Nabors improves on sector's gains; XM holds steady; Wild Oats inches higher, make-whole draws scrutiny

By Kenneth Lim

Boston, Feb. 23 - Nabors Industries Ltd. convertibles rose on the back of higher oil prices as volume in the oil and gas sector picked up on Friday.

Separately, Wild Oats Markets Inc. continued to advance outright after the company agreed to a takeover by Whole Foods Market Inc.

The Wild Oats takeover is believed to have hurt hedge investors because of its unusual take-out protection, and investors should take another look at the language of their fundamental change protections, Lehman Brothers convertible analyst Venu Krishna wrote in a report.

The rest of the convertible market was noticeably quiet, even for a Friday.

"It's the last day of a slow week," a sellside convertible trader said. "I can't wait for it to be over."

XM Satellite Radio Holdings Inc. stayed firm ahead of its expected earnings announcement on Monday as a planned merger with Sirius Satellite Radio Inc. hovered at the back of investors' minds.

The XM 1.75% convertible due 2009 traded at 87.25 against a stock price of $15.30, while XM stock (Nasdaq: XMSR) closed at $15.10, down by 1.56% or 24 cents.

"XM is holding steady; old news there," a sellside convertible strategist said.

Washington-based XM and New York-based Sirius announced an all-stock merger earlier in the week, but the deal continues to face concerns that regulators will block a merger over antitrust issues. The two companies are the only satellite radio providers in the United States.

"Guys will be looking to see how well both companies are currently doing," a buyside convertible trader said. "You want to know what kind of company they're going to be if they merge. If they do well, that's going to be good if they merge, and it's going to be reassuring if they don't merge. But if they do too well, maybe the FCC may decide that they don't really face a dire need to merge in the first place. It could go in a lot of ways."

Nabors climbs with sector

Nabors Industries' 0.94% convertible due 2011 rose about a point outright on Friday as firm oil prices provided support for the sector.

The Nabors convertible traded at 97.25 versus a stock price of $31.05. Nabors stock (NYSE: NBR) improved 0.2%, or 6 cents, to close at $30.64. Nabors is a Bermuda-registered land drilling contractor for the oil and gas industry.

Crude oil prices reached a high for the year on Friday amid recent data that reflected tight inventories and concern over tensions with Iran. Oil prices rose 19 cents per barrel to $61.14 on the New York Mercantile Exchange on Friday.

"Names like Nabors are always going to be a little volatile because their stocks move so quickly with oil prices," a buyside convertible trader said. "The sector's been pretty active this year, I think because a lot of people think oil prices could remain high and there's possibility for M&A events."

Other oil and gas names also saw interest pick up on Friday, a sellsider said.

"We've seen some good two-way flow on Goodrich Petroleum, Nabors, Superior Energy," the sellsider said.

Wild Oats gains further

Wild Oats' 3.25% convertible due 2034 rose another quarter-point on Friday in the wake of a planned takeover by rival Whole Foods.

The Wild Oats convertible traded at 110.25 versus a stock price of $18.45. Wild Oats stock (Nasdaq: OATS) finished the day at $18.43, up by 0.11% or 2 cents.

Wild Oats said late Wednesday that it had agreed to an $18.50-per-share cash offer from Whole Foods. Boulder, Colo.-based Wild Oats and Austin, Texas-based Whole Foods are grocers that specialize in organic and natural foods.

The deal brought Wild Oats' convertibles, which are usually quiet, back to life.

"I've never seen them quoted before yesterday," a convertible trader said.

The convertible, which has gained just over 2 points outright since the takeover announcement, brought gains for outright holders, but hedge investors were widely believed to have incurred losses.

"If you were holding them on swap, you probably got hurt," a convertible analyst said. "But if people got hurt, it's always been more of an outright name, and again, it wasn't a super active name."

A research note by Lehman's Krishna on Friday recommended that holders of the paper convert the security rather than exercise the change-of-control put.

Holders of the convertible will receive a make-whole premium regardless of whether they put or convert the security, Krishna explained. But the make-whole premium is calculated based on an old structure that does not afford hedge investors as much protection as newer make-whole features, the analyst wrote. Krishna estimates that the make-whole premium will be 8.28 points.

The parity of the convertible is around 104.5 based on the takeover price, Krishna wrote. That means the convertible is worth about 111.5 if converted, and about 109.6 if put back to the company.

Compared to the convertible's latest pre-announcement prices, outright holders can gain about 2.4 points. But hedge investors on a theoretical delta of 75% could face a net loss of about 9.1 points, Krishna wrote.

Make-whole under scrutiny

In the same report, Krishna noted that the Wild Oats deal demonstrated the risks of market value-based make-whole structures that limit the amount of protection arbitrage investors get in the event of a takeover.

"The potential loss to arbitrage investors from the announced all-cash takeover of OATS serves as another reminder that the presence of takeover protection language does not guarantee that investors are made whole in all scenarios," Krishna wrote.

Krishna highlighted six other convertibles that have market value-based takeover protection and warrant a closer look. Those convertibles are CV Therapeutics Inc.'s 2.75% convertible due 2012, the Kulicke and Soffa Industries Inc. 1% convertible due 2010, the Oscient Pharmaceuticals Corp. 3.5% convertible due 2011, the Palm Harbor Homes Inc. 3.25% convertible due 2024, the Sunterra Corp. 3.75% convertible due 2024 and the Thoratec Corp. 1.38% convertible due 2034.

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