Delta Airlines deal buzz swirls as Pinnacle Airlines soars to 103.5; Tower crumbles to teens on filing

By Ronda Fears

Nashville, Feb. 2 - Not that anyone was burying their heads on this Groundhog Day, but chatter of new deals continued to provide a diversion for convertible players Wednesday while adjusting to the much-anticipated quarter-point hike in interest rates by the Federal Reserve and further heightened worries about risk as Tower Automotive Inc. filed bankruptcy.

As a backdrop to elevated angst levels, returns in January were coming in negative on all sides of the market. Merrill Lynch reported its convertible index dropped 2.2% in January, and Citigroup said its convertible index dropped 2% on a cap-weighted basis while underlying stock fell more than 4% during the month. Also, Merrill said its convertible hedge index was off 0.72% after fees and hedging out interest rates.

If the prophecy of Groundhog Day is transferable to the convertible market, then there could be six more weeks of lackluster returns, as perhaps the most famous groundhog in the United States, Punxsutawney Phil in Punxsutawney, Pa., saw his shadow and thus it was declared that there will be six more weeks of winter weather.

One convertible fund manager, who admits he's been liquidating a lot of positions recently, though not in large dollar amounts, remarked that "hopefully, it won't be like the movie 'Groundhog Day' where the day just keeps repeating and repeating and repeating. Hopefully there will be some folks in the convert market step back and get a hold of themselves, bring some rationality to the market."

Amid the deal buzz a couple of small deals actually surfaced and were getting a nice reception as demand for new paper is one of the hottest areas of the market.

Pinnacle Airlines Corp., a Memphis-based feeder to Northwest Airlines Corp., was pitching a $110 million deal, and a small private placement from Xoma Ltd. broke to trade in the Rule 144A market. Both were getting chased, with Pinnacle well above par in the gray market and Xoma rising 2 to 3 points right out of the gate.

Meanwhile, in addition to several other new deals rumored in the convertible market, there was a revival of chatter that Delta Air Lines Inc. was prepping another convertible offering. Other market buzz this week suggests Eastman Kodak Co. and MetLife Inc. are preparing to return to tap convertible investors. None have been confirmed, however.

"We are hearing that one of the potential underwriters is circulating the noise on Delta, which frankly would not surprise me. This came up a few weeks or months ago, right before year-end, but nothing ever came of it," a buyside trader holding Delta convertibles said.

Delta's existing converts both added about 1 point on the day, with Delta shares gaining 23 cents, or 4.23%, to end Wednesday at $5.67.

Pinnacle propped by Northwest

Some of the popularity in the Pinnacle issue was its relationship with Northwest Airlines as many onlookers expected the legacy carrier to continue to support the feeder. Pinnacle is using proceeds to buy back a $120 million note payable to Northwest at a 15.3% discount to par and aims to repay $5 million under its revolver with Northwest.

Pinnacle is pitching $110 million of 20-year convertible notes with yield guidance for a 2.75% to 3.25% coupon and 20% to 25% initial conversion premium for Thursday's business. It was last seen at 103.5 in the gray market.

"Good cash flow and cheap security," was one remark from a buyside source eyeing the Pinnacle deal, who agreed that it makes sense for Northwest to keep propping Pinnacle up, if need be.

The biggest barrier to the Pinnacle deal, buyside sources said, was the tough borrow on the stock. One suggested that a stock borrow facility like in the Calpine Corp. issue last fall would help immensely.

"The company can create an 'off the shelf' borrow facility as was done in the most recent CPN deal," he said. "So, it could work."

Xoma issue climbs to 102

Xoma's $60 million of seven-year convertible senior notes priced with a 6.5% coupon and 15% initial conversion premium - cheaply outside of original price talk for a premium range of 22% to 28%, which had been sweetened to 15%, and at the wide end of yield guidance for a 6.0% to 6.5% coupon.

Sold as a private placement under Section 4(2), the issue broke to trade under Rule 144A and immediately shot up. Early Wednesday the issue showed a 102 bid and 103 offer, a convertible market source said, and that level held right up to the end of the session.

Xoma shares on Wednesday closed at $1.64, up a penny on the day.

Convertible players said the deal appealed to buyers on the terms as well as a view that the company had "turned a corner" with a restructured agreement with Genentech Inc. for its single commercial product, Raptiva. Xoma executives said after restructuring the Genentech agreement that they expect the company to be profitable within three years. Xoma also has ventures or is working in collaboration with several other bigger drugmakers for new products.

Tower 5.75s drop to 13/14 area

Tower Automotive's bankruptcy was not a big surprise to the markets, but there were some holding out hope that such a drastic measure would not be necessary. On the news, the Tower convertible bonds crashed into the teens and the preferreds barely registered on a price chart. Further stress came with at least one analyst saying the convertibles might be worthless in a bankruptcy scenario.

The 5.75% convertible bonds fell to the 13 bid, 14 offered by the end of the session, after opening with a bid at 13.5 and an offer at 15, which deteriorated during the day. Tower stock traded lightly and ended unchanged at 77 cents. The 6.75% preferreds fell in a big selloff, ending down by 1.15 to 1.55.

In conjunction with the filing, which listed about $1.5 billion of debt, Tower said it had arranged commitments for up to $725 million in debtor-in-possession financing from JPMorgan, which was seen late in the day at Libor plus 275 bps, Libor plus 375 bps.

The convertibles were trading flat, or without accrued interest, Wednesday.

A couple of months ago there were many holders worried that Tower wasn't going to be able to make the first interest payment on the 5.75% issue, which was due Dec. 15, but that was paid although two weeks later the company deferred the $4.4 million dividend payment on its 6.75% convertible trust preferreds that was due Dec. 31. The deferral came amid a liquidity crunch caused by the termination of the early payment programs by most of its North American automotive OEM customers.

Then, a flurry of optimism prevailed when in January the company announced a $50 million accounts receivable securitization facility through GE Commercial Finance and said it was continuing efforts that began around six months ago to increase its collateralization financing package to $200 million.

Tower convertibles may be left out

The Tower converts were "trading in a controlled manner, no panic," one sellside trader said, as the news was already factored into predictions. Yet, even in the teens the converts are probably trading at an optimistic level, according to one analyst.

Earlier in the week, Tower's bonds popped on short covering, and one convertible holder said the impact was not so bad for convert holders on swap.

"Fortunately, we only have a few million, and we're 10% hedged, so the most we can lose is about 12 points," he said. "I think the bonds will be worth something though for nuisance value in the bankruptcy."

Joseph Farricielli, an analyst at Imperial Capital, speculated the RJ Tower 12% junk bonds are "still a good buy" even after the bankruptcy filing, but suggests recovery in the convertible bonds and preferreds could be nil. He sees the likely recovery for the 12% bonds in the mid-70s.

Some of the convertible holders set up with the 12% junk on a capital structure trade hope Farricielli is right, as it suggests there could be a dead-cat bounce of sorts in those bonds.

"I hope so - that would help," said a convertible analyst on the buyside, referring to the estimated recovery level for the 12% bonds. "The bigger position we had is in the 12%'s and ironically they went up today so I hear!! Still better than 54 yesterday at least for now!!

In any event, a sellside distressed trader said, "It's too late to panic now anyway, right? And if this [Tower bankruptcy] caught anyone as a total surprise, then they've been on Gilligan's Island!"

Apria buyers buck Street view

Amid the repercussions of a more active pace of merger and acquisition activity and a high level of fear that cash takeover offers will decimate some convertible issues, there have been many markdowns. But, for those with a view, it has developed into opportunity, as with the case of Apria Healthcare Group Inc. - which has been identified by Merrill Lynch and other big sellside shops as an attractive takeover candidate.

"One name we are playing that has gotten crushed because of cash takeover fears is AHG. Because the bonds have no takeover protection, the Street dumped them after BEV [Beverly Enterprises Inc.] received its takeout bid," late last month, said a buyside market source.

Beverly's convertibles were slammed following news of a $1.5 billion bid getting prepared by a group of investors, with the potential of pealing off its nursing homes from other assets which basically consist of homecare and in-home therapy services.

Lake Forest, Calif.-based Apria provides services in the home respiratory therapy, home infusion therapy and home medical equipment areas.

"The AHG story is totally different," the source said. "BEV is essentially a real estate play, while AHG is a service play. In fact, all the large industrial gas [or oxygen] companies have gotten into the market through smaller, inexpensive (and mostly private) acquisitions. The gas component is only 5% of the cost of the service, so there's not as much synergy as people think. Also, there's a lot of reimbursement issues, so the large companies are making sure they buy into the business cheaply.

"At the price AHG is trading at, there is almost a zero chance that AHG gets taken out. Even within the industry, Lincare [Lincare Holdings Inc., another convertible issuer], the largest player, would not buy them because their models are so different."

Further explaining the mention of gas, the buyside source said, "I meant oxygen. AHG delivers respiratory therapies and oxygen to people's homes when they have chronic pulmonary conditions. It's a tough logistics business, but Air Products got into it a few years ago through an international acquisition, and then expanded into the U.S. with a small public purchase and now tuck-in mom and pop deals.

"It's a very fragmented business. In fact, rumor has it that AHG tried to sell themselves a few years ago when they saw the industrial gas companies like Air Products coming in, but no one wanted to pay the multiple then, and the stock has only gone up since."

Apria shares closed Wednesday up 12 cents, or 0.36%, at $33.10. The 3.375% converts were quoted Wednesday at 113.125 with the stock at $32.98. The company is scheduled to report earnings Feb. 10.

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