Injection of $4 billion in much-needed new paper welcomed in otherwise very quiet session

By Ronda Fears

Nashville, April 8 - Some $4 billion of new paper from The Walt Disney Co. and Wells Fargo & Co., while not cheap, roused players from a sleepy trading session beset with fewer and fewer "reasonable" opportunities.

"It was one of the quietest days we've had in a while," said a convertible dealer, referring to secondary trading action.

But salesmen stirred players first with the Disney deal, pitching the $1 billion deal intraday to price after the close.

The deal did not spark an incredible amount of secondary trading, as days of yore, however, due to so much excess capital sitting on the sidelines, traders said.

While sources said the books ran heavy on Disney - mostly hedge funds climbing all over each other to get to play - traders said it was "straddling par, give or take a quarter to half point" in the gray market.

The Disney convert traded as low as 0.25 point below issue price to as high as 0.75 point over issue price, traders said.

Disney shares closed off 61c, or 3.44%, to $17.13.

After the close another round of calls went out from mostly a different group of salesmen pitching the $3 billion Wells Fargo floater, which also features the avant-guard warrant kickers seen on a couple of other floaters lately and another record-setting conversion premium of 110.75%.

At pricing, Disney upsized its deal to $1.15 billion and sold the 20-year convertibles at par to yield 2.125% with a 72% initial conversion premium - at the midpoint of guidance, where sellside analysts put it roughly at fair value to 7% rich.

"I think it's okay," said Yuri Garbuzov, portfolio manager with the Pimco Convertible Fund, referring to the Disney convert.

"The credit should hold and it's a volatile stock. It's not cheap, though."

Indeed.

Wachovia Securities, Inc. convertible analyst Kimberlee Brody put the deal 7% rich, using a credit spread of 147 basis points over Treasuries and 34% volatility in the stock.

Deutsche Bank Securities Inc. convertible analysts put it 1.5% rich to 1.4% cheap, using a credit spread of 100 bps over Libor and a 35% stock volatility.

Merrill Lynch & Co. analysts put the deal 0.6% cheap, using a credit spread of 140 bps over Treasuries and a 35% stock volatility.

Disney said only that proceeds would be used for general corporate purposes, but analysts said it only makes sense that the entertainment giant will be using the money to refinance some hefty debt coming due.

Merrill convertible analyst Tatyana Hube noted that Disney has $1.65 billion of debt maturing in the next year and some $5 billion in the next 2 years.

She said that given the low yield and high premium on the deal, the rating agencies are likely not to acknowledge much equity content toward the balance sheet for this deal. She also noted that both Moody's and S&P downgraded Disney credit last year, and S&P still has the credit on negative watch.

"I still can't figure out who is buying these high premium bonds. With SARS and a slow economy, you can be sure that DIS stock price will be capped below the conversion price in the near term," said a convertible market observer.

"The [Disney] bonds, given that it is a registered public offering, may have some appeal to the retail investors ... but given the high conversion premium, the total return may still be limited by any stretch.

"There are some discretionary retail accounts that may buy these bonds if the management goal is capital preservation, but that's a very small segment of the market,' he added.

"If you have a long-term perspective, you probably don't care much about the put that is embedded in these bonds. As such, we are going back a full circle. There should be no buyer for these bonds except for hedge funds."

Disney five-year credit default swaps were said to have widened slightly right after the deal launched, and derivatives traders said that was the trend in high-grade credits pretty much across the board.

A distressed trader noted, though, that spreads were tightening in junk credits, which is considered an indication that bond investors are reaching for yield by stepping down the credit scale.

It was not a reach down the credit scale, but some market players said the Wells Fargo overnight convert was "a stretch."

Wells Fargo & Co. launched $3 billion of 30-year convertible floaters with a warrant kicker. The issue carries a 110.75% conversion premium and is expected to price for a yield to maturity of 3-month Libor minus 0.25% to 0.5%.

If the stock price exceeds the $100 conversion price, then warrants are included in the conversion rate. But if after five years, Wells Fargo shares remain below $100, the bonds may be remarketed as zero-coupon straight debt, or put back to the company, both in five-year intervals.

There is a contingent conversion trigger of 120% and a contingent interest trigger of 120%.

Conversion can also be triggered if Wells Fargo senior credit is downgraded below A1 by Moody's or below A- by S&P, or if the bond's trading price is less than 98% of parity.

There also will be additional contingent interest of 0.0625% of the bond trading price per quarter if it is trading at 200% or more of the accreted price.

"Hey, this looks like great financing for Wells Fargo," said a buyside source based on the West Coast.

There was not a lot of analysis available on the Wells Fargo deal, but it was loosely described as similar to the Affiliated Managers Group and Mandalay Resort Group floaters that recently priced with warrant kickers. Sellside analysts put the Mandalay deal about 3% to 3.5% rich, and several ascribed little to no value to the warrants.

Amid the seemingly insatiable demand for new paper in convertibles, partly due to fund managers' ability to continue to lure new capital into the asset class, terms have remained in favor of issuers, however.

Redemptions probably have played a bigger role in the demand side of the market equation, though.

Market watchers have been warning of a shrinking convertible market for several months now, with all the redemptions taking place and lagging flow of new paper. The latest comes from Bear Stearns (see separate story in this issue).

The lack of new product also exacerbates the richness of the market, and underscores the danger from situations like that of Anadarko Petroleum Corp. a couple of weeks ago with the redemption of its zero-coupon convert that was trading above the call price.

That said, traders note another side of the market - the beaten-down credits, particularly in energy and power, along with cable and a few telecoms - heading north as some of the funding pressures seem to be subsiding.

Calpine Corp., Mirant Corp. and El Paso Corp. have been the darlings recently, although traders said there was not a lot happening with those converts Tuesday.

By all appearances, reaction was also muted in the convertible market to Standard & Poor's downgrade of i2 Technologies Inc. on the delay in filing its 2002 10-K and the possible violation of the indenture for the $350 million convertible subordinated notes if the failure to file is not cured within 60 days - which the company says it can achieve.

i2 remains on negative watch pending the completion of the re-audit of its annual financial statements from 1999 through 2001, which follows allegations regarding i2's revenue recognition with respect to certain customer contracts, S&P said.

The recurring accounting problem, on the heels of the dot.com bubble bursting, meant that the i2 converts have been in the tanks for quite some time, one trader said. He said the 5.25% converts due 2006 looked to have lost about 0.5 point on Tuesday.

The i2 Tech convert was quoted at the end of the day at 56 bid, 60 asked at one major shop and at 56.5 bid, 58.5 asked at another.

i2 shares have been halted since March 31, at 60c, when i2 first announced the delay in filing its financials. On Tuesday, the company said it had been notified by the Nasdaq that it will seek to delist the stock, which the company said it will appeal.

There is an SEC investigation into i2 Tech's accounting practices, as well.

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