Nortel holds firm on cross-default hopes; American Axle survives downgrade but JetBlue crashes

By Kenneth Lim

Boston, March 10 - Nortel Networks Corp.'s convertible bond was bid slightly higher on Friday as investors eyed opportunities from what some speculated could be a potential debt default after the company said it would restate past results.

Meanwhile, the convertible market shrugged off American Axle and Manufacturing Holdings Inc.'s credit downgrade by Fitch Ratings, with the stock and convertibles staying largely flat.

JetBlue Airways Corp. also fell in line with the stock, which was downgraded Friday by a research analyst who warned of structural problems at the low-cost carrier.

The week ended quietly for the convertible market, market sources said.

Hard-disk drive component maker Hutchinson Technology (Nasdaq: HTCH) saw its 3.25% convertible due 2026 trade lower by just under a point in line with the stock, which opened down on Friday. A trading desk marked the security at 98.92 bid, 99.42 offered against the closing stock price of $27.43, compared to 99.256 bid, 99.756 offered versus $27.54 on Thursday. Shares of the Hutchinson, Minn.-based company closed 3 cents, or 0.11%, lower on Friday.

Transocean Inc.'s 1.5% convertible due 2021 also gained about a point in line with the stock on Friday, carrying on the momentum from Thursday's rebound. The security was marked at about 110.25 bid versus a stock price of about $76.50 on Friday. It was trading at 108.5 versus $74.75 on Thursday. The stock ended Friday at $76.15, up 96 cents or 1.28%. Transocean (NYSE: RIG) is a Houston-based oil drilling contractor.

Cephalon Inc. did "a little better with the stock," said a sell-side source, with its convertible bonds rising under a point. The A tranche of its zero-coupon convertible due 2033 was marked at 141 bid, 141.5 offered against a stock price of $81.33 on Friday, while the B tranche zero-coupon convertible also due 2033 was marked at 147.89 bid, 148.39 offered versus the same stock price.

The company's 2% convertible due 2015 was 183.77 bid, 184.27 offered, also at that stock price. Cephalon stock (Nasdaq: CEPH) closed at $81.44 on Friday, higher by 59 cents or 0.73%. Frazer, Pa.-based Cephalon is a pharmaceutical company with products aimed at treating sleep disorders, neurological disorders, cancer and pain.

Nortel to restate earnings, may default

Nortel Networks' 4.25% convertible due 2008 was seen flat or bid slightly higher on Friday after the company's newly announced accounting error raised the possibility - discounted by some analysts - of a default that could trigger a put option on the security.

The convertible was "basically unchanged," said a buy-side analyst who said its credit has not changed. The security was seen at about 94.625 against a stock price of $3.04 on Friday. It had been marked at 94.63 bid, 94.63 offered versus a $3.09 stock price on Thursday by a major convertible shop.

Nortel stock (NYSE: NT) closed at $3.03 on Friday, down 6 cents or 1.94%.

A sell-side analyst said "nobody's really thinking too much about" Nortel's announcement.

Brampton, Ont.-based Nortel said early Friday that it would have to delay filing its 2005 annual report to restate its financial results for 2003, 2004 and the first three quarters of 2005 because of revenue that was incorrectly recognized too early. But that revenue was not fictitious, the telecommunications equipment maker stressed.

"This revenue is real - it was recognized in the wrong periods," Nortel chief executive Mike Zafirovski said in a statement. "The restatements do not affect the company's cash position."

Because of the restatement, Nortel will not be able to file its annual report by March 16, which would trigger a default on a $1.3 billion one-year loan unless the company can secure waivers from the creditors. The failure to get those waivers could be a cross-default event that would give holders of the company's outstanding $1.8 billion in convertibles the right to accelerate the bonds. Nortel must also secure another waiver from Export Development Canada in relation to an outstanding $161 million from a support loan.

"If an acceleration of the company's and NNL's [Nortel operating arm Nortel Networks Ltd.] obligations were to occur, the company and NNL may be unable to meet their respective payment obligations with respect to the related indebtedness," Nortel said in its statement. "Nortel and NNL are working with its lenders and EDC to obtain waivers."

Standard and Poor's said on Friday it was placing Nortel's B- long-term corporate credit rating on watch with negative implications. But the credit rating agency said the financial restatements are limited and are expected to be modest compared to previous restatements by the company.

A sell-side source said the convertible was "actually a little better bid on that news" because some investors were hoping for a cross-default event.

"People think you can get par for them, and they're also thinking that the company may be forced to pay a sweetener to creditors and bondholders to not claim default," he said. "If you look at Navistar as an example, that's what they're thinking."

Navistar in January also delayed the filing of its annual report, which led to holders of the company's convertible and straight bonds filing default notices. Navistar in February secured a $1.5 billion loan that could be used to refinance the notes alleged to be in default and has since tendered for some of its straight bonds.

But two other analysts thought it unlikely a cross-default event would occur. One of them said Nortel would "probably" get the waivers it needs to avoid a cross-default, a position also taken by Standard and Poor's.

The analyst was more concerned about the fact that Nortel had to make another restatement two years after firing its former chief executive Frank Dunn over another accounting scandal.

"What's surprising is that it's new management," he said. "I'm hoping that it's what they're saying, basically that nothing changed economically, just the timing of the revenue that was recognized."

He added that the mistake, even if it is minor, is a blow to the company's credibility in light of its history.

"If it weren't for previous restatements that they did on the scandal, this probably wouldn't be a big deal," he said. "You'd yawn and move on. Going forward nobody can trust the numbers that they're presenting."

American Axle firm despite downgrade

Investors also brushed aside a credit downgrade at American Axle by Fitch Ratings, which cut its rating down two notches to a junky BB from its previous BBB-, the lowest investment-grade rating.

A buy-side source said the convertible was seen around 73.75 mid-day, in line with the stock, which gained despite the downgrade. American Axle stock (NYSE: AXL) closed at $16.34 on Friday, up 23 cents or 1.43%.

Fitch cut the auto parts supplier's rating late Thursday and said the outlook was negative. "Fitch's view is that lower production levels and elevated risks associated with GM [General Motors] production over the next several years, as GM enters a critical restructuring period, has the potential to pressure revenues and margins," Fitch said.

General Motors accounted for 78% of American Axle's revenue in 2005, Fitch explained. The negative outlook takes into account the view that General Motors will continue to face sales trouble, operating losses, production uncertainties and lower liquidity, which could put pressure on revenues and margins at Detroit-based American Axle.

A sell-side analyst said the Fitch downgrade was not a surprise for investors. "These part makers are at risk as usual, I don't have anything different to say about this name," he said.

The Fitch rating "already reflects what people are felling about these names," he added.

JetBlue grounded on downgrade

A downgrade, this time an equity one, had greater impact on JetBlue, which saw its convertible fall in line with the stock after a Prudential analyst cut his recommendation on the stock to underweight from neutral, a sell-side source said.

JetBlue's 3.5% convertible due 2033 was seen trading at about 89 against a stock price of $10.30 on Friday. Data on Trace showed trades between 88.75 and 89.375 across the entire session. JetBlue stock dived 7.74%, or 86 cents, to close at $10.25 on Friday.

Prudential analyst Bob McAdoo wrote in a report on Friday that the airline may be facing structural problems behind its recently announced first quarterly loss and guidance for more red ink in 2006. The company's losses are due to higher fuel costs as well as poor route selection, the analyst said.

He wrote that 17 of the 20 markets that the airline has added have not been profitable, even though the earliest short-haul routes have been consistent winners.

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