Southern Union advances, prices tight; Protein Design Labs seen rich; Level 3, EDS dive on results

By Ronda Fears

Nashville, Feb. 8 - Moods turned fickle and selling became the theme in the convertibles market Tuesday, traders said. Meanwhile, new issues were a diversion as Southern Union Co. advanced its deal, Protein Design Labs Inc. was at bat after the closing bell and Huntsman Corp. was due for Wednesday's business.

There had been some rumblings in the market that another new deal would launch after Tuesday's close, but that never came to pass.

"The market is ready for some fresh paper," one sellside dealer said. "It's been such a sputter and stutter start, that you might say the natives are getting restless" and resorting to selling positions.

Fund managers seem to agree on some level.

With the secondary market having been "very tough" lately, as one portfolio manager in New York put it, convertible players perceive "the re-starting calendar is a positive development."

Yet, many complain that terms on new deals are still not reflecting the market yet. Southern Union's deal, which many hoped would price at the cheap end of price talk, sold at the wide end, and some fear the same may be in store for the pending Protein Design Labs issue.

Protein Design seen as much as 2% rich

Protein Design Labs' new convertible was nowhere to be seen in the gray market, and onlookers said they were expecting the deal to price at the cheap end of guidance despite the scarcity of new deals so far this year.

The $250 million convertible is talked to price to yield 1.25% to 1.75% with a 30% to 35% initial conversion premium.

Merrill Lynch analysts put the new Protein Design Labs convertible 0.6% rich at the middle of price talk, using a 40% volatility and a credit spread of 400 basis points over the comparable Treasury. At extreme ends of the guidance range, Merrill puts the issue 2.9% rich to 1.8% cheap.

Another sellside shop's convertible analyst is putting the new Protein Design Labs convertible 2% rich at the midpoint of guidance, using a credit spread of 300 basis points over Libor and a 37% volatility.

"I think 400 bps over Treasuries is too aggressive. The spread I'm using may be tight, but the markets are tight right now," he said.

Protein Design position seen improving

The sellside analyst continued, "This acquisition will help their revenue stream, too, while they proceed with a couple of drug candidates in trials."

Protein Design Labs has as many as four antibodies in clinical development, according to company information.

Merrill convertible analyst Tatyana Hube also noted that the new issue ranks higher on the food chain. She said the new convertible will increase the company's debt burden and financial risk by virtue of lower interest coverage, but she added that the new issue has a senior unsecured ranking and should command a higher rating than Protein Design Labs' 2.75% convert (CCC), probably in the neighborhood of CCC+ or B-.

Fremont, Calif.-based Protein Design Labs has 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 for a total of $500 million in cash and roughly $175 million in common stock.

Protein Design Labs shares on Monday lost $1.88, or 9.35%, at $18.22.

Southern Union goes to 50.55

Southern Union advanced its deal to price a day early, and it came at the tight end of guidance rather than wide as the market hoped. Still, it gained ground out of the chute.

The $100 million of three-year mandatory convertible preferreds were printed with a 5.0% dividend and 25% initial conversion premium - at the aggressive end of guidance for a 5.0% to 5.5% dividend and 20% to 25% initial conversion premium.

Pre-market Tuesday, the new Southern Union mandatory was bid 0.75 point over par, and joint bookrunner Merrill Lynch sent the issue out at 50.55 bid, 50.65 offered. Both were up from a gray market bid of 0.25 point par over at Monday's close. The Southern Union 5.75% mandatory due 2006 was described as basically steady to slightly lower at 73.5, while Southern Union stock added 3 cents on the day, or 0.12%, to end Monday at $24.64.

Players had half expected the new deal to price wide of indicative terms, since the Wilkes-Barre, Pa.-based natural gas pipeline operator had sold 14.9 million shares of common stock at $23 a share - a discount to Friday's close of $24.15 - raising $342.7 million.

"This was obviously a disappointment [the terms on the new deal] but people were willing to pay up for this one," an outright fund manager said. "The structure is nice for this market; we're not concern about the premium, it was decent. We really like the Southern Union story."

Southern Union is using proceeds from the convertible and stock sale to repay debt incurred in connection with its investment in CCE Holdings LLC - a joint venture of Southern Union Co. and a unit of GE Commercial Finance, which bought three natural gas pipelines from bankrupt Enron Corp. for $2 billion, plus the assumption of $430 million in debt.

Players peel out of Level 3

Level 3's earnings showed a narrower loss, but the company's tightened guidance spooked convertible holders and, as a result, traders said many players were "peeling off" those bonds.

On swap, Level 3 converts were described as coming in 2 to 3 points. Outright, the bonds fell 6 to 8 points. The 2.875% convertibles due 2010 were pegged at 60 bid, 61 offered and the newer 5.25% due 2011 at 81 bid, 82 offered by one sellside shop. Another sellside trader said the 5.25s went out at 80 bid, 83 offered. The older 6% Level 3 converts were similarly lower, with the 2009 issue quoted in the 54/56 context and 2010s at 55/57.

Level 3's junk bonds also were in retreat, with the 9.125s due 2008 losing 2 points to 82.

And, Level 3 shares plunged 11.71% on the day, losing 35 cents, to close at $2.64.

"These guys (Level 3) always seem to be on the cusp of a restructuring," a sellside desk analyst said. "But they just can't seem to pull it together."

The Broomfield, Colo.-based communications company, a big internet provider, ended 2004 with $5.2 billion of total debt and $782 million in cash and short-term investment balance, declaring its liquidity position "healthy," but said it would seek opportunities to improve the balance sheet and debt maturity profile.

For fourth quarter, Level 3 reported a net loss of $77 million, or 11 cents a share, which was trimmed from a loss of $121 million, or 18 cents, in fourth quarter 2003, and a gain in revenue to $1.06 billion from $988 million.

"I am currently long, [and] have been for too long. I kept thinking the next conference call... Well, fool me once, shame on you, fool me twice (or 20 quarters) shame on me - or us. This is not going to change - it is always NEXT year," one seller of Level 3 convertible positions said.

"Yeah, I am selling. There are definitely better places to put money. If they change their tune, I can always buy back in, but bondholders' patience is wearing thin, gone, in fact. The cash burn and the mountain of debt are sort of like a slap in the face to wake you up."

Level 3 chasing, not chased

Communications revenues are a sore spot for Level 3, although company executives asserted they have no anxiety about the pace of mergers and acquisitions in the industry. In fact, Level 3 chief executive James Crowe said in the company's earnings conference call that he is not afraid of consolidation but sees the company as "a winner" in the unfolding evolution of the industry.

"Our [M&A] group continues to be very busy," Crowe said on the call. "The acceleration in industry consolidation may create additional opportunities for Level 3 to acquire valuable assets."

The rising number of phone-industry mergers might even help to ease further price declines for communications services, he said, and Level 3 is looking to expand to achieve greater economies of scale. But, he added, "Level 3 does not intend to pursue volume at the expense of profitability."

Still, for first quarter, the company said communications revenue is likely to range from $400 million to $420 million, down from $482 million for the division in fourth quarter, amid what company executives referred to as a "challenging" environment from a revenue and cash flow perspective.

For all of 2005, however, Level 3 said it expects communications revenue to decline by less than 10% from $1.68 billion in 2004, which was off from $1.95 billion in 2003.

EDS sold off on weak results

Another sell-off noted by convertible traders was in Electronic Data Systems Corp., again on weakness illustrated in its earnings report and a disappointing outlook from the company.

The EDS 3.875% convertible dropped 2 points to 100 bid, 100.375 offered on Tuesday, while the stock fell $1.30 on the day, or 6.09%, to $20.05 following the company's earnings after Monday's close.

EDS results "continue to highlight the company's fundamental weaknesses - difficulties in increasing new bookings, improvement in free cash flow on a sustainable basis, and low visibility on the NMCI [Navy Marine Corps Intranet] contract," said CreditSights analyst Frank Lee.

For fourth quarter, the Plano, Texas-based technology services giant posted earnings of $53 million, or 10 cents a share, compared to a restated loss of $337 million, or 70 cents per share, a year earlier when a $559 million write-down related to the troubled Navy contract impacted the bottom line. Sales declined to $5.25 billion from $5.50 billion and, more importantly, analysts say, contract signings were down 5% to $3.8 billion from $4.0 billion

The profitability improvement was due to cost savings stemming from restructurings and lower finance costs, which Lee said "is nice but not what we expect from a company that is enhancing the top line as a competitive player."

CreditSights has an underweight ranking on EDS bonds, as the firm sees upcoming issues such as the renewal competition for the General Motors Corp. contract this year (to expire in 2006) and the deployment and integration of the new Tower Perrin's acquisition announced in January will elevate its credit profile to closer scrutiny.

Some look for PMA opening

Convertible players have mentioned PMA Capital Corp. on a couple of occasions in the past week or so, some looking for a possible bounce but to no avail so far.

PMA announced after Tuesday's close that it plans to release fourth quarter results after the market close Feb. 15, and some now think that may be the catalyst they've been looking for since the workers compensation insurer didn't get much of a boost after its financial strength rating was restored to an "excellent" level.

The PMA convertibles are closely held by five holders, a trader said, and they are looking for better prices on the 6.5% issue, which he said is trading at 109 bid, 112 offered - further illustrating the lack of a market for the tiny issue.

PMA shares ended Tuesday up 9 cents on the day, or 0.91%, at $10.

A.M. Best restored the A-, or "excellent," rating to The PMA Insurance Group, with a stable outlook, but that was back on Nov. 15, and nothing has transpired in the bonds thus far.

The restored financial strength rating followed a year of work for PMA Capital that involved stabilizing its financial results and withdrawing from the reinsurance business, among other things. The 6.5% convertible was part of the actions taken, in addition to the exchange of its older 4.25% convertibles.

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