Southern Union, Protein Design launch; Pinnacle Airlines edges up, raises Northwest paper

By Ronda Fears

Nashville, Feb. 7 - The buying mood hinted of late last week in the convertibles market gained steam Monday but trading overall, including some selective selling, picked up on anticipation that deal flow will be revving up. Indeed, a couple of new deals emerged Monday from Southern Union Co. and Protein Design Labs Inc., both repeat issuers in the convertible market.

At mid-week, the convertible market also is expecting to see Huntsman Corp. price its $250 million three-year mandatory convertible - talked with a 5.0% to 5.5% dividend and 18% to 22% initial conversion premium - alongside the Salt Lake City-based chemical company's initial public offering of 55.7 million shares estimated in a range of $21 to $23 a share.

"Earnings are dying down so we are fully expecting deal flow to pick up, finally," a buyside trader said.

Meanwhile, dealers said trading volume looks better, "even for a Monday." There was a fair amount of selling, though mostly "story driven" rather than the more widespread sales seen in the past couple of weeks, one dealer said.

Alkermes Inc. was one example mentioned with its 2.5% convertibles dropping further, following its warning last week that its results would be lower than the company originally forecast for fiscal 2005, which ends March 15. Convertible holders also balked at the company pledging revenues from its lead commercial product to service a 7% junk bond last week.

Protein Design Labs returns

Protein Design Labs returned to tap convertible investors for another $250 million, or up to $300 million with the greenshoe, and players were vacillating as to whether it would be hot or not. The seven-year convertible notes, non-callable for five years, are talking to price to yield 1.25% to 1.75% with a 30% to 35% initial conversion premium.

"It looks fair on the cheaps," one onlooker said.

Another said, "The terms are OK, relatively speaking, because of what we've been seeing lately. The key is the UOP [use of proceeds]. The acquisition they are making has some dilutive impact to the common, and they also have a convert out. We'll just have to hear the pitch on the [acquisition] deal."

Fremont, Calif.-based Protein Design Labs said it expects to use proceeds for working capital and other general corporate purposes, including research and development, capital expenditures and expansion of manufacturing facilities. The company also said it may use a portion of proceeds to pay for the proposed acquisitions of ESP Pharma Holding Co. Inc. and the drug product Retavase, and to acquire or invest in other complementary businesses, products or technologies.

Earlier this month, Protein Design Labs said it would increase its price for ESP Pharma by $25 million to a total of $500 million, to reflect the revenue stream from ESP Pharma's Retavase, a blood-clot buster. The company has said it would pay $175 million of the price tag with common stock.

The existing Protein Design Labs 2.75% convertible due 2023 was quoted at 122 bid, 122.5 offered at the close Monday, off a half-point.

Protein Design Labs shares closed Monday off by 15 cents, or 0.74%, at $20.10. Immediately following the convertible announcement, the stock dropped $1.35, or 6.72%, in after-hours trading. Later, the stock bounced back in after-hours trading and was last seen down by just $1.26, or 6.26%.

Southern Union bid up in gray

Southern Union launched its deal before Monday's open and was higher in the gray market, while Protein Design Labs did not toss its deal out until after the close. Buyside market sources, though, also were a bit indecisive as to how the new Southern Union deal would go ultimately.

Indicative terms on Southern Union's $100 million of three-year mandatory convertibles put the dividend at 5.0% to 5.5% and initial conversion premium between 20% and 25%. The Wilkes-Barre, Pa.-based natural gas pipeline operator said it would use proceeds to repay debt incurred in connection with its investment in CCE Holdings LLC.

Traders said they did not see a lot of the proposed Southern Union mandatory trade but it was bid 0.25 point over issue price with an offer at 1 point over in the gray market. The existing Southern Union 5.75% mandatory due 2006, however, saw heavy buying, one dealer said. The 5.75s shot up 1.625 points to 73.5, he said, while Southern Union stock gained 46 cents on the day, or 1.9%, to $24.61.

Market sees deal pricing wide

A hedge fund manager said the convertible market is expecting Southern Union's new mandatory to price at the cheap end of guidance, though, which gave the issue some bounce in the gray market.

"The terms don't exactly seem all that great, and it's a bit frustrating [since] they priced the common deal down at $23 this morning and then come out with the DEC [mandatory] a day later off a higher stock price," one buyside source said.

Also Monday, Southern Union announced that it had sold 14.9 million shares of common stock at $23 a share, for a total of $342.7 million, with those proceeds also earmarked to repay debt incurred in connection with its investment in CCE Holdings LLC. Southern Union stock closed Friday at $24.15.

"Outright guys like the story and I'm assuming HedgeLand thinks they will price the premium near the cheap end after the equity deal was done at $23 this morning," a buyside source said.

"At the right premium, it makes sense, but [the underwriters, JPMorgan and Merrill Lynch] took all the profit out of it for the convert community - not only by pricing off a higher stock price, but trying to get away with a 25% premium on a 20% volatility stock. It's kind of disappointing."

Pinnacle up, lifts Northwest

Pinnacle Airline Corp.'s new 3.25% convertible continued to edge higher Monday, and a sellside trader remarked that the deal from last week put a buying spotlight on Northwest Airlines Corp. on some modest spread tightening.

The Pinnacle Airlines 3.25% convertible edged up another 0.625 point to 103.25 bid, 103.75 offered on Monday, with the stock up 6 cents on the day, or 0.55%, at $10.98.

Pinnacle being a feeder carrier for Northwest helped the legacy carrier's paper, too, as proceeds from the convert will be used to pay back a note and part of a credit line to Northwest. Traders said Northwest was benefiting from lower fuel costs, too, as were other airlines on Monday.

Northwest's 6.625% convertible was pegged at 82.5 bid, 83.5 offered, up 1.5 points, and the 7.625% convertible at 72 bid, 73 offered, up 1 point. Northwest shares closed Monday up 21 cents, or 2.73%, at $7.90.

Hedge fund returns still sliding

Hedge fund returns continue to come in, and in negative territory so far this year. Merrill Lynch reported Monday that its convertible hedge fund index last week, the first week of February, was down 0.2% net of fees and after hedging out interest rates. The HFRX convertible arbitrage index showed that for January the strategy lost 1.06%.

Merrill convertible analysts said secondary market cheapening made the highest negative contribution, subtracting 66 basis points, to hedge index returns. Somewhat countering that effect, the analysts said spread tightening - chiefly in high yield - added back about 32 basis points.

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