Deutsche sees upside in ResMed as a mispriced credit

By Ronda Fears

Nashville, Tenn., July 9 - ResMed Inc. is a mispriced credit, Deutsche Bank Securities Inc. analysts said, and as such there is some 3 points of price upswing potential in the convertible.

"ResMed is a real company selling real products and generating real free cash flow," said analysts Jeremy Howard, Jonathan Cohen and Robert Barron in a report Tuesday.

"Given a market offer price of around 82.50, it is clear that the implied credit spread is currently Libor plus 780 bps. We believe that L+650 bps is the widest realistic assumption. L+650 bps would result in a theoretical value a full three points above where the bonds are currently trading."

The analysts added that the upside/downside participation over one year is also highly compelling, with the bond gaining in price even with the stock declining and in addition capturing 53.4% of the upside.

"This is an excellent outright convertible profile in itself, but with a sustained rally in the share price we believe that the actual upside delta might be even higher than suggested," the analysts said.

ResMed is the No. 2 player in the $350 million obstructive sleep apnea market, which has a projected growth rate of 15% to 20%. Deutsche Bank equity analyst Bruce Jacobs has a strong buy rating on ResMed stock with a $48 target price.

A credit analysis shows healthy operating statistics, the analysts said.

"Although the leverage is not insignificant, ResMed currently enjoys healthy operating metrics, in terms of solid revenue growth and an operating margin of 24%," the analysts said.

"An EBITDA to interest expense ratio of 7.69 times, conservatively adjusted, is a solid ratio and a debt to EBITDA ratio of 3.25 times is by no means unacceptable."

The analysts noted they were unable to locate a reliable, directly comparable bond to the ResMed issue, so they fell back on proxies in the healthcare sector (non-Hospital/HMO) carrying single B ratings from one or both rating agencies.

The average Libor spread was just L+ 398 basis points and the average yield only 8.78%, the analysts said.

In addition, the analysts pointed out that ResMed recently purchased some of the convertibles and announced on Friday that it has bought back almost 350,000 shares of the stock.

"Knowing that the company retains over $113 million in cash and near cash assets and has purchased bonds before around 88 makes it much easier for us to recommend the bonds at 82.50," the analysts said.

ResMed 4% due 2006

Ask Price: 82.59

Parity: 45.97

Premium: 79.10%

Yield To Maturity: 9.174%

Equity Price: $27.86

Current Yield: 4.858%

Implied Volatility: 31.87%

Bond Floor: 78.03

Risk Premium: 5.52%

Delta (theoretical): 39.88%

Theoretical Value: 85.63

Stock Volatility 40%

Credit Spread: 650 bps over Libor

Dividend Yield: 0%

Stock Borrow: 75 bps

Call: June 22, 2004

Call Price: 101.6 for first year, then 100.8, with 130% hurdle

Soft Call: Before June 20, 2004

Soft Call Hurdle: 150%

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