Sharp rally in Viacom, L-3 could lead to profit taking; Pride deal up out of gate; Carnival jumps in

By Ronda Fears

Nashville, April 22 - Spreads tightened and stocks rallied, so nearly the entire convertible market saw nice gains Tuesday. Traders said flow picked up as well with the market better bid, but some run-ups have evoked thoughts of profit taking.

In the primary arena, Pride International Inc.'s overnighter was not re-priced - a detail that many bankers were eyeing - but sold at the cheap end of yield talk. It was followed by the launching of another overnighter by Carnival Corp. with another high premium deal sold as an OID with a warrant kicker.

"Sink or swim, Carnival jumped in," said a convertible hedge fund manager in New York.

"The deal is reminiscent of the Mandalay deal and not a lot of people in converts were excited about that deal. It will be interesting to see how this goes as an OID, though."

Also abuzz was the possibility a convertible may be part of Xerox Corp.'s financing in the near future.

Talk began circulating in the leveraged markets late Tuesday of Xerox's plans.

When pressed for details by Prospect News, sources would only state that details would not emerge until Xerox released its first quarter earnings, scheduled for 7 a.m. ET Wednesday, with a conference call to follow at 10 a.m. ET.

There was no confirmation that a convertible would be included. But a couple of convertible market sources thought "it would make sense."

Meanwhile, Carnival Corp. launched a $500 million proceeds overnighter with an issue price set at 64.688 for a yield-to-maturity of 1.75% and the issue carries a 93% initial conversion premium. The issue will pay cash interest until year five, at 1.75% of the issue price.

Through the first five years, the base conversion ratio is 12.18, with a maximum set at 23.5. If Carnival shares are below the conversion price of $53.11, the base conversion ratio applies. If the stock is higher, the payout value of 11.32 additional warrants is kicked in.

Mandalay Resort Group sold $350 million of 30-year convertible floaters to yield three-month Libor plus 0.75 and a 100% initial conversion premium with warrant kickers. That followed a similar deal from Affiliated Managers Group Inc. in February.

Earlier this month, Wells Fargo & Co. sold $3 billion of 30-year convertible floaters at par to yield 3-month Libor minus 0.25% with a 110.75% conversion premium, on a call spread.

These types of deals led to what many referred to as a buyers strike of sorts that had prompted underwriters to re-price the issues to buyers at a discount to par, while the issuer received full proceeds, which effectively lowered the banks' fees.

In fact, market sources on the buyside said there must have been intense competition among the bankers for the Pride deal. Deutsche Bank Securities was thought to be the lead on the deal up until it was launched right after the close Monday off the Morgan Stanley desk.

One hedge fund manager in New York speculated that convertible bankers got corporate bond investors to look at some of these new deals that aren't "classic" convertibles, but bankers haven't indicated that has been the case.

Instead, bankers said hedge funds are still making up the majority of orders on new deals and they note the high returns of hedge funds, which has boosted their capital flows, has tipped the scales in terms of supply and demand.

The CSFB/Tremont hedge fund index showed recently that the convertible arbitrage strategy gained 0.95% in March for a year-to-date return of 5.44%. That compares to the broad hedge fund index gaining 0.26% in March with a 2.23% return year-to-date.

Still, many convertible participants, hedge funds included, have been complaining about new deal terms.

"These are convertibles in name only," said John Siebel, head of trading at Silverado Capital Management.

"I am getting fewer calls on these new deals, because when I see the premium I'm walking away. Until they bring a convertible, I will continue to walk away."

Pride was not re-priced but several buyside sources said they placed their order with the stipulation that the yield had to be at the wide end of guidance of 2.75% to 3.25%.

"We put in for some due to our relationship with MS, but only if it comes at 3.25%, and for less than what we normally put in for a new issue," said an outright manager on the West Coast.

Ted Southworth, convertible portfolio manager with Northern Trust Co. said he looked at the Pride deal, but passed.

"I just can't get excited about 80% premiums on BB deals, five-year put or not," Southworth said.

The Pride deal did come at 3.25% and with a new record for initial conversion premium, at 80%, when those issued with warrant kickers or on call spread are excluded.

And, traders said Pride's offering went from slightly under par in the gray market, by about 0.25 point, to over par out of the gate. Morgan Stanley closed it out at 101.75 bid, 102 offered.

Pride shares ended up 28c, or 2%, to $14.56, which one salesman pointed to as proof the deal got support, as many onlookers expected the stock to come under pressure right after the new issue.

Sellside analysts put Pride's new deal pricing right at about fair value.

"The pent-up demand for new paper has definitely skewed the playing field in favor of issuers," said Bear Stearns & Co. convertible analyst Matt Hempel.

Still, market sources from both sides - buyside and sellside - expect issuance to pickup before long, mostly likely the heaviest once the bulk of earnings have been released.

On whole, many have not been disappointed with earnings so far, and in some cases - like Viacom Inc. and L-3 Communications Holdings Inc. - rather pleased.

"There's not much to get hurt on right now," one hedge fund trader commented.

"In fact, we're probably looking to take some profits in a few names, like L-3. They are bleeding premium and the call is coming up."

L-3's 4% convertibles are callable in December at 102.625.

The L-3 converts closed Tuesday up about 2.25 points to 108.25 bid, 108.75 offered while the stock ended up $2.63, or 6.5%, to $42.80 in a rally on its earnings.

L-3 reported first-quarter earnings rose 38% on increased sales to the U.S. military as well as acquisitions such as two Northrop Grumman Corp. units. L-3, which also makes bomb detectors for airports, reported earnings of $49.7 million, or 50c per share, compared with $4.9 million, or 6c per share, a year earlier. Sales rose to $1.09 billion from $696.8 million.

Looking ahead, L-3 said it expects sales growth in 2003 of about 20% and operating income growth of more than 25%, with EPS of $2.70 to $2.75 for the year.

Jeanine Oburchay, Wachovia Securities convertible analyst, said in a report Tuesday that she also sees L-3 continuing to be an acquirer of defense businesses "and that it will likely have to tap the high-yield markets to do so." She also noted the company also has access to roughly $670 million on its credit line.

Viacom also had a nice day, due to earnings and acquisition news.

The Liberty Media Group/Viacom 3.25% exchangeable due 2031 added about 3.5 to 4 points, traders said, to 103.125 bid, 103.625 offered.

Viacom shares closed up $2.53, or 6.2%, to $42.40.

The company reported a swing into the black with a profit for first quarter, and also that it was buying AOL Time Warner Inc.'s 50% stake in Comedy Central for $1.23 billion in cash, giving Viacom full control of the network.

Strength in its cable networks group and Blockbuster video chain offset war-related costs and weakness at its Infinity radio group, Viacom said.

For first quarter, Viacom posted net income of $443 million, or 25c a share, compared with a year-before loss of $1.11 billion, or 63c a share. Revenue rose 7% to $6.05 billion and EBITDA increased 12% to $1.23 billion.

Viacom also said it is on track to meet its 2003 revenue and earnings outlook.

Standard & Poor's Corp. said the Comedy Central acquisition temporarily consumes some of Viacom's unused debt capacity within the rating, but its strong free cash flow can accommodate the investment. It will have no affect on Viacom's ratings or outlook, though, S&P said.

The acquisition, assuming an all debt-financed deal, results in trailing 12 months pro forma balance sheet debt to EBITDA of roughly 2x, based on preliminary March 31 disclosures, compared with about 1.8x prior to the acquisition. S&P said.

With high-yield returns grinding higher and investment flows gaining in that group, and ultimately also in convertibles, Merrill Lynch analysts took a look at the entire capital structure of power and utility names in a recent report. They held a conference call on the matter Tuesday. (See full story elsewhere in this issue.)

"From a convertible market perspective, reports that cut across the whole of the capital structure make a lot of sense because all aspects of the capital structure - debt, equity and derivatives - have an impact on the valuation of convertibles," Yaw Debrah, head of U.S. convertible research at Merrill Lynch told Prospect News.

"The call was very well attended with participation from across the full spectrum of the capital structure, debt, equity, derivative and convertible investors."

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