Level 3, Time Warner Telecom, Transocean gain on stronger outlooks; Affiliated Managers plans new deal

By Kenneth Lim

Boston, March 28 - Expectations of stronger results and cash flows at Level 3 Communications Inc., Time Warner Telecom Inc. and Transocean Inc. sent their stocks and convertibles climbing on Wednesday.

Level 3 Communications Inc. convertibles gained sharply on Tuesday in line with a surge in the stock after the company raised its first-quarter guidance.

"This is one of the companies that have been waiting for good news," said a sell-side analyst. "It's like a Lucent, a debt-heavy company, C credit...spreads are 900 [basis points], so people have been looking for some good news."

Meanwhile, prospects of an improving credit story also helped Time Warner Telecom's new convertible bonds continue to gain outright along with the stock on the back of analysts' upgrades.

In the oil sector, Transocean also rose outright after a report from Merrill Lynch highlighted the company's strong cash flow outlook.

New York-based oilfield services giant Schlumberger Ltd. was also in play and its convertibles traded slightly higher as oil prices gained on Tuesday. Schlumberger's 1.5% convertible due 2023 was up about 3.5 points mid-day at 174 versus a stock price of $123, while its 2.125% convertible due 2023 rose about 4 points at 162.5 versus the same stock price. Schlumberger stock (NYSE: SLB) closed at $1245.58 on Tuesday, up $1.63 or 1.33%.

Futures of light sweet crude for May delivery rose to $65.80 on Tuesday, up by $1.64, in New York.

"Schlumberger's just a high-priced stock and a bellwether in the sector, which is pretty volatile, so it's always active," said a sell-side source.

Meanwhile, fund manager Affiliated Managers Group Inc. launched an overnight $300 million offering of 30-year convertible preferreds expected to price on Wednesday morning before the market opens.

Level 3 raises guidance

Level 3 Communications' convertibles shot up with the stock on Tuesday after the network operator said it would meet or exceed its first-quarter forecasts on the back of its communications business.

Level 3's 2.875% convertible due 2010 changed hands about six points higher outright at 88 versus a stock price of $4.50, while the 5.25% convertible due 2011 rose about 16 points outright to 132 against a $5 stock price, said a sell-side source. Another trading desk marked Level 3's 6% convertible due 2009 at 83 bid, 84 offered versus the stock's closing price of $5.18. The 6% convertible due 2010 was marked at 79 bid, 80 offered against the closing stock price.

Shares of Level 3 (Nasdaq: LVLT) jumped 71 cents or 15.88% on Wednesday.

Broomfield, Colo.-based Level 3 said early Wednesday that it was raising its first-quarter estimate for operating income before depreciation and amortization to between $140 million and $150 million, from between $105 million and $125 million.

For the whole of 2006, Level 3 is forecasting operating income before depreciation and amortization of fall between $600 million and $650 million, from the earlier $550 million to $600 million estimate. Net cash interest expense for 2006 is expected to increase from $505 million to $520 million.

The network operator attributed the better forecasts to stronger than expected results from its higher-margin core communications services business as well as progress in integrating WilTel Communications, an internet services company that Level 3 acquired.

Convertible analysts agreed that the news was positive for the company. A sell-side analyst said "cash flow is always good," and the surge in the stock and convertible prices are a reflection of that.

Another sell-side analyst said the improved guidance was a sign that Level 3 was finding success in its restructuring efforts.

"They're executing their refinancing, their restructuring strategy," the analyst said. "With the huge debt burden that they have, and as much as they can benefit from pricing stability in the business, that will end up increasing cash flow."

But a buysider said Level 3 is not out of the woods yet.

"There's still a lot of concern out there about their credit, because they've got so much debt," the buysider said. "They've increased EBITDA, but they're still cash flow negative."

The buysider acknowledged that Level 3 has benefited from a steady increase in its stock price, with its current market capitalization of over $4 billion more than double what it was back in October 2005.

"But they've got some debt coming due in 2008, and that's going to be their next hurdle from a credit perspective," the analyst noted.

Time Warner Telecom keeps gaining

Time Warner Telecom's convertibles continued to gain in line with the stock on Wednesday as investors bought into an optimistic upgrade from Morgan Stanley earlier in the week that suggested the company could finally be free cash flow positive this year.

The telecommunications services provider's new 2.375% convertible due 2026 was seen trading at 112 versus a stock price of $18 on Wednesday, up 12 points outright from its secondary market debut on Friday last week. Time Warner Telecom stock (Nasdaq: TWTC) climbed $1.25 or 7.41% to close at $18.12 on Wednesday.

Time Warner Telecom stock started its surge on Tuesday after Morgan Stanley analyst Vance Edelson upgraded the stock to overweight and raised his end-2006 price target to $20.

"Growth prospects are at their highest level in years," Edelson wrote in a report. "The company is ready to leverage its existing network infrastructure, and last week's convertible bond offering should accelerate free cash flow profitability."

Edelson also noted that Littleton, Colo.-based Time Warner Telecom has had negative free cash flow since inception. The convertibles offered last week would help to reduce annual interest expense by about $25 million a year, and could bring Time Warner Telecom's free cash flow into positive territory as early as the first quarter of 2006, he wrote.

"According to our model, the company will have moved from FCF [free cash flow] of negative $20 million per quarter to positive $20 million per quarter in just two years' time," Edelson wrote.

A buy-side analyst said "people think that the credit's getting positive" at last for Time Warner Telecom, and that was driving the buying activity in the stock and the bonds. Hedged convertible investors who were short less stock would also be able to capture some of the gains.

A sell-side analyst said it remains to be seen if the stock price, which has been propping up the price of the convertible, is justified. But even at these levels, he estimated that the new convertible was still about 1% cheap compared to the stock price.

Transocean sees bright cash pipeline

Transocean's convertibles also climbed in line with the stock on Wednesday after a research report from Merrill Lynch highlighted the company's strong cash flow prospects.

Transocean's 1.5% convertible due 2021 was seen marked at about 115.375 against a stock price of $82.25 on Wednesday. Transocean shares (NYSE: RIG) gained 2.3% or $1.85 to end the day at $82.20.

"We believe the most underappreciated facet of the Transocean story is the free cash flow potential," Merrill analyst Alan Laws wrote in a report. "Even when factoring in the new build Discoverer Clear Leader and the two High Spec upgrades, we expect RIG to generate roughly $15 billion of FCF over the next five years."

All that cash could benefit shareholders if Houston-based Transocean buys back its stock, pays out a special dividend or adds drillships that would operate by 2014, Laws wrote. A leveraged buyout, while unlikely because of the sheer size of Transocean, could also make economic sense with the strong cash flow easing the burden on acquirers, he added.

A sell-side analyst said he thought a leveraged buyout was "far-fetched," but agreed that Transocean, a contract driller, has been a key beneficiary of the strong rig business over the past year. He added that the company's management is now trying to figure out how to use all the cash coming down the line.

Another convertible analyst said he liked the fact that Transocean's business has "high revenues and great visibility," and the stock has been climbing steadily over the past few months.

"Convert guys like the volatility," the convertible analyst said. "I don't know if these things have moved up - they've probably come down a little - but they've been moving up and down a lot. For any vol traders involved, they're still having a good time."

Affiliated Managers plans $300 million deal

Affiliated Managers Group Inc. is pricing $300 million of 30-year convertible preferreds with a dividend of 5.1% and an initial conversion premium of 48%.

The securities will be offered through AMG unit AMG Capital Trust I, but will be guaranteed by the parent. The price of each preferred is expected to be set on Wednesday morning before the market opens.

Goldman Sachs, Bank of America and Merrill Lynch are the bookrunners of the Rule 144A deal.

AMG, a Prides Crossing, Mass.-based fund manager, plans to use the proceeds from the deal to buy back about 1.3 million shares and for general corporate purposes, which could include more share buybacks.

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