Deutsche: Discount of Waste Connections floater to 5.5% converts unwarranted

By Ronda Fears

Nashville, Tenn., May 22 - The Waste Connections floating-rate convertible is trading at an unwarranted discount to the company's 5.5% convertible note due to the implied volatility used to evaluate the bonds, said Deutsche Bank Securities analysts in a report Wednesday.

"Even allowing for some investor uncertainty regarding the new structure, we believe that the (Waste Connections floater) is mispriced in the market," said analysts Jeremy Howard and Jonathan Cohen in the report.

"The correct implied volatility for both bonds is probably in the low 40s (%), implying a cheapening of the WCNX 5.5% 2006 bond and a significant richening of the FRN, over time."

Waste Connections floating rate note, which pays Libor plus 50 basis points was issued in April and was the third floating-rate convertible in the U.S. market.

The new structure is currently trading at a 32.62% implied volatility, a significant discount to the older Waste Connections 5.5% convertible due 2006, which is trading at a 50.55% implied volatility, the analysts said.

The analysts said they evaluated the floater using discrete coupons derived from the forward curve and a fixed rate equivalent of 5.49%, and got implied volatilities of 32.62% and 32.33% respectively. The 5.5% ranks pari passu with the floater, the analysts noted, and said they used a credit spread of L+500 basis points for both securities.

"The correct implied volatility for the two convertibles can be implied from the, albeit thinly traded, listed options market," the analysts added.

Waste Connections Jan 2003 $40 strike calls are the best proxy, the analysts said, and are trading around the 42/43% implied volatility level.

"With a conversion price a little lower ($38.03), the older WCNX 5.5% bond should trade a little higher, perhaps 45/46% implied," the analysts said.

"But the current 17.9 point discount on the (floater) is clearly a long way out of line with the listed / OTC markets."

Waste Connections

Floater due 2022

(pays Libor plus 50 basis points)

Stock Price: $35.07

Convertible Price: 100.25

Parity: 72.474

Conversion Premium: 38.32%

YTM/P: 5.426% approximately

Bond Floor: 74.582

Delta: 72.8%

Implied Volatility: 32.62%

Call: May 7, 2006

Upside: 62.3%

Downside: 40.2%

Waste Connections

5.5% due 2006

Stock Price: $35.07

Convertible Price: 118

Parity: 92.217

Conversion Premium: 27.96%

YTM/P: 0.781%

Bond Floor: 86.412

Delta: 69.2%

Implied Volatility: 50.55%

Call: April 15, 2004

Upside: 53.6%

Downside: 43.0%

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