Vale gets tepid response in gray market; Medtronic, Transocean active; Chesapeake steady

By Rebecca Melvin

New York, July 7 - Vale SA was slightly better in the gray market early Tuesday but lost steam as the day wore on amid tepid interest in the new convertibles, market players said.

The offering, expected to price after the market close Tuesday, was large at about $1 billion of mandatories but was not seen as that impressive because it's coming in two tranches, a New York-based sellsider said.

The terms were criticized as not "good enough," by a New York-based outright buysider.

The Brazilian mining giant's existing convertibles and American Depositary Shares dropped in heavier-than-average volume.

Also in the primary, Regis Corp., which is expected to price $125 million of five-year convertible senior notes after the market close on Wednesday, was seen as "going to be OK," a sellsider said. But there was no gray market in the name, as Vale was a major focus of the day, sources said.

The session was "noisy," according to a sellsider, who faulted the day's trading activity for being concentrated in only a few names, namely Transocean Ltd., Medtronic Inc. and PNC Financial Services Group Inc.

Another market source said there wasn't much happening during the session. "People are still out from the holiday weekend, and there were not a lot of big vol. events. Volatility is falling, and earnings season is coming up, so companies are probably in their quiet periods," the source said.

On Wednesday, convertibles issuer Alcoa Inc. will report its latest earnings after the market close, unofficially kicking off earnings season.

Equities sold off heavily late in the session, dragging down the S&P 500 index by 2% to 881.03, while the Dow Jones Industrial Average fell 1.9% to 8,163.60 and the Nasdaq Stock Market dropped 2.3% to 1,746.17.

Oil prices were down, which was probably whacking energy names, a sellsider said. But Chesapeake Energy Corp.'s 2.25% convertibles due 2038, which fell in active trade on Monday, were mostly steady at about 58 to 59.

Among financials, KeyCorp was up about 5%, probably on the upgrade by Keefe, Bruyette & Woods Inc. to "outperform" from "market perform," according to a New York-based outright buyside analyst.

Vale plans $1 billion of mandatories

Vale's existing convertibles, two mandatory issues due in 2010, fell on Tuesday. The mandatory preferreds, which are listed under ticker symbol CJA, fell 6% to 34, and the mandatory preferreds, issued at the same time in June 2007, which are listed under ticker symbol CJB, fell 7% to 34.48.

The ADRs of the Rio de Janeiro-based diversified metals and mining company also fell 7% to $15.88.

The company said Monday that it planned to price about $1 billion of three-year mandatory convertibles in two tranches after the close of markets Tuesday.

The valuation depends pretty heavily on dividend growth assumption, a New York-based sellside analyst said of the new paper.

Since it's a mandatory, the credit spread doesn't really matter, he said. But another sellside analyst assigned the existing convertibles a credit spread of 350 basis points over Treasuries.

The registered offering was talked at a coupon of 6.25% to 6.75% with an initial conversion premium of 17.5% to 22.5% for both tranches.

It was quoted in the gray market at plus 0.125 point to 0.625 point early on and later was seen down 0.25 point.

"They generally try to price these to be slightly positive, so people don't like the paper," a sellside trader said.

As far as the credit impact of the new paper, he didn't see any problem in having staggered mandatories such as the two tranches due 2010 (existing paper) and the new ones, which will mature in 2012.

Mandatories trade strictly on cash flow, he said.

The company's credit rating and market capitalization are viewed as positives. But one outright buysider said that the existing Vale mandatories looked better to him than the new ones.

The structure of the bond is that there's 100% of dividend pass through, which means the conversion ratio will be adjusted depending on how much dividend the common stock pays out. If more dividends are paid out, then the company will increase the conversion ratio to compensate the mandatory holders. The upward ratio lowers the premium.

There hasn't been a new issue in the convertibles market of $1 billion in size for the last 12 months, a sellside analyst noted. But because there are two tranches, the size was not seen as that impressive.

Citi and J.P. Morgan are joint bookrunners of the paper, which will be issued through Vale's wholly owned subsidiary Vale Capital II.

Under an agreement between Vale and Vale Capital II, Vale will sell to Vale Capital II the number of ADSs that Vale Capital II will require to satisfy its obligations under the terms of the notes. The Brazilian Securities Commission authorized Vale's use of treasury stock to constitute the ADSs it will sell to Vale Capital II.

The first series, the VALE-2012 notes, will be converted to American Depositary Shares representing one common share of Vale, and the second series, the VALE.P-2012 notes, will be convertible into preferred class A shares. Together, the ADSs will represent up to 18.4 million common shares and 47.28 million preferred class A shares.

Vale will use proceeds for general corporate purposes.

Chesapeake 2.25% paper steady

Chesapeake Energy's 2.25% convertibles traded at 58 to 59 on Tuesday, which was flat versus Monday when the price declined 6 points along with a drop in the underlying shares.

The paper still has a certain amount of optionality, a sellside analyst said, noting that its bond floor is 46.

Mentioned in this article:

Alcoa Inc. NYSE: AA

Chesapeake Energy Corp. NYSE: CHK

KeyCorp NYSE: KEY

Medtronic Inc. NYSE: MDT

PNC Financial Services Group Inc. NYSE: PNC

Regis Corp. NYSE: RGS

Transocean Ltd. NYSE: RIG

Vale NYSE: VALE

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