CV Therapeutics bid at 100.375 in gray market; Pixelworks still; OSI Pharma, ImClone up sharply

By Ronda Fears

Nashville, May 12 - Convertible players were bemoaning further weakness as the 10-year Treasury note continued to see a selloff, although the slide was stemmed somewhat Wednesday as stocks staged a midday comeback. Meanwhile, no new deals came to light and little was seen in the gray market in regard to the pending CV Therapeutics Inc. and Pixelworks Inc. deals pricing after the close.

CV Therapeutics' new convertible was seen with a bid of 0.375 points over issue price but no offer, while the biotech group as a whole was widely mixed. Several biotech issues were sharply higher, traders said, like OSI Pharmaceuticals Inc. and ImClone Systems Inc., as companies with new drugs on the market or drugs up for approval imminently were catching bids.

"We stayed busy and there were some bids today, but people are telling us the market still looks too rich," said a convertible trader at one of the busiest desks.

The bottom line, as one convertible trader for a hedge fund put it, is that bond floors have just caved in. The yield on the 10-year Treasury backed up to 4.8% on Wednesday, even with Monday's level, which was the highest in two years, one buyside source said.

"Blood is being spilled," said another buyside trader.

"Lots of names have been coming in hard, especially Monday. It seems to be stabilizing a bit, but it was pretty ugly for a while. Fundamentally, there probably isn't a whole lot to support current valuations over the long run, only excess liquidity and a herd mentality in my opinion.

"In the short run, there may be some plays for a bounce, but longer term, I can't say I'm crazy about valuations, especially with the prospect of rising interest rates."

Volatility under watchful eye

Several buyside sources remarked that the market is no bargain yet, as credit spreads have not widened very dramatically, but with the gyrations in stocks some are looking for a volatility play or plays as volatility begins to tick up from an historically low spot.

"The market is cheaper and there are losses...but vol is higher and many people are fully interest rate hedged," said a portfolio manager who runs a multi-strategy fund.

"The only thing I can think of is that sellers who are not fully interest rate hedged are aggressive sellers. The market was just too rich and frothy and it's coming back down to earth. Converts have been cheaper each day for the past four days.

"It's too soon to say if there is a vol play as we have had vol spikes before only to see vol collapse."

A sellside analyst said convertibles have generally been for sale. "I get the sense that a lot of funds are sitting on cash as well, waiting to find where the real bid comes," he said.

For much of the past two years the credit trade made money, said another portfolio manager, who is involved in both outright and hedged funds. "Now, we're into a lot of volatility trades," he said. "The big picture is where do I think the cheapest vol is, or what is the most out of balance."

Some bottom-fishing bids are even resulting in trades that wouldn't have happened a week ago, a sellside source commented.

"It appeared low bids thrown out were getting hit," a sellside trader said, "and that doesn't make anyone feel good about positions."

Pain nondiscriminatory

Outright convertible funds and hedge funds alike are feeling the pain of the backup in interest rates combined with the softness in stocks.

Merrill Lynch's convertible index lost 2.4% in April but is still ahead by 1.7% on a year-to-date basis through the end of April. The Merrill convertible hedge index was down 0.80% net of a 2% annual management and a 20% performance fee in the first week of May, trimming the year-to-date net return to 0.47%.

Citigroup's convertible index also was down 2.4% in April and remains higher by 1.6% on a year-to-date basis. Citigroup convertible analyst Adrian Miller noted in a monthly report that the convertible market has not seen a month that dropped so sharply since September 2002 when it lost 3.2%.

Lehman Brothers' convertible index lost 1.73% in April and is holding onto a 2.23% gain year to date.

Convertibles were assaulted from many different fronts but got a boost from tight spreads that still hover near five-year lows, which contributed to out-performance of virtually every other asset class. Equities have come under pressure - especially tech stocks, which account for some 20% of the convertible market - while volatility remains low.

Yet, a buyside trader at a hedge fund in New Jersey said the convertible market is not really cheap enough to entice him to become a buyer.

"Talk to me when they triple the Fed Funds rate from 1% to 3%," he said.

Reminiscent of 1994

The rising rate climate evokes flashbacks of 1994, and a severe market cheapening is feared by some, but credit analysts say this season of rising rates should be less dramatic.

"Does the number 1994 mean anything to you," commented one fund manager based in New York who runs a capital structure portfolio, when asked about the magnitude of the market's recent pullback.

"The Federal Reserve left little question it will hike interest rates soon, leading many to question whether a repeat of 1994 can be expected," said Standard & Poor's analysts in a report Wednesday.

In 1994, the analysts said, "some financial institutions were caught on the wrong end of the market and ended up in trouble because they were supporting long-term assets with short-term liabilities as rates shot up quickly. Despite many of the market parallels between these two periods, significant differences remain, making a repeat unlikely."

Back in 1994, for example, the S&P analysts noted that the Fed raised the Federal Funds rate by 3 percentage points in a year's time, with little advance warning. In contrast, the Fed in early 2004 began to telegraph its intention to gradually raise interest rates, most recently as "measured increases."

CV Therapeutics bid 100.375

CV Therapeutics' new $100 million of eight-year convertible senior notes - talked to yield 2¾% to 3¼% with a 25% to 30% initial conversion premium - was bid 0.375 point over issue price but there was no offer, and buyside traders said they didn't see a trade in the gray market. The deal was pricing after the close Wednesday.

Lehman Brothers analysts put the new CV Therapeutics convertible 1.0% cheap at the midpoint of price talk, using a credit spread of 425 basis points over Treasuries and a 50% stock volatility. Collateralization of the first six coupon payments added about 0.5 points of value to the bond, the analysts noted.

Lehman analysts also noted that it was richer than the year-to-date average new issue cheapness of 1.64%. An upside/downside participation profile of 75%/64% estimated for a 25% stock move over one year.

Deutsche Bank Securities analysts put the new CV Therapeutics convert 0.28% rich to 4.59% cheap at the middle of guidance, using a credit spread of 450 basis points over Libor and a 50% stock volatility.

A buyside trader commented, also, on the new CV Therapeutics breakeven point, estimated at 7.18 years by the Lehman analysts.

"When you are carrying positions at 1%, you're breakeven is so far out there already," he said. "When bonds back up, those breakevens get pushed out even farther."

Pixelworks also on tap

The Pixelworks convertible was not seen at all in the gray market. The $125 million of 20-year convertible notes - talked to yield 1.5% to 2.0% with a 40% to 44% initial conversion premium - also were on tap after Wednesday's close.

Lehman Brothers analysts put the Pixelworks convertible 1.34% cheap at the midpoint of guidance, using a credit spread of 450 basis points over Treasuries and a 50% stock volatility.

Deutsche Bank Securities analysts put the Pixelworks convert 2.46% rich to 1.61% cheap at the middle of price talk, using a credit spread of 450 basis points over Libor and a 50% stock volatility.

Pixelworks shares on Wednesday lost $1.79, or 9.42%, to close at $17.21.

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