LabOne, Saks convertibles rise on merger talk; REITs extend decline while Mercury Interactive drops

By Rebecca Melvin

Princeton, N.J., Aug. 8 - The convertibles of LabOne Inc. jumped on news Monday that Quest Diagnostics Inc. agreed to buy the medical laboratories and research company for $934 million, the amount calculated after assumed settlement of LabOne's $132 million of convertible debt.

Likewise, the convertibles of Saks Inc. jumped after Monday's editions of Women's Wear Daily reported that a group of investors could launch a bid for the upscale retailer. But Saks' six-plus-point jump generated less excitement in the market than LabOne's nine-point surge because the Saks paper lacks takeover protection, making it unappealing to hedge funds, sources said.

In another merger item Monday, the convertibles of E*Trade Financial Corp. didn't see much activity after the online brokerage said it plans to buy Harrisdirect from BMO Financial Group for $700 million in cash. The securities were seen unchanged at par bid, 101 offered, with traders noting not many of the convertibles remain outstanding.

Meanwhile, real estate investment trusts extended a move lower after a Barron's report fanned investor concerns related to the effects more interest rate rises from Federal Reserve policymakers will have in the sector.

Mercury Interactive Corp. traded down, in line with its underlying stock, after the software company said it will miss a deadline on Tuesday for filing its second-quarter financial report because of an ongoing accounting investigation.

Biotechnology convertibles were mostly lower and retail names were mixed.

Takeover protection lifts LabOne

The convertibles of LabOne jumped more than 10 points early in the session and then settled back about nine points higher after news that the Lenexa, Kan.-based company will be acquired by Quest Diagnostics.

LabOne provides health screening and risk assessment services to life insurance companies, as well as clinical diagnostic testing services to healthcare providers and drug-abuse testing to employers.

"It's a great smaller player, with great growth. I'm almost sad that the bond is going to be gone. This could have been another 100% gainer over the next few years," said an outright player on the West Coast.

In addition to its great fundamentals, LabOne, which has 3,100 employees and reported revenue of $468 million for the year ended Dec. 31, had takeover protection on its 3.5% convertible bonds, which contributed to the day's big jump.

"Without protection, those bonds would have fallen to 110, 111, which would have killed holders," said a Connecticut based buysider.

"As it was, the takeover protection did what it was supposed to do," he added.

The 3.5% convertible due 2034 traded to as high as 125.50 in the session, before settling back to the 124.50 bid, 125.50 offered level.

The takeover protection means that at closing, which is expected sometime in the fourth quarter, holders will get about 29 shares per bond, instead of the old conversion of 25.336 at issue.

But since it's an all cash deal, holders expect to get the extra over par as cash too instead of as stock.

LabOne operates major laboratories in Lenexa, Kan., and Cincinnati, Ohio, as well as a call center in Lee's Summit, Mo., and provides paramedical examination services throughout the United States and Canada.

Quest Diagnostics is a Teterboro, N.J., provider of diagnostic testing, information and services. It expects to finance the transaction through a combination of cash on hand, available credit facilities and public debt.

The acquisition isn't expected to have a material impact on Quest Diagnostics' 2005 earnings per share, excluding anticipated charges associated with the transaction, according to a press release.

Quest Diagnostics expects the transaction to generate annual synergies of approximately $30 million upon completion of the integration, which is expected to occur within two years of closing.

Specter of losses softens Saks' surge

The 2% convertibles of Saks jumped after a news report that department store Bon-Ton Stores Inc. and hedge fund Cerberus Capital Management are considering a joint bid for the Birmingham, Ala.-based retailer of about $28 a share.

The newspaper report was unconfirmed by reported buyers. Nevertheless, the convertibles lifted to 123.7586, from a level of 115.375 on Friday; and Saks shares jumped $1.85, or 9.14%, to $22.10.

"It's maintaining its cheapness. But the theoretical value doesn't recognize the takeover," a New York based sellside analyst said, suggesting that the convertible is 7.25% cheap and becoming an equity surrogate.

"For an outright, buy and hold, it looks good if they can't own the stock, but for hedge guys it could result in losses because it has no takeover protection," the analyst said.

The analyst contrasted Saks' surge with that of LabOne, which "pretty well protected holders in this case," the analyst said.

"Assuming the $43.90 [stock price to be paid] isn't adjusted, the convert holders are getting the benefit of about 16 points of value, compared with yesterday [Friday] when there was about 20 points of value from parity of 96," the analyst said.

REITS push lower

The convertibles of several REIT names, including Simon Property Group Inc., Lexington Corporate Properties Trust and Vornado Realty, traded lower Monday extending losses Friday which were spurred by inflation concerns related to the government's report on U.S. payrolls for July. The report showed better-than-expected job growth and average earnings.

In addition, bond yields moved higher on Monday and Barron's warned of a possible speculative bubble in the REIT sector.

Bond yields rose Monday as investors widely anticipated another interest-rate increase Tuesday by the Federal Reserve. Higher Treasury yields often push down REITs because they are sensitive to interest rates. Investors also keep a close eye on the difference between dividend yields of REITs and bond yields.

Barron's also ran an article highlighting Wall Street fears that last week's sell-off may presage a prolonged downturn in the sector after years of outperforming the broader stock markets.

Barron's reported that the major risks facing REIT investors are more Fed interest-rate rises, a popping of the bubble in real estate, a sluggish economy and a shift in investor sentiment. Some analysts also point to insider selling as a danger sign of a potential top.

On Monday, Simon Property's $3 perpetual lost 1.85, or 2.87%, to 62.20.

The 7.5% convertibles of Affordable Residential Communities Inc., which received a warm reception by investors in the primary market last week, moved down to 101.93 bid, 102.43 offered, from 102.5 bid, 103 offered on Friday.

Vornado Realty's 3.875% convertible traded down to 104.63, compared to trades as high as 105.75 on Friday.

Mercury expects to miss deadline

The convertibles of Mercury Interactive fell about 1.5 points on Monday after the Mountainville, Calif.-based software company announced that it would miss the deadline for filing its quarterly report and likely be forced to restate past results and book material charges.

The delay comes as Mercury carries out a previously announced internal investigation related to past stock option grants.

Mercury's 0% convertible due 2008 traded at 92.93, compared with a level Friday of 94.385.

Mercury shares lost 65 cents, or 1.7%, at $37.62.

Correction: The Monday, August 8, issue of Convertibles Daily misquoted a source regarding Friday's market move in REITs. The quotation should have read, "The credit spread widened to 400 basis points over Libor" on REITs instead of "The volatility credit spread widened to 400 basis points over Libor."

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