Deutsche: Limited holding, asset swapped converts may put Solectron tender price at high end

By Ronda Fears

Nashville, Tenn., July 18 - Solectron Corp.'s tender price for its 0% due May 2020 may be boosted due to limited holding in the issue and a good deal of the paper being asset swapped, said Deutsche Bank Securities Inc. convertible analysts. The analysts recommend participating in the tender.

Having bought back a sizable quantity of the bonds in the market, Solectron is now offering to purchase for cash 64% of the outstanding $2.35 billion (face value) of the 0% due May 2020 bonds in a modified dutch auction with a price range of 58 to 60.

Tendering bondholders have to decide whether or not to specify a tender price limit, or simply to accept whatever the repurchase price results from the tender. If more bonds are tendered than the $1.5 billion, the bonds will be repurchased on a pro rata basis.

The deadline for the tender is midnight on Friday.

"Our view is that the majority of holders of the [0% due May 2020] will tender their bonds, but that the total amount tendered will be capped by the sizable percentage that was asset swapped at much tighter levels," said Deutsche analysts in a report Thursday

"Because of the percentage that we believe has been asset swapped, and the apparent heavy position concentration of the remaining bonds, according to publicly available news sources such as Bloomberg, we feel there is a good chance that the tender price will come in towards the upper end of the 58 to 60 range, with a tender at 60 a real possibility.

"Based on this analysis, our advice to holders is to participate in the tender. A tender at 60 represents a YTP of less than 6%, around L+400 bps. Given that the pari passu, although longer dated, [0% due November 2020] bond is yielding 15.1%, we feel this would be a reasonably good outcome.

The 0% due May 2020 bonds were trading around 57.25 on June 20 before the announcement of the tender, the analysts note. Holders should also consider reinvesting their tender proceeds into the 0% due November 2020, which now yields 15.13% to a May 2004 put and is also senior.

The analysts had a word of caution, saying their reading of the offer document suggests that Solectron can unilaterally terminate it.

"Although it is clearly unlikely, there is just a chance that in the current market environment a severe market deterioration causes the Offer to be postponed," the analysts said, adding, "Also note that it is an offense under Rule 14e-4 to short bonds into the tender."

Holders of the 0% due May 2020 have three choices, tender with no price limit, tender with a price limit, or hold on and wait until the put in May 2003.

"The decision comes down to making two judgment calls: What will the tender price be? and, How will both bonds trade subsequently?," the analysts said.

"Some holders argue that the fact that the company has tendered for bonds will support the [0% due May 2020] price following the tender. We are skeptical because SLR had been buying bonds periodically for a long time before this tender, almost $1 billion in cash will have been removed from the balance sheet and remaining liquidity will be poorer as the issue size shrinks."

Therefore, the analysts said, a level of 57, 57.25 is probably where the issue will eventually settle after the tender is completed, where it was before the tender. As this is substantially below the lowest possible tender price of 58, there is clearly a short-term incentive to tender.

"The impact of the tender on the [0% due November 2020] bond was initially muted," the analysts said.

"Over time, however, they have drifted lower as the market has concluded, correctly in our view, that the exit of cash from Solectron outweighs the benefits of the debt reduction in the current environment. The focus on removing the [0% due May 2020] bond from the market must also weaken the credit of the [0% due November 2020] to some extent."

At a current level of 45.875, the 0% due November 2020 is yielding 15.13% (L+700 bps) to the next put in May 2004.

"The way the tender is being conducted would normally be favorable to the company if the bonds were held by a very large number of small holders," the analysts said.

"Then the 'prisoner's dilemma' effect of each small holder worrying about not participating in a repurchase if they limited their price above 58 would probably lead to a tender price closer to the lower boundary."

But this situation is complicated by two facts - a large number of bonds were asset swapped at much tighter credit levels in 2000 and, based on public filings, a small number of large holders appear to control a sizable minority of the un-asset swapped issue.

That is crucially important in assessing the likely tender price, the analysts said.

"If we assume that $300 million (face) of the bonds have been asset swapped and cannot profitably participate in the tender, then if just two or three of the largest holders were to tender their bonds at 60, 60 would be the tender price for the whole issue," the analysts said.

"We assume that between $300 million to $400 million (face) was asset swapped in the year between the issue date of May 2000 and May 2001 at levels between 150 bps to 200 bps. We assume that at least $300 million of these bonds cannot be recalled because the unwind cost at the recall spread will be significantly in excess of the highest tender price."

Publicly available sources of holders of the bond indicate that the bonds are concentrated heavily in between five and 10 investors' hands, the analysts said, adding that "in a situation such as this, it is reasonable to suppose that the probability of a tender price towards the upper end of the price band is higher than if the holdings were very widely dispersed."

Solectron 0% due May 2020

Ask Price: 58.50

Parity: 6.67%

Premium: 777%

Yield to Put: 9.25%

Equity Price: $5.42

Current Yield: 0.0%

Call: May 8, 2003

Call Price: 62.857

Put: May 8, 2003 at 62.857 and on May 8, 2010 at 76.100

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