Bear Stearns sees Royal Caribbean as solid addition to convertible portfolio

By Ronda Fears

Nashville, Tenn., August 16 - Bear Stearns & Co. convertible analysts recommend Royal Caribbean Cruises Ltd.'s 0% convertible senior unsecured notes due 2021 for outright or swap investors.

"The combination of equity sensitivity, attractive valuation, and downside protection support of the put make this a solid addition to a convertible portfolio," said analysts Rao Aisola, Sarah Gallagher and Matt Hempel in a report Friday.

"With the current state of the markets, the universe of 0% convertibles that exhibit high equity sensitivity (i.e. not-busted) is relatively small. With a conversion premium of 33%, we like RCL 0.0% notes' ability to benefit substantially from the expected upside in the equity. The market hedge is 65% and we would recommend a lighter hedge to take advantage of our bullish position."

The stock has traded off the past few months as worries about a slowing economy have hit many of the leisure stocks, the analysts noted. But, they added, the company has stated that inventory for the third quarter and full year bookings are lining up well and give good visibility for a strong year end.

"RCL shares are trading at 12.7x and 10.1x our 2002 and 2003 EPS estimates of $1.45 and $1.82, respectively, very cheap in our view," according to Jason Ader, Bear Stearns leisure products analyst.

"We think earnings risk for the balance of the year is quickly diminishing given the good visibility at this point, and therefore reiterate our Buy rating and target multiple of 13.0x-14.0x our 2003 EPS estimate, implying a target price of $24-$25 per share."

Assuming a 600 basis points spread and a 35% volatility, the Royal Caribbean convertible models out at a fair value of 41.5, or 7% cheap based on the current level, the convertible analysts said.

"Another attractive feature is the (soft) put option on 5/18/2004, which is at a 8.99% YTP. Even though we are bullish on the company's prospects going forward, it is reassuring to have the downside protection of owning short duration paper (1.75 years)," the analysts said.

"RCL Jan 17.5 puts are trading at an implied volatility of 68%, while realized volatility for the last three-months on the common was 43%. Given our bullish bias on the common, we would consider selling these puts at current levels."

As for the credit, the convertible analysts noted the cruise industry is characterized by high leverage ratios, to which Royal Caribbean is no exception. Total debt stands at $5.3 billion and EBITDA is expected to be $882.3 million for fiscal 2002.

Royal Caribbean

0% senior unsecured convertible note due 2021

Price: 38.625%

Common: $18.45

Conversion premium: 33.62%

Conversion price: $24.96

Current yield: 0.00%

Yield to maturity: 5.14%

Market delta: 65%

100-day volatility 39%

Put: May 18, 2004

Spread: 600 basis points over Treasuries

Next put 1.75 years

Credit: Ba2/BB+

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