minus 5% on the downside, for a participation profile of 2.3-to-1.
OSI 3.25% convertible senior subordinated notes due 2023
| Price: | 90.5
|
| Stock price: | $25.25
|
| Amount outstanding: | $150 million
|
| Yield to put: | 5.59%
|
| Premium: | 79%
|
| Cheapness: | 3.3%
|
| Stock volatility input: | 45%
|
| Spread: | 550 bps, 650 bps OAS
|
| Implied volatility: | 39%
|
| Put: | Sept. 8, 2008, at 100
|
|
|
| OSI 4.0% convertible senior subordinated notes due 2009
|
| Price: | 90
|
| Stock price: | $25.25
|
| Amount outstanding: | $160 million
|
| Premium: | 79.2 %
|
| Yield to maturity: | 6.2%
|
| Cheapness: | 1.76%
|
| Stock volatility input: | 45%
|
| Spread: | 550 bps
|
| Implied volatility: | 39%
|
| Call: | Provisional for life
|
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