Leucadia gains on MCI event; Citizens trades down to about parity on dividend; chips tumble

By Ronda Fears

Nashville, July 12 - Leucadia Communications Inc. convertibles got a nice gain Monday as the conglomerate's plans to buy a controlling stake in MCI Inc. hit the tape, with the news seen as a particularly wily move on the heels of acquiring control of Wiltel Communications Group last fall.

Citizens Communications Co. was another telecom name moving, but the convertibles dropped down to around parity levels on the Stamford, Conn.-based phone company's announcement of a special dividend, and the credit also was cut to junk.

The Leucadia headlines also caused some spillover activity in a few cable names that have been whispered in context of takeover speculation, such as Charter Communications Inc. and Adelphia Communications Corp. Also, an old convertible name that hadn't been heard in ages - McLeodUSA Inc. - was brought up at one desk.

Software names continued to soften, generally, traders said. Mercury Interactive Corp. was specifically mentioned, with the convertibles off about a quarter-point to the stock drop of 1.26% on the day.

Chip names and equipment makers also tumbled Monday, as Merrill Lynch & Co. analysts severely cut back their outlook on the semiconductor industry and lowered recommendations on those stocks.

Leucadia gains to around par

New York-based conglomerate Leucadia - involved in telecom, banking, manufacturing, real estate, wine making, copper mining and reinsurance - has set its sights on a 50% equity stake in MCI Inc., the former WorldCom Inc., and onlookers were calling it a crafty move.

Leucadia's 3.75% convertible notes due 2014 added 0.75 point to close at 99.5 bid, 100.5 offered, with the underlying stock gaining $1.12, or 2.29%, to end the day at $50.05.

"This seems like a very smart thing to do," said a convertible trader at a hedge fund in New York. "The only problem is no one knows exactly what the price will be. That aside, if you want to get involved, you really are forced to make your move now."

Apparently that strategy was rampant, as MCI shares zoomed up $2.45, or 16.78%, to close Monday at $17.05.

No offer price was named by Leucadia, however. MCI disclosed Monday that Leucadia had notified it of plans to file for approval by the Federal Trade Commission and the Department of Justice to purchase a 50% majority stake in MCI.

One buyside trader also noted that Leucadia has made no binding commitment to purchase MCI shares.

"They could decide that, after the spike in the stock, they just changed their mind," he said. "Then there's a lot of people stuck, and mad."

But some think even at the current valuation for MCI being bandied about, $5 billion would be a bargain. MCI, which entered bankruptcy in 2002 as WorldCom amid an $11 billion accounting scandal that landed several executives in court facing criminal charges, exited in April essentially debt-free.

"MCI has a lot of cash and, from what I can tell, will generate about $1 billion in free cash flow this year due to low capex and low debt, thanks to the bankruptcy," a sellside trader said. "When you combine all this, essentially I think Leucadia can get the assets pretty cheap and sell off the parts they don't want for a profit."

MCI would complement Wiltel

Wiltel was a key component of the applause for Leucadia in making a move for MCI, as well.

Leucadia bought Wiltel, formerly Williams Communications Inc. - another bankrupt telecom - in November, and many onlookers speculate it would likely try to merge the two if successful in winning control of MCI.

"What seems to be crucial would be to drive Wiltel's capacity utilization while cutting MCI's cost structure," said a hedge fund strategist.

"Capacity vis-à-vis Wiltel could be very strategic. There would be no replacement costs of building out further infrastructure, as the technology to lay the fiber is no big deal, and Wiltel is using old natural gas lines."

The real prize in the MCI network, the strategist said, is its international unit, UUNet, a leading internet protocol, data and voice communications services provider.

Earlier this year, Leucadia had been trying to best Vulcan Energy Corp. with a bid for Houston-based independent oil and gas producer Plains Resources Inc. But on Monday, Plains said it had agreed to a new takeover proposal by Vulcan that raised its overall offer by 3% to $410.6 million.

Citizens to pay stock dividend

Rural telephone company Citizens Communications said it would pay a special dividend of $2 per share and set an annual dividend rate of $1, which was a hard knock against the dividends on its convertibles. Thus, both issues were seen lower on the news.

The Citizens 6.75% mandatory due in August 2004 was quoted at 25.88 bid, 25.98 offered and the 5% convertible preferred at 53 bid, 53.125 offered.

Citizens shares, which were not receiving any dividends until Monday, shot up $1, or 7.63%, to $14.11.

Also, Citizens affirmed its 2004 financial outlook and said it completed a review of its options after having solicited bids in February - ultimately a fruitless exercise - and now has decided to remain an independent company. The company is looking for 2004 revenues of $2.18 billion to $2.22 billion and free cash flow of $450 million to $475 million.

But in the wake of the news, Moody's and Fitch Ratings downgraded Citizens' debt to junk, both citing the special dividend.

Fitch said the dividend plan would leave less cash flow available to reduce debt.

Moody's said the $2 per share one-time dividend, estimated to cost $670 million, and the presumed ongoing $1 per share annual dividend, estimated at $335 million, were additive to the growing degree of business risk for the company.

A negative outlook was assigned to the credit by Moody's, saying it may lower the ratings further over the next 12 to 18 months based on the decidedly more aggressive fiscal policies being undertaken by management and the board, which would seem to reduce financial flexibility at an inopportune time of increasing industry competition.

Chips, equipment makers fall

Micron Technology Inc. chairman Steve Appleton was injured last week when his stunt plane crashed in an Idaho desert east of Boise, Idaho, according to an Associated Press report.

His jump to safety from the falling aircraft seemed to reflect many investors' attitude toward Micron and the field of semiconductor and equipment makers following several cutbacks by Merrill Lynch to forecasts for the chip industry.

Concerns about possible oversupply and slack demand were cited by Merrill analysts who slashed their forecast for the sector's revenue growth for fiscal 2005 to 6% from 16%. Merrill downgraded global semiconductor stocks as a sector to underweight from overweight and semiconductor equipment maker stocks to neutral from overweight.

In addition to Micron, other convertible names in the chip space heading south included Advanced Micro Devices Inc., Applied Materials Inc., Cypress Semiconductor Corp. and LSI Logic Corp.

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