Beazer, Lennar drop; Novell overtaking Red Hat as Linux pick; Delta, airlines ease back

By Ronda Fears

Nashville, Sept. 20 - Homebuilders were getting destroyed Monday after Lennar Corp. reported stellar earnings but weaker orders than Wall Street expected. A widespread expectation that Tuesday's Federal Open Market Committee meeting will hail a 25-basis-point hike in interest rates compounded the damage to homebuilders, which included Beazer Homes USA Inc.

Anticipation of higher interest rates hadn't produced a rush for capital, however, as no new deals emerged Monday, contrary to what some players expected. Well, there was a tiny $30 million deal from Anadigics Inc., a chipmaker that was returning to the convertible market with a five-year non-callable convert talked to yield 5.0% to 5.5% with a 22.5% to 27.5% initial conversion premium.

Meanwhile, new paper from last week was mixed but continued the trend seen Friday with Vitesse Semiconductor Corp.'s issue gaining while Sepracor Inc.'s newest convertible continued to lose ground.

Sepracor's new 0% convertible lost 1 point to 98.5 bid, 99 offered with the stock off 34 cents, or 0.67%, to $50.13. Vitesse's 1.5% issue added 1.75 points to 104.75 bid, 105.75 offered with the stock up a nickel, or 1.71%, to $2.97.

Overall, traders said the convertible market felt firmer insofar as there were "lots of bids on the table." That said, though, market sources are saying a selling frenzy could be coming.

"It seems like we have all priced in a top to the interest rate cycle again. Is our bigger worry now deflation? I have been legging into a rho hedge on the premise that oil is closer to a high than a low, and I have said that before too," said a buyside source on the West Coast.

"The new military head in China [President] Hu Jintao is good news for China, even though I still think they have a hard landing [coming]. But if China can consume more and let some air out of the Yuan, then I could get more constructive on world markets.

"Lastly, the CBS news and polls favoring [President Bush] are giving a bid to almost everything - great! But sell the news could be coming."

On Monday, CBS and veteran journalist and chief news anchor Dan Rather backpedaled regarding a source of documents used in a Sept. 8 story questioning President George W. Bush's service record in the national guard.

Airline paper, meanwhile, was gaining interest on recent weakness, which was exacerbated Monday as crude oil prices shot up again to more than $46 a barrel.

"There has been a psychological blow to the entire airline industry and all of them have suffered," said a sellside trader. "The problem in converts is that the stuff people are wanting, the JetBlues, Atlantic Coast, Alaska Air, are not liquid issues. Those just aren't around much."

Some players were tiptoeing through the technology sector, too, and a buyside source suggested taking a gander at Novell Inc. A sellside trader said in just the past week Novell seemed to have overtaken Red Hat Inc. as the convertible market's pick in the Linux software race, noting that Red Hat's earnings after the closing bell Monday showed it was feeling some pricing pressure from competitors like Novell.

Lennar loses 2.5 pts, Beazer 4.5 pts

Slower order growth at Lennar, among other factors like a rising interest environment, spurred a selloff in homebuilder issues, including Beazer. Traders said the market had already been expecting some affect on Miami-based Lennar's current quarter due to all the hurricane damage in Florida.

"The effect of the hurricanes was no surprise, that really won't show up until the next earnings report, anyway," said a sellside trader. "This [homebuilder] paper was just getting too rich, and I expect after the Fed, this stuff will come down some more."

Lennar's 0% convertibles due 2021 were knocked down by a whopping 2.5 points to 67.25 bid, 67.5 offered while the stock plunged $1.61, or 3.39%, to $45.95.

Beazer's new 4.625% convertible dropped 4.5 points to 105.5 bid, 106 offered and the stock fell $1.99, or 1.87%, to $104.61.

Before the market opened Monday, Lennar reported a 12% gain in quarterly profit and raised its forecasts for the current and following year, citing a stable economy, but slower order growth and a drop in gross profit margins alarmed analysts and investors.

Lennar posted fiscal third-quarter net earnings of $225.2 million, or $1.36 a share, up from $201.6 million, or $1.21 a share, in the year-earlier quarter. Sales in the quarter ending Aug. 31 gained 21% to $2.75 billion.

"We continue to see a healthy homebuilding market, particularly in our land-constrained markets," Lennar chief executive Stuart Miller said, pointing out that new orders rose 1% for the quarter despite some new order and delivery delays in some markets due to hurricanes and a slowdown in refinance activity.

Delta, airline paper decline

Airline paper was a focal point of softness in the convertible market Monday, traders said, as oil futures shot up again past $46 a barrel. The bankruptcy of US Airways Group Inc. and Delta Air Lines Inc.'s dire straits have caused a sharp pullback in the entire group, and periodically investors are peaking at where those bonds are hovering.

"I have no exposure to any airline [but] have been looking at AMR," said one fund manager. "But I'm not ready, [though], if things turn around then these will all get chased straight up."

Monday brought general weakness, bucked only by a couple of names in the convertible universe - FLYi Inc., formerly Atlantic Coast Airlines Holdings Inc., and Alaska Air Group Inc. - but traders said those convertibles are extremely "difficult to get your hands on." The FLYi securities got a boost from a positive story in "Barrons" magazine over the weekend, traders said.

The Atlantic Coast 6% convertibles were quoted up 2 points at 62 bid, 64 offered, while the underlying stock closed up 22 cents, or 5.39%, to $4.30. Alaska Air's convertible floaters were pegged 0.625 point higher at 119.375 bid, 119.125 offered as the stock gained 33 cents, or 1.33%, to $25.21.

More activity takes place in the paper of the major carriers like Delta, the trader said, noting that AMR Corp., parent of American Airlines Inc., seems to be the market's favorite these days.

AMR's 4.25% converts dropped 1 point Monday to 77 bid, 78 offered, and the 4.5% convertibles were off 0.625 point to 69.25 bid, 70.25 offered. AMR shares dropped 22 cents, or 2.39%, to end at $8.99.

Gerard Arpey, chief executive of AMR, will be discussing the airlines' recent financial performance and turnaround plan before the Society of Airline Analysts on Thursday at 7:30 a.m. ET.

AMR sailed out of its financial troubles last year without having to file bankruptcy, but more and more onlookers are expecting that it is inevitable for Delta to land in bankruptcy court.

Even after a weekend of talks with pilots, there was no news from Delta or the union pilots about the pressing early retirement issue or wage concessions.

Delta's convertibles were off slightly Monday, with the 8% issue down a half-point to 34.25 bid, 25 offered and the 2.875% issue down 1 point to 35.75 bid, 36.75 offered, with the stock dropping 15 cents, or 3.79%, to $3.81.

Novell outshines Red Hat

Even before Red Hat's earnings, which traders said were expected to be sparkling, there was chatter about Novell becoming the market's choice among software names, particularly those wanting to get in early on the Linux race.

After Monday's close, Red Hat reported a fiscal second quarter profit of $11.8 million, or 6 cents a share, more than triple its year-ago profit of $3.64 million, or 2 cents a share. Revenue rose 60% to $46.3 million as its Enterprise Linux subscriptions rose to 144,000 units.

"One of the major concerns is pricing pressure as the Linux race heats up," a sellside trader said.

Red Hat, which has been a volatility play for lots of convertible players, stock ended down 13 cents, or 0.85%, to $15.10 on Monday and then in after-hours trading the stock lost another quarter, or 1.66%. Red Hat's 0.5% convertible had remained steady Monday ahead of the earnings at 96 bid, 96.5 offered.

Novell's 0.5% convertible on Monday gained 1 point to 97 bid, 97.5 offered, the sellside trader said, while the underlying stock closed off a penny, or 0.14%, to $6.97.

"On the [Red Hat] conference call, their guidance seemed sort of blurry. The new CFO didn't seem comfortable with specific details. They have some fiscal accountability issues coming back to haunt them, too," the trader said.

"The revenues also sounded light compared to what analysts were looking for. So while it was a solid quarter, results going forward lack visibility."

Proxy advisory firm Glass Lewis is asking Red Hat shareholders to withhold votes for the Linux software maker's former audit committee chief and reject a new stock incentive plan, according to media reports. The vote is scheduled at the company's annual stockholder meeting Tuesday.

The audit controversy stems from the company's announcement in July that it would restate results for the last three fiscal years and for the current fiscal first quarter to reflect a more precise way of recognizing revenues, which also resulted in Red Hat delaying its 10-Q filing at the Securities and Exchange Commission.

Another sellside market source noted, too, that Novell is a lot cheaper than Red Hat as a volatility play. He pointed out that the Novell bond is trading with an implied volatility of 50%, versus the actual volatility of 64% on the stock, and arguably should be trading more in line with the Red Hat convertible, which has an implied volatility of 55%.

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