Inco deals steady out of gate; Watson trading up in gray as credit, put offset pricey terms

By Ronda Fears

Nashville, March 4 - New issues dominated activity in convertibles Tuesday as participants played the field largely for lack of anything else to do.

"It was another horrible day in the market. S.O.S. (same old story/same old ****)," said a convertible dealer, mentioning weak economic data and the war.

"So, in the lesser of two evils, everyone was focused on playing the new deals."

Inco Ltd.'s deals were technically upsized to $440 million from $400 million amid strong demand, although the greenshoes were downsized for a wash in total potential proceeds that still stands at $500 million, and the paper was steady at issue prices in the immediate aftermarket.

While buyers of the Inco paper may not have been overjoyed with the terms, Salomon Smith Barney convertible analyst Stuart Novick said the exposure to the metals sector was a plus.

Demand obviously was not deterred.

"We're seeing more and more money coming into hedge funds and it's got to go somewhere," Novick said.

He added that terms on many of the new deals are balanced somewhat as "these ridiculously high premiums we're seeing are being offset with call protection."

Watson Pharmaceuticals Inc.'s $450 million deal was bid 1.125 points over par with offers at 1.5 points over par, as the stock closed down $2.26 to $28.19.

"People are just killing each other to get it," said a salesman working on the Watson deal.

"People are attracted to the credit (investment grade) and they like the put."

The books on the Watson deal were closed at about 2:30 p.m. with orders running in excess of 12 times the deal amount, according to market buzz.

There had been speculation that the Watson deal would re-price and/or be upsized but nothing firm emerged on those fronts.

Watson's $450 million convertible deal was talked to yield 1.75% to 2.25% with a 38% to 42% initial conversion premium.

Bear Stearns & Co. convertible analysts put the Watson deal - at the midpoint of guidance - right at fair value, or 2% rich to 2% cheap, using a credit spread of 300 basis points over Treasuries and 35% volatility in the stock.

Deutsche Bank Securities Inc. analysts put it, also at the midpoint, between 1.3% rich and 2.5% cheap, using a spread of 225 bps over Libor and 35% volatility.

Sellside analysts found both Inco deals a bit more aggressive than seen lately - as much as 3% rich - but many market sources said the paper was bought for exposure to the metals sector.

Inco's two-part deal priced with mixed terms vis-à-vis guidance, and both were in the area of issue price in the immediate aftermarket.

Inco sold $220 million in proceeds of 1% discount convertible senior notes at 91.381 to yield 1.41% with a 43% initial conversion premium - at the richer end of yield guidance and at the middle of premium talk.

Inco also sold $200 million of convertible subordinated notes at par to yield 3.5% with a 30% initial conversion premium - at the cheap end of yield talk and at the rich end of premium guidance.

The OID closed at 91.25 bid, 91.5 asked and the 3.5s at 99.5 bid, 100 asked.

Inco shares closed down 2c to $19.99.

"We bought a small amount of the 3.5s, only because it's the best of a bad lot," said John Siebel, head of trading at Silverado Capital Management, saying he did like the nickel exposure but picked the 3.5s over the OID in order to clip a coupon.

Although the subordinated notes were structured more for outright buyers, some like Northern Trust Co. were not comfortable with the deal even as a sector play.

"We have not been getting involved in many of the new issues so far this year, maybe one in five have any real interest to us," said Ted Southworth, portfolio manager of the Northern Income Equity Fund, which focuses on convertibles.

Even to participate in the deals to flip them shortly after pricing has not enticed him, as allocations have been low due to such high demand in the market right now.

"It's barely pays to write the ticket," to get a small block of a new deal, Southworth said.

Also, as deals price richer, the chances of making a quick profit by flipping the paper are getting slimmer.

Inco's deals, while roughly steady with issue prices, were both bid 0.125 point below par with offers at just 0.125 point over par at the close Monday.

Many expect issuance to remain somewhat brisk through around midyear at least, but market participants don't anticipate any great swing in deal terms to their side anytime soon.

There could be some relief, however, from the buyers' perspective if the lackluster performance of new issues causes buyers to invoke restraint.

February's new issuance continued the richening trend begun in January - about 2% cheap to theoretical fair value when the discounted Sierra Pacific deal is excluded, according to a Merrill Lynch & Co. report Tuesday.

Average yield at-issue was 4.5% for the new deals in February, but the conversion premium at-issue expanded to 41.6% from 30.5% in January.

"This tendency is bound to persist as long as equity markets remain flat or down," said Merrill convertible analyst Tatyana Hube.

But she added that the new issue richness "is pushing the limits" and beginning to weigh on performance. The relatively high delta of the new issues was also a factor in the face of declining stock prices.

Merrill's new issue index, which includes new issues for six months after pricing, declined 1.4% in February as those underlying equities lost 3.7%, according to the report.

At the same time, the broad Merrill U.S. convertibles index declined only 0.2% versus the 3.1% drop in those underlying equities.

Outright convertible investors are not overly optimistic that much pricing power will be exerted on the buyside, regardless of terms, because hedge funds can make money even on the new deals pricing rich.

"My guess is most of the companies willing to issue will be because they don't have any choice," Southworth said.

Many of those may well be companies with more volatile stocks, he said, which will allow them to price deals with higher premiums and lower coupons because of the hedge fund presence in converts.

"We've had a long period of expanding volatility," Southworth said.

"Some of that will begin to leak out. Meanwhile, we just have to work harder" to find opportunity in the secondary market. He said, like many other convertible players, he is holding more cash than usual.

In the secondary market, traders said the only noteworthy moves were in other recent new deals.

Drug issues were widely mixed, but the Watson deal was said to provide some impetus to move Axcan Pharma Inc. up sharply as those subordinated notes have a heftier coupon.

Axcan's new 4.25% due 2008 added 4.875 points on the day to 106.875 bid, 107.875 asked with the stock up 43c to $10.65.

McData Corp.'s new convert moved south as some holders lightened up on that issue to play the newer deals, traders said. The issue lost 2 points on the day to 107.875 bid, 108.875 asked as the stock closed off 18c to $8.01.

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