Amazon rise burns heavy hedges; Emulex bonds hold on stock drop; distressed buyers remain active

By Ronda Fears

Nashville, April 25 - Traders reported considerable profit taking in techs and telecoms Friday as sentiment wavers amid a hodge-podge of earnings results this week.

Still, there were plenty of gainers, particularly in junkier or distressed convertibles, as spreads continue to tighten at that end of the credit scale. For the most part, anyway: one trader noted Calpine Corp. convertible bonds were flat to slightly lower and the junk bonds dropped about 1.25 points.

At the upper end of the credit spectrum, onlookers noticed high-grades were taking a break Friday from this week's bond rally.

"People are beginning to think that some of the turnaround stories have faltered, so we're seeing some profit taking on a few names that have made a run recently," said a dealer.

In convertibles, moves can often be deceiving, due to the wide divergence of positions between hedged players and outrights.

Thus, the sharp spike in Amazon.com, Inc. - after the internet retailer posted a narrower loss plus raised its 2003 outlook - was bittersweet.

Market sources said holders who set up Amazon's converts on a heavy hedge were burned by the 15% gain in the stock. Hence, one trader noted, the huge volume in Amazon shares - 40 million versus the running average of 7.1 million - was probably a lot of short covering.

Amazon's 4.75% convertible due 2009 gained 5-6 points, one trader said, to 92.625 bid, 93.125 offered. The 6.875% convertible due 2010, he said, added 4.5 points to 90.25 bid, 91.25 offered.

Amazon shares climbed $3.85, or 15.3%, to $28.97.

The Amazon converts, however, were helped as they will move up in the capital structure on the company's call of the 0% straight bonds, noted Wachovia Securities, Inc. head of U.S. convertible research Steve Jones. That is, he added, unless Amazon issues another tranche of senior debt.

Given the improved profit performance, strong guidance and stable operating model, he suggested the spread on the Amazon convertibles could be tightened to 575 basis points from 650 bps.

Along with earnings, Amazon announced the redemption of its step-up 0% senior notes due 2008 at 105 on May 28. Those would step up to a 10% cash coupon on May 2. The company said it will use $277 million of cash on hand, saving $27 million in pretax interest expense annually.

As that bond was senior to both convertibles, Jones said the elimination of that debt will effectively move the convertibles bonds up one notch in the capital structure.

A heavy hedge helped holders of Emulex Corp. converts, though, when the stock dived 22.5% as analysts criticized the quarterly results because almost half of the 4% growth in revenue was from storage components the company no longer makes.

The Emulex converts held up well on a dollar-neutral basis, said one market source, adding: "You were okay if you were set up on a 70% hedge."

Emulex shares plunged $5.50, or 22.5%, to $18.88, following its late Thursday earnings report. While the company reported a break-even third quarter versus a loss in the year-ago period and revenues rose, the results missed analysts' expectations.

Emulex's 1.75% convertible due 2007 fell about 7 points, one dealer said, to 82.875 bid, 83.875 offered.

Also noteworthy was a huge run in XM Satellite Radio Holdings Corp.'s convertible bonds this week. It is a small issue, but distressed traders said the bonds were very active this week and in general gained about 10 points from last week although they weakened Friday in sympathy with the broad market.

The XM Satellite 7.75% convertibles due 2006 were quoted closing Friday at about 96.75 bid, 97 offered. The stock ended off 35c, or 3.9%, to $8.70.

Bear Stearns upgraded the stock on Wednesday, the trader said, and: "Bang! The converts shot up. The common rocked up to about $9 and we were trading them at 110."

But they have been all over the map since then, he said, noting bids Thursday were in the 108 neighborhood.

Still, the XM Satellite convertible bonds are about 10 points better than a week ago, he said. The story has gained credence this week from new contracts to put the company's satellite radio products in Toyota, Acura and Audi automobiles. The company already has contracts to put their goods in several General Motors vehicles and BMWs.

For the most part, traders said high-yield convertibles were benefiting from the continuing surge in junk bonds as AMG reported another hefty inflow of fresh money chasing yields in junk bonds.

"We, converts that is, usually get a fair amount of crossover money from high-yield accounts," said a dealer.

"So these days when junks bonds see an inflow we can count on seeing some of that."

Charter Communications Inc. was one cross-over name mentioned in particular, with another dealer saying: "They [Charter converts] were headed north all week. People still want to jump into these."

Charter's 4.75% convertible due 2006 added about 2.25 points, he said, to 37.5 bid, 38.5 offered and the 5.75% convertible due 2005 gained about 2.5 points to 40.5 bid, 41.5 offered. About 500,000 of the 5.75s changed hands, at least, he noted.

New players in convertibles have been blamed for a good deal of the tolerance to terms on new issues lately, as well.

Several market sources from the sellside - bankers included - have commented about hedge funds switching into the convertible strategy, and oftentimes are not familiar with the nuances that make a convertible rich or cheap.

A couple of bankers have said those new convert players have been big participants in some of the new deals lately - several that have raised complaints by longer standing convertible players because of quirky features like warrant kickers and gigantic premiums that squeeze all the juice out of them.

"A lot of these new guys don't know if these deals are good or not, they've just decided suddenly they like the convertible strategy and they want to be players in this market," said a source at one of the bigger shops.

"That probably has something to do with the richness of the secondary market too. They just keep bidding up what's out there."

Mercury Interactive Corp.'s new deal, however, dropped about 2 points on the day, as the stock fell $1.27, or 3.63%, to $33.75 in sympathy with the downturn in tech shares.

Chips also were lower, on whole, including new issues from Micron Technology Inc. and Photronics Inc.

King Pharmaceuticals Inc. was another name continuing a losing streak. The drug firm guided lower on results Friday and the 2.75% convertible due 2021 was quoted down about 10 points to 85.375 bid, 86.375 offered as the stock ended off 42c, or 3.75%, to $10.77.

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