Citadel driven up on rumors; General Motors fall on Moody's downgrade; Meristar deal could hurt bonds

By Kenneth Lim

Boston, Feb. 21 - Speculation pushed the convertible of Citadel Broadcasting Corp. up another two points on Tuesday as the debate raged on over whether a merger with Walt Disney Co.'s ABC Radio network would trigger a change-of-control put option.

General Motors Corp.'s trio of convertible bonds slid after credit agency Moody's Investors Service downgraded the company's rating to B2 with a negative outlook, citing increased uncertainty over the automaker's ability to manage costs as well as the threat of bankruptcy as union negotiations drag on.

Meanwhile, MeriStar Hospitality Corp.'s convertible bond could take a hit after the real estate investment trust agreed to a $2.6 billion cash buyout from private equity firm Blackstone Group, said an analyst.

Investors looking for new deals will also be hearing more from India, which continues to pour new issues into the marketplace.

"For the Indian market, the convertible market is very active," said a convertible analyst who covers emerging markets. "They have a lot of new issues coming compared to other parts of Asia. Although the valuation is not cheap, fundamentally it's quite strong and growth momentum is quite strong too."

Citadel rumors drive bonds up

Citadel's 1.875% convertible bonds due 2011 gained about two points outright on Tuesday to 83.5 bid as confusion continued over the enforceability of a change-of-control put option, said a convertible analyst. A major trading house marked the securities at 80.12 bid, 81.12 offered against the closing stock price of $11.58.

"They've rallied back quite a lot from the initial slide," said one buy-side trader who noted that the convertible bonds have been actively trading. "Now they're even better."

Citadel (NYSE: CDL) stock ended the day nine cents, or 0.77%, lower to that $11.58 level.

Las Vegas-based Citadel has said that it would merge with Disney's ABC Radio to form the third-largest radio network in the United States in a $2.7 billion deal. The merger will entail Disney breaking off the radio arm and distributing ownership of the split-off entity, but analysts remain split over whether the process will be considered a change of control, which would let bondholders force a redemption. That put option would mean a profit for bondholders, since the securities currently trade below par.

The debate was given new life last week as rumors emerged that a group of major bondholders may have organized a conference call to discuss the possibility of a class action to force enforcement of the put option. Market sources have mentioned that hedge fund Whitebox Advisors could have been in a call, but its involvement could not be confirmed.

"I wouldn't be shocked that some bondholders would try to get something out of this," said the trader, who did not know if the conference call took place.

Michael Knox, managing partner at Breckenridge, Colo., research firm Xtract Research LLC, said his initial opinion was that "this was clearly not a change of control." But a Securities Exchange Commission filing last week that said Disney was deemed to be in control of 67.6% of Citadel stock - which could be a change of control - made him less certain.

"This has moved into legal territory," he said. "It really kind of clouds the issue somewhat."

A Connecticut-based analyst said that while he agreed the situation may be in the realm of lawyers, "we all have to do our best to guess the outcome."

While he remains skeptical that the put will be triggered, he said "if a large enough group of holders makes enough noise, the company may move to appease them in some way regardless of the merits."

He added, "I simply feel that it behooves me, as an objective voice, to remind everyone that this is not a slam dunk."

Looking at other aspects of the merger, Xtract Research's Knox said it was negative for bondholders that the radio broadcaster would not adjust the conversion ratio of the convertible bond despite a special dividend payment to be made as part of the merger. Citadel plans instead to add a cash component to the conversion ratio to account for the dividend.

"You have less upside because the stock needs to go up further before the convertible bond will move," he said.

In a research note, Bear Stearns highlighted that the minimum base dividend for stockholders will be $2.46 per share under any scenario, with up to $1.97 per share in special dividends if the stock exceeds $12.68.

General Motors slides on downgrades

Moody's Investors Service lowered Detroit-based General Motors' credit crating to B2 with a negative outlook from B1, ending a review for downgrade begun on Jan. 26. That sent the stock and convertible bonds downhill.

General Motors' 4.5% convertibles due 2032 (NYSE: GXM) eased back two cents, or 0.09%, to $22.97, while the 5.25% notes due 2032 (NYSE: GBM) lost 38 cents, or 2.41%, to close at $15.41. The 6.25% convertibles due 2033 (NYSE: GPM) ended at $16.78, 32 cents or 1.87% lower.

General Motors (NYSE: GM) stock closed at $21.41, down 51 cents or 2.33%.

Moody's said the downgrade to five rungs below investment grade "reflects increased uncertainty that the company will be able to achieve all of the steps necessary to establish a competitive wage, benefit and supplier cost structure outside of bankruptcy."

The rating agency said General Motors still needs to resolve the reorganization of former subsidiary Delphi corp. and negotiate for a more competitive labor contract with the United Auto Workers union. Although General Motors has taken steps to reduce its employee-related costs by cutting retiree health-care benefits and wages, Moody's said more had to be done.

"In the absence of material progress in reducing its UAW-related cost burden through negotiations, GM could resort to bankruptcy as an option to reduce this burden," Moody's said.

The company also needs to complete the sale of finance arm General Motors Acceptance Corp. and reverse its retreating market share in the United States, Moody's said. The auto maker had a 26% slice of the United States market in January 2006.

A sell-side convertibles analyst said he was not surprised by the downgrade.

"It's just a continuation of the degrading credit story there," he said. "There's been a fair amount of steps by management to try to halt the decline but it hasn't really done anything. They have a below-market product in a competitive environment with huge obstacles that includes pension as well as healthcare liabilities."

"I don't see many positives coming in the near term," he added.

MeriStar buyout could bite bonds

MeriStar (NYSE:MHX), the country's third-largest hotel real estate investment trust, said on Tuesday that its board had agreed to be bought by an arm of private investment firm Blackstone for $2.6 billion. While the trust's stock rose 35 cents or 3.52% on Tuesday to close at $10.28, a trader said he did not see the company's existing 9.5% convertible bond due 2010 trade. Data from Trace shows the last report of a trade in the security on Nov. 22, 2005, at 113.

But an analyst said the deal is likely to hit bondholders by erasing any option value on the convertible bonds, giving them value only as fixed-income instruments.

MeriStar said Blackstone will pay $10.45 per share in the deal, a 20% premium over the closing stock price on Nov. 10, 2005, when reports were first published regarding a potential acquisition of the trust. The buyout still needs shareholder approval, but MeriStar plans to complete the deal in the second quarter of the year.

The Bethesda, Md.-based trust has a portfolio of more than 50 upscale hotels and resorts in the United States, with brands that include Hilton, Sheraton, Marriott, Ritz-Carlton, Westin, Doubletree and Radisson. The buyout will not affect an earlier sale, announced at the start of February, of nine hotels and one golf and tennis club to Blackstone.

"When a convert gets taken out for cash, the option value goes down to zero, so any and all option value that was left is essentially erased," the analyst said.

As for the change-of-control put option, the bond will only be worth about 102.65 upon redemption, which "sucks relative to the market," he added. "Obviously you're not going to put it back."

But because the convertible bonds are non-callable for life and do not mature until 2010, bondholders could still hold on to their convertibles and collect on the coupon.

"It becomes Blackstone credit, which is not bad," the analyst said. "If you just model it as a fixed-income, it's worth around 111 to 113."

India deals keep pipeline busy

Companies in the Sub-Continent have been busy issuing convertible bonds this year, and another three companies signaled their intentions to make new offerings soon.

Kolkata-based water and sewage pipe maker Electrosteel Castings Ltd. said its shareholders had approved the issuance of up to Rs. 5 billion of foreign currency convertible bonds earlier in the week.

Uttar Pradesh-based Simbhaoli Sugar Mills Ltd., which refines sugar, said it had secured shareholder approval for up to Rs. 1.5 billion of foreign currency convertible bonds.

Meanwhile, Cipla Ltd. is seeking shareholder approval to issue up to $200 million of convertible bonds, stock or other equity or equity-linked securities. Cipla is a Mumbai-based pharmaceutical company.

A convertible analyst who covers emerging markets said the Indian wave is driven by a growing domestic economy as well as interest from foreign investors looking for exposure in Asia's growing markets.

"The domestic interest rate is very high, so they tend to make converts with relatively high premium and low yield," the analyst said. "And if they want to issue dollar-denominated bonds, the dollar rate is also rising a lot."

The analyst said the momentum of the convertible market in India is strong compared to the more established markets like Hong Kong and Taiwan, and more varied.

"Taiwan used to be dominant in tech, financial sectors. Hong Kong was more in property. In India you have more diversified names," the analyst said.

And while Indian convertible names used to be from the pharmaceutical, telecommunications and environmental sectors, now there are also names from industries such as construction.

"I'm quite positive on these markets," the analyst said.

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