St. Paul Cos. $375 million mandatory talked at 8.75-9.25% yield, up 18-22%

By Ronda Fears

Nashville, Tenn., July 25 - St. Paul Cos. was in the overnight market pitching $375 million of three-year mandatory convertible preferred talked to yield 8.75% to 9.25% with an 18% to 22% initial conversion premium. Merrill Lynch & Co. and Salomon Smith Barney are joint book-running lead managers of the deal, which was set to price after the close.

There were no gray market quotes on the deal, which is not so unusual for a mandatory, but it made it more difficult to gauge demand. A source at one of the lead underwriters said the concurrent $375 million stock offering by St. Paul is oversubscribed and the convertible is thought to be doing very well.

While it is widely believed that there is a great deal of capital ready to be invested in the market, especially among hedge funds, market turmoil has put a damper on activity and made investors more skeptical.

A deal earlier this week from Orbital Sciences, a vanilla convertible bond, with talk of 7.5% to 8.0% yield and a 15% to 20% premium has been stalled due to market conditions.

Certainly, if valuations are a gauge of a deal's reception, the market is widely mixed, or at least uneasy.

Widening credit spreads and spiking volatility are the main culprits.

"It's too expensive in this market," said a convertible trader at a hedge fund in New Jersey. "It's not for me."

Salomon puts the deal, at the midpoint of price talk, about 2.8% cheap, assuming a spread of 250 basis points over Treasuries and 34% volatility in the stock. Factoring in a 5-year growth rate in the common stock dividend of 4.6%, it drops to 2.6% cheap.

Bear Stearns puts it 3.7% cheap, using a spread of 275 basis points and 35% volatility and a 4.8% common dividend.

"For mandatories, 4-6% cheap is pretty standard, so this deal looks a little aggressive, especially in light of the current markets," said Bear Stearns convertible analyst Matt Hempel.

"The fact this is the first deal in over three weeks could help to support the issue."

But other analysts are more "aggressively conservative," as one put it.

"We put in a small order, limited to the cheap end of the price talk, and it's barely tolerable there," said a convertible trader at a hedge fund in New York.

Deutsche Bank Securities puts the deal about 0.75% rich, assuming a spread of 450 basis points over Libor and 40% volatility, and a 4.8% common dividend.

"Certainly, that's [the credit spread] wide for the rating, but if you look at where the existing zeros are trading, that's reasonable," said Jeremy Howard, head of U.S. convertible research at Deutsche.

"I don't think that's unreasonable in the current market. This is a nervous environment."

St. Paul's existing 0% bonds appear to be trading at about 72, he said, which gives it an implied credit spread of 450 bps over Libor.

"It's quite brave of anyone to bring a deal to this market," Howard said.

"In a normal market, we would be using 250 to 300 bps and that would be fine."

© 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.