Marshall & Ilsley flat at par; Sonic Automotive up 1 point; Starwood falls on REIT buzz

By Ronda Fears

Nashville, July 27 - Starwood Hotels & Resorts Worldwide Inc. was seen trading lower by as much as 1.5 points Tuesday, a buyside trader said, which was related to market buzz that the hotel chain was considering shifting entirely to a real estate investment trust or splitting off its real estate business.

Chiefly, hedge fund holders were selling the Starwood convertibles, because of the blow from higher common dividends and lower volatility if the company became a REIT. Starwood shares, however, gained more than 1% on the day.

King Pharmaceuticals Inc. also was lower Tuesday, backtracking on skepticism about Mylan Laboratories Inc.'s $4 billion buyout offer, in stock, getting done, at least at that price. The convertibles gave back 0.25 point to the 98 area, and the stock lost more than 7%, dropping to $11.97.

"There are more people now thinking the King/Mylan deal will fall through," said a buyside market source. "A lot of people would have liked for this to happen, hope it will, but there's not a lot of faith."

But there were several pieces of good news influencing the convertible market Tuesday, not the least of which was a solid gain in the major stock indexes and just a slim uptick in bond yields, countered slightly by a dip in market volatility.

"Finally," a sellside trader said there were some upside earnings surprises that moved some issues higher on buying interest. A good portion of the buying interest is still in the busted area of the convertible universe, however, he noted. Sonic Automotive Inc. and Fairchild Semiconductor Corp. were two busted convertible names mentioned in that vein.

Marshall & Ilsley sold wide

Marshall & Ilsley Corp. priced its new convertible at the cheapest or cheaper end of indicative terms, but buyside market sources said it still traded "terribly," and after coming out of the gate up by just about 0.125 point, it closed out the day at around par.

The Milwaukee-based regional bank sold the $365 million of three-year non-callable mandatory convertible units at par of 25 to yield 6.5% with a 24% initial conversion premium - at the wide end of dividend guidance of 6.0% to 6.5% and at the cheaper end of premium talk of 23% to 27%.

Marshall & Ilsley shares closed Tuesday up 65 cents, or 1.74%, to $37.97.

Starwood as a REIT not hot

Starwood convertible holders were selling off the 3.5% issue on market rumors circulating about the New York-based hotel chain possibly transiting into a REIT. While the stock on Tuesday added 55 cents, or 1.26%, to end at $44.12, the convertible dropped as much as 1.5 points to 106.25 bid.

The buzz centered on a Bear Stearns equity report that was out late Monday after the market closed.

"We sense an increasing probability that the company will somehow split itself in the months ahead," Bear Stearns equity analyst Mark Abramson said in a report Monday. "We believe management may be signaling a split-off of the real estate into a REIT, one of several possible transactions management in the past has publicly acknowledged they are considering in an effort to unlock value."

Abramson speculated the stock market would react favorably, which may have been the case since Starwood shares gained ground Tuesday, but the convert was slammed. Both reactions were for the same reason - because a REIT would likely pay a higher common dividend, a buyside trader said. There is a 1.93% common dividend yield on Starwood stock currently.

Starwood becoming a REIT "would kill the volatility on the stock and the dividend would be way up," further killing the convert's option value, explained a sellside market source.

REIT signals seen at Starwood

Abramson said he sees strong signs at Starwood that suggest management is thinking about the REIT status change, including delay in naming someone to the top post at the company.

"While there is some disappointment at the fact that another quarter has elapsed without the appointment of a new CEO, there may be unseen factors causing this delay. It is our hypothesis that management of Starwood may be considering an imminent split-up of the company," Abramson said in the report.

"The most logical form this would take would be to create a pure hotel REIT to hold the property and an operating company. In the past, management publicly have discussed this as an eventual possibility. And an imminent split-up of the company might help explain the delayed timing of the new CEO appointment.

"Another signal that a split-up may be expected were management's emphatic comments on the conference call and subsequent" management comments, Abramson said in the report.

"They unequivocally stated their intent to take any action necessary to 'unlock the hidden asset value of the real estate base.' which the company estimates is significantly higher than $500 million. These comments struck us as more forceful than previous comments. Adding to the picture is the fact that the company is facing rising tax payments."

Abramson specifically took note of Starwood management's guidance, which suggests a declining rate of RevPAR and EBITDA recovery in the quarters to come; moreover, expressing surprise by the modest increase in EBITDA guidance - $15 million - for the remainder of the year.

Abramson, however, left his rating on the stock at market weight, pending conversation with management on this issue.

Sonic 5.25% convert driven up

Sonic Automotive was cheered Tuesday for stepping back its aggressive acquisition policy. The 5.25% convertible due 2009 was sighted trading steadily higher during the session, closing out the day up by about 2.5 points at 96.625 bid, 97.125 offered with the stock ending up by 15%, or $2.82, to $21.52.

Also on Tuesday, the Charlotte, N.C.-based car dealership chain reported better-than-expected earnings. The company also affirmed its 2004 operating income targets and boosted its quarterly common stock dividend by 20%.

"The second quarter results reinforce the appropriateness of our current strategy to reduce the acquisition pace and focus on expense control," said chief executive O. Bruton Smith, noting a "challenging sales environment for both new and used vehicles."

On July 1, Sonic closed on two previously announced BMW dealerships in the Houston area, bringing year-to-date acquisitions representing some $700 million in annual revenues, with no acquisitions planned for the remainder of 2004.

New vehicle same-store sales declined 5.4% in second quarter, the company reported, but the new vehicle same-store gross margin rate increased to 7.4% compared to 7.1% a year ago. Combined retail and wholesale used vehicle same-store sales were down 6.1% for the quarter, the company said, while the retail gross margin increased 10 basis points.

Net income for second quarter was $30 million, or 70 cents per diluted share, up from $28.5 million, or 68 cents per diluted share, in second quarter 2003 while revenues edged up to $1.88 billion from $1.82 billion.

Sonic buyback program upped

Sonic Automotive also said its board of directors has increased by $20 million its authorized repurchase program for its common stock and convertibles. The company did not report any convertible purchases but said during second quarter it bought back $10.9 million of stock, or 474,800 shares.

At June 30, the company said it had $196 million available under its revolving credit facility.

The debt-to-total-capital ratio was 49.3% at June 30, which the company attributed primarily to the recently completed acquisitions. The company said it remains committed to its long-term debt-to-total capital target of 40%, and expects the ratio to be between 45% and 49% by year-end.

For 2004, the company affirmed its guidance for income from continuing operations of $2.65 to $2.80 per diluted share. Income from continuing operations for the first half of 2004 was $53.3 million, or $1.25 per diluted share, compared to $47.7 million, or $1.14 per diluted share, for the same period in 2003.

Fairchild eyed on cheapening

In the busted universe of convertibles, where a considerable amount of attention has been focused in the search for bargains, Fairchild Semiconductor Corp. has gotten some attention in the past week or so, and a sellside trader said the interest has intensified in the past couple of days.

Fairchild's 5% convertible due 2008 was trading Tuesday at 98.5 with the underlying stock at $13.33, the trader said. That is off from a level of 99.5 a week ago with the stock at $14.83.

Fairchild shares ended Tuesday up 20 cents, or 1.5%, at $13.50.

Another sellside market source, on the West Coast, pointed out that Fairchild ended second quarter with $660 million in cash and equivalents and might be looking to refinance some of its $850 million of debt, which in addition to the $200 million convertible includes $350 million of 10.5% straight bonds due 2009 and $300 million of secured bank debt.

"They [the convertibles] are callable in November this year at 102.25. If they refinance them, it's a 12.23% yield to call," he said. "If not, you can clip your 5% coupon and look to minimum participation in any near-term stock move."

If interest rates are static for a while, he added, Fairchild could probably refinance the issue cheaper than the 5% coupon.

In a Barron's article Friday, Fairchild got some positive ink on the turnaround in power management chips, where 75% of its chip sales are focused, as an ever growing market with more than one-third of those chips going into communications gear.

"Barron's online had a positive write-up Friday on Fairchild," said a buyside market source. "The focus was on their position in chips that help save power, extending battery life. The market includes cameras and phones, and the market for these devices is expected to double by 2008."

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