Bear Stearns: Royal Caribbean Cruises two 0% convertibles are cheap put plays

By Ronda Fears

Nashville, Tenn., March 4 - The two Royal Caribbean Cruises Ltd. 0% convertibles are cheap right now as put plays, said Bear Stearns & Co. head of convertible research Yaw Debrah in a valuation analysis report Monday. The report identified several such put plays, as well as cheap convertibles based on their high-yield counterparts.

"Despite falling volatility, the convertible market richened slightly during the week, buoyed by better economic data and stock market sentiment," Debrah said in the report. "With our macroecnomic market outlook, we would expect convertible valuations going forward to be aided by firmer bond floors, but hampered by declining volatility."

Volatility continued to sink last week in the convertible market, with 90-day volatility on stocks underlying the convertible index dropping to 50.7% from 51.1%, Debrah said, noting the market is only 1.6% higher than the 52-week volatility low reached on Sept. 10 of 49.1%. Zero implied volatility indicates that a convertible is trading at or near its investment value.

The convertible market also richened during the past week, the analyst said, moving to a discount to theoretical value of 3.9% from a 4.3% discount as stronger than expected economic data boosted investor sentiment. Spreads on issues in the Bear Stearns high yield index also improved slightly, from 841 to 838 basis points on the week, he said, noting that spreads have now been relatively flat at about 840 basis points since the beginning of December.

To evaluate put plays, the analyst focused on investment-grade and near-investment-grade, or higher than BB-, issues and used spreads on the corresponding credit default swaps, where available, or high-yield straight and Bloomberg fair-market credit spreads where a credit default swap market was not available.

Royal Caribbean was the featured convertible of the report. The cruise line has two 0% convertibles - one due February 2021 and another due May 2021. Based on Friday's closing prices, the report noted that the February 2021 issue was trading at 33 bid and the May 2021 issue was trading at 37.5 bid. Using a 35% volatility, the implied credit spread at which these convertibles are trading is something in the neighborhood of 1,100 basis points to Treasuries.

That spread is too high, Debrah said, given that Royal Caribbean's straight debt , the 8.75% 2011 bond is trading at 89-91, or 572 to 534 basis points to Treasuries. The 8.75% bond was issued at the same time as the convertible due February 2021 and have equal seniority in the capital structure, the analyst noted.

In the prospectus for the convertible, Debrah said, it clearly states that the issue will be unsecured and unsubordinated indebtedness of the company and will rank on a parity with the company's other unsecured and unsubordinated indebtedness, including the senior notes also being offered. In discussions with Royal Caribbean's treasurer, he added, it was confirmed that the convertible is at the same level in the capital structure as the 8.75% notes and rank equally in terms of seniority.

Hence, the analyst said the Royal Caribbean convertibles should be trading on a spread of around 600 basis points, which would put the proper trading levels at 36.7 for the February 2021 issue and 40.1 for the May 2021 issue. The Royal Caribbean 0% due February 2021 was quoted Monday at 34 bid and the 0% due May 2021 at 38 bid.

Others in the list include Agilent, Anixter, Cendant, Chiron, Corning, D.R. Horton, Electronic Data Systems, Hasbro, International Paper and Lowe's.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.