Sandisk slips on downgrade; Equity Residential, National Retail gain on rate play; Charles River up on vol

By Kenneth Lim

Boston, Sept. 25 - The convertible bond market was as quiet as expected for a Monday, with Sandisk Corp. losing about a point outright after the stock was downgraded.

Real estate investment trusts such as Equity Residential and National Retail Properties Inc. were also slightly better after housing data showed sale prices falling year-on-year, adding weight to views that rates may be lowered over the next few quarters.

Charles River Laboratories International Inc. was also slightly better on a dollar-neutral basis as investors sought out volatility plays.

The convertible bond market otherwise had a dull session on Monday. It was typical of the start of a week, and convertible investors were seen mostly adjusting positions as the equity markets rallied, a buyside convertible bond trader said.

"A lot of the vega names were better to buy today," the trader said.

Sandisk slips on cut stock

Sandisk's 1% convertible due 2013 was lower by about 1.5 points outright on Monday after Merrill Lynch downgraded the stock.

The convertible was marked at 95.625 bid, 96 offered against a stock price of $54.125 on Monday, in line with Sandisk stock (Nasdaq: SNDK), which dropped 0.98% or 54 cents to close at $54.84.

"They were cut to neutral from buy by Merrill Lynch, which probably created a lot of volatility in the stock," a sellside convertible bond trader said. "But there's always quite a bit of volatility in this name."

Merrill Lynch analyst Sidney Ho on Monday cut the firm's recommendation for Sandisk stock, citing growing concerns of a fall in NAND flash memory prices. Ho said stabilizing flash memory prices could benefit Milpitas, Calif.-based Sandisk in the near term. But recent plant visits in Asia raised the risk that supply will outrun demand going into the first half of 2007, which could erode prices for flash memory manufacturers such as Sandisk in the intermediate term.

A sellside convertible bond analyst said concerns about flash memory prices have been present in the market for some time.

"Oversupply has been a concern since earlier this year, and I think some of that may already be in the price," the analyst said. "Maybe that's why the price hasn't fallen any further."

But Sandisk's credit is likely to remain solid even if Ho's prediction comes true, the convertible analyst said.

"Sandisk isn't trading on credit," the analyst said. "The company's cash flow is still pretty strong, the credit isn't a problem at all."

REITs improve on data

Real estate investment trusts convertibles were bid up on Monday amid data supporting views of a weaker market and possible interest rate reductions in the coming quarters.

Equity Residential's 3.85% convertible due 2026 traded at 100.8 against a stock price of $49.50, an outright gain of about a quarter-point. Equity Residential stock (NYSE: EQR) closed at $49.69, up by about 0.02% or 1 cent. Equity Residential is a Chicago-based investor in residential properties mainly in the United States.

National Retail Properties' 3.95% convertible due 2026 was also about a quarter-point better on an outright basis, marked at 100 bid, 100.25 offered against a $21.30 stock price. National Retail stock (NYSE: NNN) slipped 0.42% or 9 cents to close at $21.36. National Retail is an Orlando, Fla.-based developer of retail properties in the United States.

"REITs in general were better today [Monday]," a convertible bond trader said. "The interest rate names were trading."

A sellsider said new data showing a slowing housing market raised hopes of greater volatility in REIT stocks.

"Everyone expects REITs [stocks] to come down, so they're buying into the volatility," the sellsider said.

Sales of existing homes in the United States fell 1.7% year-on-year in August, the first annual drop in more than a decade, the National Association of Realtors reported on Monday. The number of units sold also fell 0.5% month-on-month in August, the fifth straight monthly decline. Bond prices, meanwhile, improved as investors expected the U.S. economy to continue showing signs of a slowdown.

The sellsider said signs of a slowing economy were not a surprise, but added that some of the REIT convertibles may not offer as much downside protection or yield advantage if REIT equity starts falling.

"The common dividend may not fall as fast as the stock, so the common yield could actually go up, so any kind of yield advantage you were hoping to have on the convert could be gone," the sellsider said.

Rate cuts possible

Market behavior suggests a growing belief that the U.S. Federal Reserve will cut interest rates within the next few quarters, investors said.

"I try not to speculate on anything, but the market's saying that the Fed will cut...over the next few quarters," a buyside convertible trader said. "Bond markets are rallying again, and a lot of the prices are starting to reflect that."

A hedge fund convertible bond trader agreed that the market seems to be leaning toward interest rate cuts, but noted that there is still some uncertainty.

"A couple of the bigger firms like Goldman and Merrill definitely see rates going lower by the end of the year," the trader said, adding: "Some people definitely think that. I wouldn't say that, and some people would say that it might go higher."

The trader said that if interest rates were cut, "it wouldn't be a negative" for the convertible bond market, although new issues may arrive with lower coupons.

Charles River gains on volatility

Charles River's 2.25% convertible due 2013 improved by about a point outright on Monday on the back of volatility in the stock.

The convertible was marked at 106.7 bid against a stock price of $42.70. Charles River stock (NYSE: CRL) rose 1.34% or 56 cents to finish the day at $42.29.

"They were up probably half a point better [dollar-neutral]," a convertible bond trader said.

Charles River stock has gained about 65 cents since Sept. 21 after the company said it received a $111.6 million 10-year grant from the National Cancer Institute to build a research and services facility and to help manage sample repositories. Wilmington, Mass.-based Charles River develops animal and other research models for the biotech industry.

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