Level 3 converts rise on private deal; UniSource, Allied Waste deals emerge; Par, Ivax, Teva up

By Ronda Fears

Nashville, Feb. 22 - Convertible players returned from the long weekend and got off to a sluggish start as stocks took a sharp dive retrospectively in reaction to last week's economic data and a spike in oil prices. Still, there were a couple of new deals launched, as well as a direct placement by Level 3 Communications Inc. - heretofore a busy issuer in the standard convertible market.

With the Level 3 placement of $880 million of convertibles directly to a group of seven institutional investors following the jumbo $2.5 billion private placement by Fannie Mae and NRG Energy Inc.'s sizable $420 million private placement of convertible preferreds - both last December - market participants said the phenomena of Section 4(2) offerings and other alternative routes for doing deals as opposed to the standard Rule 144A underwritten offerings is interesting but so far not alarming.

"I think it is very case specific," said a capital markets source, but "most issuers will still go to the public markets." Other capital markets sources also agreed that it was a case-specific occurrence, and saw no new trend developing in issuance patterns.

Level 3's deal turned heads, though, because of its finer details, while the UniSource Energy Corp. and Allied Waste Industries Inc. deals were some distraction from what traders described as an otherwise dismal day in the convertibles market.

"Our mandate is to focus on tech and telecom names for now. Unfortunately, it's an extremely quiet day. We've have had a tough couple of weeks as vol has come in hard on the tech stuff," said one sellside trader.

"There's a lot of pressure in the biz now and I think the next few weeks could continue to be tough. I have seen sellside desks as well as hedge funds losing headcount in recent weeks.

Bidders hide on exit concerns

In general, convertible players said the market seemed at a stalemate amid widespread concerns about an exodus by hedge funds - which account for upwards of 75% of market activity and trading volume - due to poor returns in the convertible arbitrage strategy.

"Bidders have gone into hiding," a sellside trader said.

Merrill Lynch reported Tuesday that its convertible hedge index last week lost 0.60% on a net basis before hedging out interest rates, or down 0.53% afterward, bringing the year-to-date net return to loss of 2.02% before hedging out interest rates and down 1.81% after.

A major culprit, Merrill analysts said, was the back up in Treasury yields last week in reaction to economic data - lower jobless claims and higher inflation numbers - plus the slightly hawkish comments from Federal Reserve chairman Alan Greenspan. The 2-year Treasury yield rose to 3.43% from 3.33% during the week while the 10-year Treasury yield climbed to 4.27% from 4.11% and the 30-year Treasury yield gained to 4.60%from 4.49%.

A fund manger on the West Coast said, the "market is just not interested in bidding anything up on continued worries that there might be more redemption selling."

Unisource Energy launches

Tucson, Ariz.-based utility holding company UniSource Energy Corp. launched $100 million of 30-year convertible notes after the closing bell with price talk for a 4.5% to 5.0% coupon and initial conversion premium between 20% and 25%. Credit Suisse First Boston is sole bookrunner of the Rule 144A deal, which is scheduled to price after Wednesday's close.

UniSource said proceeds would be funneled to subsidiary Tucson Electric Power Co. to repay debt, in whole or in part, and for other general corporate purposes. UniSource said Tucson has not determined the series of debt to be repaid or repurchased, however.

UniSource shares closed Tuesday off 68 cents, or 2.2%, at $30.16.

Allied Waste on the horizon

With pricing not slated until March 3, Allied Waste Industries Inc. launched $500 million of three-year mandatory convertible preferreds with guidance for a 6.0% to 6.5% dividend and 23% to 27% initial conversion premium.

At the midpoint of guidance - 6.25%, up 25% - it might not seem like the new Allied Waste mandatory offers whole lot more than its other convertibles, but a salesman working on the deal said the major pitch for the deal is that as a result of this financing effort the trash hauler's credit is better. The $300 million 6.25% mandatory due 2006 was sold in April 2003 with a 22.05% initial conversion premium and the $200 million 4.25% convertible bonds due 2034 were sold in April last year with a 57% initial conversion premium.

The convert is part of a larger refinancing effort that also includes the sale of $100 million of common stock and $600 million of Rule 144A senior notes by subsidiary Allied Waste North America Inc. In addition, Allied Waste is scheduled to launch a new $1.45 billion bank facility on Thursday.

"I haven't had a chance to take a look at this yet but here are some quick thoughts. Adding some equity to the capital structure and taking out the near-term debt maturity definitely helps the credit," said a buyside convertible analyst.

"During their earnings call a couple of weeks ago, management had actually talked about their intent to refinance with equity or debt, so they are following through on their plan. They still have $1.5 billion of debt coming due in 2008, but this will give them some additional time and flexibility to address their capital structure."

Level 3 bounces on deal news

The reaction to Level 3's latest capital infusion was almost identical regarding extended maturities and a better credit picture for the internet access provider, at least near-term. Level 3 announced Tuesday the sale of $880 million of 10% convertible senior notes due 2011 to seven institutional investors via a direct placement under its shelf registration.

As a result of the deal, Level 3's issues first spiked sharply then fell back and finally rebounded slightly before the close, traders said. Its other four convertible issues were marked up 5 to 10 points but settled up by 5 to 8 points. Level 3 stock also gained as much as 23% on the news but closed up 18.13% on the day, or 35 cents higher, at $2.28.

After Jan. 1, 2007, the new 10% notes are convertible at a conversion price of $3.60, which would be an 86.5% premium to the $1.93 closing price of Level 3 stock on Friday, which also was being viewed as a huge vote of confidence in the company by the investors - Southeastern Asset Management; Davis Selected Advisers LP; Fairfax Financial Holdings; Legg Mason Opportunity Trust; Markel Corp., MSD Capital LP; and The Torray Cos.

"[You] have to give them credit, they keep getting these deals done," said the buyside analyst. "Too bad they didn't raise more capital and exchange more debt for equity when the stock was near $7 last January."

In November, Level 3 sold the 5.25% converts with a 20% initial conversion premium but through using a portion of those proceeds to enter into bond hedge and stock warrant transactions to limit dilution from the conversion of the notes by boosting the conversion premium to 80.7%.

"All the bonds are better, but I have not seen the converts trade at all on the news," said a desk analyst at a big convertible shop, speaking around noon. "I would think there would be some people doubling down their bets on the name. This [capital infusion] lightened the credit risk, on a near-term basis anyway. It gives them probably another three years of breathing room."

Later, traders saw some of the Level 3 convertibles change hands, though not in a big way, but moving prices down.

"They were sort of bouncing around all day," one buyside convert trader commented.

Lions Gate old issues mangled

Lions Gate Entertainment Corp.'s new deal last week surprised some holders of its older convertibles, which were mangled as a result of a new round of takeover talk that put the Santa Monica, Calif.-based motion picture company as a target for the likes of Sony. But rather than a huge sell off, some holders just decided to dig in deeper in the name.

Proceeds from the $150 million convertible - printed at 3.625%, up 38% - were actually earmarked in part for potential acquisitions, but Lions Gate has been the subject of takeover speculation for several weeks now.

A current holder of the other two Lions Gate converts - 2.9375% and 4.75% issues - said he only got involved in the 3.625% issue in a very small way.

"The feeling was a bit of surprise at them needing new money. We like the biz model and company," the portfolio manager said. "[We] would have swapped out of the 2 15/16s and into these new ones but the existing got pretty shellacked - so we stayed with position - added a little stock. The older 4.75s also look more interesting - company a little more difficult to take over when you have to pay 'fair value' on more debt - methinks.

Par, Ivax up on Novartis news

Novartis AG announced Monday that it was acquiring German generics drugmaker Hexal AG and its U.S. sibling Eon Laboratories for a total of $8.3 billion and that boosted other generic drug names in the convertible universe like Par Pharmaceuticals Cos. Inc., IVAX Corp. and Teva Pharmaceutical Industries Ltd.

"It should be good for industry sentiment regarding consolidation in the drug sector," or specifically in generic drugs, said a sellside source, although he added that Teva was considered a "pricey" name and would likely be "forced to look for acquisitions to maintain growth."

Moreover, the news was more positive for Ivax, as a primate takeover candidate, and Par Pharma because of the price tag Novartis was willing to pay. The sellside source said that while neither Ivax nor Par Pharma's older converts carry takeover protection, they were trading well enough below par or fair value to have enough room to bounce on the event.

Par Pharma's 2.875% convert added about a point while Ivax's 1.875% convert was bumped up about a half-point, a buyside trader said.

"This had got to be a positive for IVX and the whole group," the trader said. "It eliminates a major European competitor, for one thing. For another, it sets the bar very high for generic valuations, allows other Big Pharma firms to bid high for generic properties without looking irrational."

Moreover, he added, the situation "introduces the argument that owning a generic franchise has real value to a branded company in negotiating contracts with large single source agencies. Keep in mind that TEVA, MYL and IVX probably sell more drug units than Merck. If owning a generic can increase branded sales by 5% then it may pay for itself!! This is the new business paradigm. You don't buy a generic for their profits, but to enhance your own."

Par also was finding interest, he said, ahead of its earnings announcement due before the market opens Thursday.

Teva "pricey," a forced looker

Novartis said it will integrate the two companies in its Sandoz unit, which will create the world's largest company generic drug company with combined annual sales of $5.1 billion, pushing Teva out of the top spot in the sector. Following the deal, another buyside source said Teva will be forced to look for acquisitions, possibly even targeting Ivax, "in order to resume leadership."

"Ivax is bigger and more valuable that Hexal in my opinion and Hexal went for $8.3 billion. Ivax has as market cap with debt of less than $5 billion," he said. "2005 and 2006 should be very satisfactory for Ivax holders, so that is one of the most appealing names."

Teva's converts edged up just slightly, he said, because of that sentiment and the view that the issues are a little pricey along with the underlying stock. The 0.5s and 0.25s rose about a quarter-point to half-point, he said, with both in the 96 bid area as the stock gained 34 cents on the day, or 2.14%, to $16.20.

"With Teva, you have to consider that the stock price is pretty high against the projection of single-digit growth in EPS," he said. "The consolidation trend in the industry means Teva will have to buy instead of relying on organic growth."

And that buying would come as prices are trending up based on the Novartis deals.

In part, he said, Teva will have to look outside for growth because the number of Big Pharma patents expiring is getting smaller and there are others aspiring to capture those markets, which means generic drugs are under intensive pricing pressure.

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