Lehman lists six reasons why Six Flags convertible remains attractive

By Ronda Fears

Nashville, Oct. 13 - A lot of the cheapness in Six Flags Inc.'s mandatory convertible has been squeezed out, but Venu Krishna, head of U.S. convertible research at Lehman Brothers, said many of the reasons to buy it previously still stand.

Six Flags has outstanding a $287.5 million 7.25% convertible preferred due Aug. 15, 2009 (B3/B-).

"We had recommended the Six Flags convertible preferred as a compelling swap," out of the common and into the convertible, Krishna said in a report Monday, based on the convert's unique risk/reward profile - outperformance both on the upside and downside relative to the common - significant cheapness and a credit profile that showed no liquidity concerns.

Since August 2002, the stock has returned 17.2% while the convert has provided a total return of 67.8%. The convert is quoted at $20 with the stock at $5.90.

"At these levels, we estimate the convert is fully valued," Krishna said.

"However, we continue to believe that convert remains an attractive alternative to the common."

The convertible is attractive versus the common stock, he said, for the following reasons:

1. The convert provides a decent 9.05% current yield and a yield to maturity of 12.12%. While the 182% premium suggests it would be relatively insensitive to the stock, Krishna believes investors will realize more equity exposure on the upside than the premium suggests.

2. The most attractive feature of the convertible remains its risk/reward profile. Lehman analysts estimate the convert would provide a total return of 14.3% if the common stock rises 25% and a positive return of 4% even if the stock declines 25% over the next year.

3. The convert can be mandatorily converted into common stock by the company starting Feb. 15, 2004 if the common stock reaches $25.02 or higher for 20 business days within any 30 consecutive trading days. Given that the stock has to rise over four times to hit this threshold, the risk of forced conversion is highly limited over the next year.

4. The convert is a term preferred with a cash redemption date on Aug. 15, 2009. While the convert is subordinated to all straight debt, it is a notch higher than the common stock in the capital structure.

5. Despite a highly levered balance sheet, investment characteristics of the convertible preferred are bolstered by the highly limited liquidity risk. Six Flags has a $138 million cash balance, availability of a $300 working capital revolver, a $100 million multi-currency revolver and expectation of around $40 million in free cash flow in 2004.

6. While the convert's cheapness has been largely extracted, it remains fully valued based on a 1,000 bps credit spread and 40% volatility assumption. Six Flags' straight debt - the $375 million of 9.50% bonds due 2009 - currently trades at a spread of 716 bps to comparable Treasuries. All other straight debt matures later than the convertible.

Investors should also note that Six Flags has the option to pay the dividend on the convertible preferred in cash, stock or a combination of the two, Krishna said, but thus far, Six Flags has paid all the quarterly convertible dividends in cash.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.