Reliant converts plunge 16.25 points as broader market gains; Cadence deal reoffered at 98

By Ronda Fears

Nashville, Aug. 12 - Convertibles were marked higher for the most part, as stocks rose after interest rates were left intact, but traders said there was not a great deal of buying. In fact, a massive sell-off in Reliant Resources Inc. converts sent those bonds plunging 16.25 points in reaction to its earnings.

Elsewhere in the secondary trenches, holders of HealthSouth Corp. converts found little clarity in the company's news release on an exchange for the 3.25% notes that matured April 1 - just two weeks after the accounting scandal broke. But in general, close observers expect the Birmingham, Ala. company to offer longer dated paper with perhaps a boost to the principal, along with a fatter coupon and, of course, a new conversion price.

Also, holders of Medicis Pharmaceutical Corp.'s 2.5% convertible notes due 2032 are expected to overwhelmingly participate in the company's exchange offer, which concludes Wednesday. Traders were expecting a "fair amount" of activity in the new notes once they begin trading.

On the primary front, Cadence Design Systems Inc. had to deal with the pricing power pendulum swinging toward buyers, as QLT Inc. did on Monday.

Cadence's new deal priced at the cheap end of talk and then was reoffered by lead manager JPMorgan at 98. That came on the heels of QLT sweetening its deal before pricing, ponying up an extra 50-100 basis points of yield and 5% of premium.

Those follow a string of similar developments in the convertible market.

GATX Corp., however, broke the recent trend in the market of cheapening new issue terms, pricing its small deal at the aggressive end of yield talk and middle of premium guidance.

Largely, though, players still see the convertible market cheapening, although perhaps not yet to the point where they want to dive in as buyers. Some also have yet to digest the bond market reactions to the Federal Reserve - both in terms of the expected non-event Tuesday and speculations about a rate hike.

"From my perch I see all the lower credits that got so bid up in the spring falling back down to earth," said veteran convertible manager Michael Revy, who manages a hedge strategy for Froley Revy and another outright strategy.

"I saw a few days where ... bids were wanted. The temptation here is to cut more losses before the 10-year [Treasury] goes to 5% and the Fed does a surprise hike. I think both are improbable, but both are to some extent getting priced in."

Buyers also see the window of opportunity beginning to close for issuers to get really cheap funding.

Cadence sold $350 million of 20-year convertible notes at par to yield 0% with a 17% initial conversion premium - at the cheap end of guidance - but it was reoffered at 98 by JPMorgan and the bookrunner closed it at 98.375. Cadence shares ended off 19c, or 1.42%, to $13.19.

Two buyside sources thought the Cadence deal looked too rich for current trends in the convert market. Sellside analysts put the issue 2.45% cheap to 2.41% rich at the middle of price talk.

"There was no coupon and, yes, a 17% premium, but the contingent conversion threshold is an unusually high 145%, so it's back in the neighborhood of what we saw pricing two months ago and before," said one of the buyside contacts, a hedge fund manager.

"There's no incentive to buy it [the Cadence convert] unless you are making a vol bet. I'd rather own the new Mentor floater. I thought the spreads in the 400-450 bps range [for Cadence] were way too aggressive. I'd use 550-575 bps."

QLT sold $150 million of 20-year convertible notes to yield 3.0% with a 30% initial conversion premium - at the cheap end of widened price talk. Bookrunner UBS Investment Bank closed it at 103.25 bid, 104.25 offered, while the stock ended dup 47.9c, or 3.5%, to $14.199.

A vast majority of convertibles headed north along with stocks, while the long Treasury bond dropped sharply, junk bonds slid slightly and corporate bonds were described as flat.

But, Reliant Resources plummeted amid a huge sell-off after the company posted large losses and unveiled a new cost-reduction plan along with a new chief executive.

Reliant's 5% convertible due 2010 fell 16.25 points on the day to 72 bid, 72.5 offered. The 9.5% due 2013 junk bonds were seen down 7.75 points to 86. Reliant shares plunged $1.10, or 22%, to $3.88.

The energy firm reported a second-quarter loss from continuing operations of $28 million, or 9c per share, compared to income from continuing operations of $122 million, or 42c per share, for second quarter 2002. The net loss was $6 million, or 2c per share, versus net income of $176 million, or 61c per share.

Reliant also announced a plan to reduce annual operating expenses by approximately $140 million, and said interim CEO Joel Staff will assume the position on a permanent basis.

On top of all that, the company cut its 2003 earnings outlook for adjusted income from continuing operations to 10c per share, citing weak wholesale energy market conditions and higher interest expense as well as an accelerated amortization of bank fees resulting from recent refinancings, including the convert.

Reliant slashed its 2003 earnings target to 50-70c a share from 90c to $1.10 a share in May.

While the HealthSouth situation is far from clear, interested parties see some conclusion nearing.

HealthSouth said Tuesday that, as a result of its improving liquidity from its operations and asset sales, it has paid $117 million, representing all past due interest currently owed under various borrowing agreements and plans to pay upcoming interest payments.

The troubled rehab hospital operator also said it has initiated discussions regarding an exchange offer for the 3.25% converts, circulating a term sheet last week among advisors to the holders. There is $344 million in principal outstanding on that issue.

"With these interest payments, we have fulfilled not only a legal but also a moral obligation to our bank lenders and noteholders," said Joel C. Gordon, HealthSouth interim chairman, in a news release, adding that "in just five months, we have been able to strengthen and improve our liquidity."

HealthSouth said that it had $445 million of cash prior to making the $117 million in interest payments, and that does not include any proceeds from pending asset sales.

A brokerage source close to the situation said it was still unclear as to how the accrued interest on the convertible will be calculated, since the principal amount may be increased and the new notes are expected to have a bigger coupon.

In any event, the source said the new notes are anticipated to have a long maturity date, adding: "I'd be surprised if it's as short as three years."

The Medicis exchange, which concludes Wednesday, is expected to be mostly if not fully subscribed. The company is exchanging its $400 million of 2.5% contingent convertible senior notes due June 2032 for new notes with a larger par amount, lower coupon, slightly longer maturity and higher conversion price.

Also noteworthy, the company added dividend protection, which has accompanied nearly all new issues brought to market since June as company's move to initiate or boost common stock dividends in the wake of new federal taxation rules.

"From our standpoint, we're happy either way," said a convertible hedge fund manager in New York.

"The number of shares to be sold short to hedge the new converts is actually less, so there's a net number of shares that had to be covered," but there was ample time to do so during the three-week exchange period.

Essentially, Medicis is pushing out the dilution event on the convertible, enticing convert holders to assist in that by offering up more principal.

The new issue will convert at $77.52 for a ratio of 12.8998, compared to $58.10 with a 17.2117 ratio on the old issue. The new 1.5% notes will have a higher contingent conversion trigger of 120% compared to 110% for the existing notes, and will pay 50 bps of contingent interest after June 4, 2008.

For each $1,000 principal amount of existing notes, Medicis is offering $1,230 principal amount of new 1.5% contingent convertible senior notes due June 2033. If all $400 million of the existing convertibles are tendered the company will issue $492 million of the new securities.

The company also added one year of call protection and extended the puts to 2007, 2012 and 2017.

A minimum of $200 million of existing notes must be tendered for the company to proceed. Any existing convertibles not tendered will remain outstanding.

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