Lehman suggests AudioCodes convertible worth a look on recent pullback

By Ronda Fears

Nashville, May 25 - Lehman Brothers Inc. convertible analysts said in a report Wednesday that the AudioCodes Ltd. 2% convertible is worth considering given the recent pullback in the stock, which has pressured the convert lower.

Venu Krishna, head of Lehman's U.S. convertible research, noted that on Wednesday Lehman Brothers initiated coverage of AudioCodes equity with an overweight rating and $15.00 price target, based on 25 times taxed 2006 operating income per share of $0.51 plus $2.00 per share of net cash.

Also, he pointed out that Lehman was a joint lead manager of the AudioCodes convertible, which was brought to market in November at par to yield 2% with a 32.5% initial conversion premium.

Shares of AudioCodes were sharply higher Wednesday on Lehman's stock coverage, plus news from the Israeli voice networking equipment firm that it had signed a joint promotion arrangement with Texas Instruments for AudioCodes voice over internet protocol, or VoIP, products based on Texas Instruments' digital signal processors.

The AudioCodes convertible - a $125 million senior note - is non-rated and is callable and/or putable at par on Nov. 9, 2009. When the issue priced at par in November, the stock was at $14.12. Now, the Lehman analysts said the bond is trading around 86 to 86.5, with the common stock having pulled back to $11.15.

Cheapness just one reason

At current levels, the analysts said terms on the convertible are reasonably attractive with a 5.5% yield to put and 44.7% premium, compared with a 2% yield and 35% premium at issue. Given the recent pullback, Krishna said the bonds are worth considering on the attractive valuation, plus a favorable risk/reward profile and greater income pickup over the common stock.

The bond appears roughly 3.2% cheap using assumptions of 37% volatility and a credit spread of Libor plus 500 basis points, according to the Lehman analysts. The analysts explained that the spread assumption is based on a 165 bps discount to the Lehman high-yield telecom index option adjusted spread of Treasuries plus 376 bps, or Libor plus 335 bps.

Given current trading levels, the analysts added that the bond is likely to provide a 2.5 to 1 participation profile of 60%/24% for an up or down move of 25% in the underlying stock over the next year. This translates into an estimated total return of roughly 14.7% on the upside and a negative 6.1% return on the downside.

Too, the bond is senior in the capital structure and offers investors a 232 bps current yield advantage relative to the AudioCodes common shares. Analysts also pointed out that the issue is included in the 2005 Lehman Brothers convertible recommended portfolio.

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