Merrill says MediaOne/Vodafone maturity not likely to be extended

By Ronda Fears

Nashville, Tenn., Aug. 27 - MediaOne Group's 7% mandatory exchangeable, which converts into Vodafone ADRs, matures Nov. 15 but could be extended to Feb. 15, 2003 and then to May 15, 2003. But an extension is unlikely, according to Merrill Lynch & Co. convertible analysts.

An extension would provide some extra yield for investors and optionality for MediaOne, analyst Tatyana Hube and Yaw Debrah, director and head of U.S. convertible research, said in a report Tuesday. However, they said, it's not likely due to Vodafone's low stock price, expensive financing and low tax basis.

Were the company to extend the maturity to the maximum allowable date, holders would receive $1.5747 extra dividend per security, the analysts said.

"The decision of whether or not to extend the maturity of the MediaOne 7% PIES (premium income equity securities) will be closely tied to the performance of the Vodafone common shares," the analysts said.

"If the trading price of the Vodafone ADRs is close to the flat region of [$43.4375 maturity price], the issuer will have an incentive to extend the PIES maturity in the hope that the lower ratio could become applicable in a few months.

"However, given the currently depressed levels of the Vodafone ADRs, the price would have to increase by about 165% to at least reach the lower threshold price of $43.4374. The Vodafone ADRs have not traded above that level since Sept. 1, 2000."

Meanwhile, given that the MediaOne/Vodafone mandatory trades at an 18% current yield, extending the maturity would also imply quite expensive short-term refinancing.

Settling in stock would constitute a taxable event for MediaOne. But, the analysts said, due to the depressed level of Vodafone stock, capital gains on disposal of the stock would probably not be excessive and could even result in capital losses, and would probably not merit extending the life of the convertible.

Unlike with a typical mandatory, MediaOne/Vodafone holders do not have an option to convert into the underlying stock prior to maturity, the analysts noted. The number of Vodafone shares to be received at maturity will be determined based on the "maturity price," or the average closing price per Vodafone ADR on the 20 trading days immediately before, but not including, the maturity date.

If the maturity price is below $43.4375, holders get 1 Vodafone ADR per security. If the maturity price is above $51.2563, holders get 0.8475 Vodafone ADR per security. Or, if the maturity price is between $43.4375 and $51.2563, holders get a fraction of Vodafone ADR equal to $43.4375 divided by the market price.

At maturity MediaOne can opt to settle with Vodafone ADRs, the cash equivalent of that number of ADRs, or a combination of cash and ADRs.

"We note that MediaOne can settle the PIES in stock or cash. At the time the 7% PIES were issued, the company, through its subsidiaries, owned about 148 million Vodafone ADRs," the analysts said.

"If they still own in excess of the 26 million Vodafone ADRs required to settle the contract, it probably makes more sense to pay off PIES-holders in stock as opposed to cash because the company would not have to come up with about $430 million in cash and their capital gains (there even may be capital losses) on the transaction would be low due to depressed Vodafone price."

MediaOne, a subsidiary of AT&T Corp., is required to give a minimum of 20 business days notice prior to Nov. 15 if it chooses to extend the PIES maturity. Thus holders would be notified by Oct. 18.

MediaOne/Vodafone 7% due Nov. 15, 2002

Price: 17.10

Stock Price: $16.62

Parity: 14.09

Percent Premium: 21.41%

Payback Period: 1.1 years

Current Yield: 17.78%

Market Value: $442 million

Conversion Ratio: 1.0/0.84746

Conversion Price: $43.44/$51.259

S&P/Moody's Ratings: NA / Baa3

Theoretical Value: 17.31

Discount to Theoretical: 1.21%

Investment Value: 0.75

Investment Premium: 2,180%

Parity Delta: 1.176

Delta: 0.969

Implied Volatility: 128.39%

Volatility Cap: 50.00%

Annual Stock Dividend Yield: 1.53%

Credit Spread: 372-402 bps

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