Deutsche analysts say many of convertibles with worst up/down profiles have short-dated puts

By Ronda Fears

Nashville, March 26 - Convertibles with short-dated puts, often combined with dwindling call protection, make up many of the group with the worst upside/downside profiles, according to Deutsche Bank Securities Inc. analysts.

"For bonds putable before the one-year time horizon is up we calculate the profile to the put only. Our analysis is simplified in that we do not factor in any probability of put sweeteners or inefficient call exercise by the issuer," the analysts said, acknowledging that the analysis probably undervalues short-dated putable issues.

"Our model takes account of the call announcement period option only. From an arbitrage perspective, the analysis also does not take into account the possibility of capturing gamma trading of the stock between the start and finish date of the analysis.

"But one or two names do jump out of the analysis as being interesting from a negative perspective."

Those are:

* Cell Therapeutic's 5.75% due 2008 (15.6% upside participation for a 25% move in the stock, 68.3% downside participation). "We were extremely surprised to see a biotechnology name in the Bottom 20, actually third from the worst place spot." This is the tranche of the 5.75% that the company re-struck in December 2002 to give holders a more equity sensitive convertible. The company succeeded in its exchange offer, but at current valuation levels the equity sensitivity of this bond skews to the downside.

* L-3 Communications 5.25% due 2009 (25.0%/55.1%). This is "another name that has seen a stock price rally cause the bonds to delta more heavily than they probably merit." This bond now looks significantly exposed with parity above par and the bond callable from December 2003. "This probably is not a bond to assume will not be called as soon as the issuer gets the chance."

* Symantec Corp 3% due 2006 (59.9%/83.5%). Because it has one of the highest parity values of any bond in the U.S. universe, it continues to attract support from outright investors looking for equity-sensitive issues and especially from arbitrage investors paying up for the possibility of downside premium expansion with any crack in the stock. But longer-term investors may be disappointed purchasing the bonds at these levels.

* Network Associates 5.25% due 2006 (28.6%/66.2%), "Seeing this bond in the Bottom 20 may raise a few eyebrows." Arbitrage investors like this security because of its high coupon and heavy delta. Whilst not disagreeing with this analysis, the Deutsche analysts point out that the OTC/listed volatility has come in a long way in 2003 whilst the convertible implied has stayed high. This causes the poor asymmetric profile.

*Freeport McMoRan 8.25% due 2006 (46.3%/77.7%). "The same reasoning as NET 5.25% 2006 can be applied to directly to this bond, which also commands a premium valuation courtesy of a high coupon and an in-the-money profile." The Deutsche analysts suggest outright investors may want to take a look at Freeport's recently issued 7% convertible due 2011 which, despite its 87.3% premium, returns an upside/downside profile of 59.4%/1.1% for a 25% move in the stock. The 7% is also noncallable for life, while the 8.25% becomes callable on July 31, 2004, at 102.75.

*Whole Foods 0% due 2018 (69.7%/79.0%) - "We have discussed in previous reports this bond having a valuation that is wholly dependent on assumptions about the issuer's willingness to utilize the call option. As we have previously noted, even if investors are prepared to assume that the bond will never be called to force conversion, they must be wary of a cash call with the accretion rate on the bond at 5%," the Deutsche analysts said.

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