Pharma Resources rocked, ends flat on generic drug competition; Komag gains on better outlook

By Ronda Fears

Nashville, April 12 - There were not a lot of specific names bandied about on convertible desks, with traders and analysts alike bemoaning the sluggish Monday session.

Pharmaceutical Resources Inc. was feeling some pressure, but the bonds actually held up well on news that there will be more competition in a generic hepatitis C drug it acquired to be jointly marketed with Novartis AG.

Disk drive maker Komag Inc. raised its revenue outlook for first quarter, giving the bonds a nice lift on decent volume, traders said.

The announcement by Veritas Software Corp. and BEA Systems Inc. that they are teaming up to hold onto their market share against software giants such as IBM, Oracle and the like did more for their peers than either one of them. Veritas was flat and BEA gained slightly, but Red Hat Inc., Network Associates Inc. and Symantec Corp. got the bigger boosts from the news.

Reports of the hostage situation and ongoing military activity in Iraq did not develop into any direct moves in the market, but there were some general activities going on - such as a scan of the market for potential mandatories that might be tendered early, like Solectron Corp. did late last week, and there is the never ending search for yield.

Solectron sparks call alert

There have been call shockwaves reverberating through the convertible market off and on for more than a year now, but most of the scares have been isolated to bonds. Solectron last week extended the concern into the mandatory segment of the market.

Solectron on Thursday launched an early settlement offer for 95% of its 7.25% mandatory, which matures Nov. 15, 2004. The company is offering 2.5484 shares of stock and $1.97 in cash per unit with a par value of $25. The offer is set to expire at midnight on May 5.

The stock closed Monday off 7 cents, or 1.21%, to $5.72.

The Solectron move had many players on Monday scanning the convertible universe for other potential mandatories that might be tendered for early, said a sellside market source.

Coming due later this year like Solectron are a dozen or so mandatories, another sellside market source said. Those include the Anthem Inc. 6%, Boise Cascade Corp. 7.5%, Cendant Corp. 7.75%, Dominion Resources Inc. 9.5%, Duke Energy Corp. 8% and 8.25%, Electronic Data Systems Inc. 7.625% and Northrop Grumman Corp. 7.25%.

Many of those issues were higher Monday, the source said, but he added that mandatory convertibles have been an under-performing sector recently so there "obviously is a mixed message or mixed signal going on in that group."

Yield search forces distress

Mandatory convertibles, though, have been some of the top yield providers in the market, however, but on a return basis the distressed bonds segment of the market is leading. Still, analysts say the biggest area of squeezing value out of the market is in high-grade issues.

Lehman Brothers research shows that the top five convertible securities with the highest current yield as of March 31 were all mandatories - the EDS 7.625% at 20.3%, Williams Cos. Inc. 9% at 17.7%, Sprint PCS Corp. 7.125% at 17.3%, LaBranche & Co. 6.75% at 16.4% and El Paso Corp. 9% at 15.5%.

The best performers in the convertible market will require a deeper reach down the credit spectrum, though.

Lehman Brothers research shows the best performing segments in March were distressed, gaining 2.1%, and junk, gaining 1.6%. Year to date, the distressed sector continues to lead all others with a 12.7% total return. For the entire market, returns edged up 0.12% and for the year through March 31, convertibles as a whole are up 4%, according to Lehman.

But Venu Krishna, head of U.S. convertible research at Lehman, said he's still pushing high-grade issues.

"The attractiveness of the investment-grade convert space relative to non-investment-grade converts has been a recurring theme of ours," Krishna said.

"As recently as March 15, the spread differential between non-investment-grade converts and high yield was actually negative. In other words, average spreads in non-investment grade converts were tighter, at 393 basis points, than the U.S. [Lehman] high-yield index at 412 bps.

"Generally speaking, it would appear that any incremental value left in the non-investment-grade space has been nearly fully extracted, and rather sooner than we had expected. This also suggests investors should expect a high degree of correlation between spread performance of non-investment-grade converts and the high-yield sector going forward.

"Investment-grade converts meanwhile, continue to offer decent relative value, though less so than this time last month."

Non-investment-grade convertible spreads tightened by 36 basis points to 426 basis points last month, and the spread differential versus the Lehman U.S. high-yield index was just 12 basis points at the end of March While relative value has been largely extracted, spread movements in non-investment-grade convertibles are likely to be in sync with high-yield spreads.

Veritas, BEA pact lifts peers

Veritas Software and BEA Systems announced an engineering and marketing alliance that will package their major products jointly for "utility computing," which is referred to as one of the hottest technology trends for 2004.

The companies said the joint packaging is intended to help customers manage clusters of low-cost computers as a single system. The products are expected to be available in the second half of the year.

Veritas' 0.25% convertible due 2013 was described as flat at a 98 bid, with the stock closing off 42 cents, or 1.57%, at $26.27.

BEA Systems' 4% convertible due 2006 edged up 0.25 point to 101 bid with an offer at 101.5, while the stock ended up 22 cents, or 1.76%, to $12.72.

Several other software issues gained more sharply, which one sellside trader attributed to a perception that the Veritas pact with BEA Systems showed "a sign of weakness that they had to put their heads together, so to speak, in order to compete."

Red Hat, which has been enjoying a good deal of exuberance as a Linux operating platform provider, got a nice spike on Monday. The 0.5% convertible due 2024 added 2.375 points to 122.75 bid with an offer at 123. The stock shot up 81 cents, or 3.34%, to $25.06 - hitting a new 52-week high. The 52-week range was $5.60 to $24.80 before Monday's close.

Pharma Resources bonds manic

After rallying early last week and then sinking with the market later in the week, Pharma Resources bonds again were tossed about Monday. But traders said the bonds held up rather well against the tide of bad news, as some believed there was an over-reaction to the news.

Last Thursday, Schering-Plough launched a generic version of its hepatitis C medicine ribavirin, a day after Pharma Resources and Novartis won approval to market a generic version of the drug. Pharma Resources had acquired the rights to the drug from closely-held Three Rivers Pharmaceuticals LLC.

The Pharma Resources 2.875% convertible due 2010 on Monday was "about even, on a dollar neutral basis, from a week ago," a market source said. "It rallied a half point on good news last week and then gave it up on the stock hit later in the week."

The stock fell 10% just last week.

Much of the pressure came after analysts' comments expressed concern that Schering-Plough will discount its generic version, Rebetol, to wholesalers by 65% to 70%, which would undercut the 35% to 40% discount for which Pharma Resources and Novartis planned to sell their generic versions.

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