Wild Oats blooms for outrights, pricks hedges; Peabody improves on outlook; XM improves amid merger

By Kenneth Lim

Boston, Feb. 22 - Wild Oats Markets Inc. rose outright but hurt hedge investors on Thursday after the company agreed to an all-cash takeover offer from larger competitor Whole Foods Market Inc.

Peabody Energy Corp. gained on the strength of industry data showing that the coal miner and its peers were keeping a rein on production levels.

XM Satellite Radio Holdings Inc. improved slightly in the wake of a planned merger with competitor Sirius Satellite Radio Inc. as another broker said there was little downside for XM even if the deal did not go through.

The convertible market in general was slower than usual.

"I think with Monday being off, a lot of folks are probably out skiing and having more fun than us," a buyside convertible trader said.

Wild Oats mixed on takeover

Wild Oats' 3.25% convertible due 2034 rose about 2 points outright but fell several points on a hedged basis after it agreed to be bought by Whole Foods for about $565 million.

The convertible traded at 110 against a stock price of $18.40 on Thursday. Wild Oats stock (Nasdaq: OATS) jumped 17.11% or $2.69 to close at $18.41.

"Unless you were outright you lost money," a buysider said. "If you were hedged you probably lost 2 to 4 points."

Boulder, Colo.-based Wild Oats said late Wednesday that Austin, Texas-based Whole Foods will pay $18.50 in cash for each Wild Oats share and assume about $106 million of debt. The deal is expected to close in April. Wild Oats and Whole Foods are organic and natural foods grocers.

A sellside convertible analyst said hedge investors may have lost even more than just 2 to 4 points depending on the weight of their delta positions. Hedge investors with a lighter hedge would have experienced a smaller loss, while those on a heavier hedge would have suffered more.

"The problem here is that there's no takeover protection as we know it now," a sellsider said. "It's kind of an old-school takeover protection based on the market value of the convertible prior to the announcement of the deal."

Another convertible analyst said the deal was not a complete surprise.

"Wild Oats is a relatively small grocer and their CEO resigned just last year, so I think if anyone was a possible takeover target they would have been one of them," the analyst said. "I would think it's a pretty good fit. Wild Oats and Whole Foods both focus on the same types of products. There's going to be some overlap in terms of their markets, but they're going to end up with a stronger market presence and they'll likely be able to cut down on costs."

The analyst said Wild Oats will likely be taken over, one way or another.

"I believe there's a very good chance that a deal will be done," the analyst said. "Of course, if someone else comes forward with a competing bid, it will get more interesting. But even if that's the case, Wild Oats is probably still going to get taken over."

Peabody improves on data

Peabody's 4.75% convertible due 2066 rose about 1.5 points outright on Thursday after industry data suggested that coal producers were holding supplies in check.

The Peabody convertible traded at 101.75 versus a stock price of $43.92, while Peabody stock (NYSE: BTU) moved higher by 2.12% or 91 cents to end at $43.88.

"The BTUs continue to be active," a sellside convertible trader said. "They've come in a bit since they were launched, but these are still attractive whether you're outright and you like the stock or you're buying it for the volatility."

Peabody is a St. Louis-based coal mining company.

Coal mining stocks gained across the board on Thursday following numbers from the Energy Information Administration that showed production for the week of Feb. 17 slightly lower from the week before and flat from the year-ago period.

A buyside convertible analyst said Peabody remains an attractive name, although its valuation is close to fair at the moment.

"I think one of the smaller sellside shops said they're expecting a turnaround for the sector this year," the analyst said. "I wouldn't be surprised if numbers are better this year because last year wasn't as good as expected and the companies have kept production at reasonable levels...Peabody is one of the largest coal producers in the world, so any gains in the sector will translate into gains for the company. The convertibles are close to fair at the moment, but in the medium to long term the stock still has a nice outlook."

XM gains slightly

XM Satellite Radio's 1.75% convertible due 2009 gained about 1/8 point in the wake of the recently announced merger deal with Sirius Satellite Radio. Even with regulatory approval for the merger still in question, XM faces little downside regardless of whether the deal goes through, Credit Suisse said in a research note on Thursday.

The XM convertible traded at 87.5 versus a stock price of $15.22. XM stock (Nasdaq: XMSR) closed at $15.34, up modestly by 0.59% or 9 cents.

"The XMs continue to be active, although it's starting to slow down a little from the last two days," a sellside convertible trader said.

Washington-based XM and New York-based Sirius announced plans for an all-stock merger earlier in the week. The deal, which will give XM investors 4.6 Sirius shares for every XM share, is valued at more than $4 billion. Regulatory approval is still required.

"The market is clearly telling us that investors believe the probability of the Sirius-XM merger being approved is very low," Credit Suisse equity analyst Bryan Kraft wrote in a report. "We are more optimistic."

Kraft said he takes the contrarian view that both companies will have to increase prices if they were to stay separate and remain viable businesses. For regulators, approving a merger and imposing price caps for three years may be a better decision than rejecting a merger and getting price increases, Kraft wrote.

Even if the deal is rejected, higher rates will support XM's current stock price, "which makes the optionality of the deal being approved almost free" for XM, Kraft wrote.

Kraft rates XM stock outperform with a $23 target price.

"We would be aggressive buyers of XM at current levels," Kraft wrote.

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