Convertibles enjoy momentum from junk bond frenzy

By Ronda Fears

Nashville, May 15 - Discounting by underwriters to convertible buyers continued with the Northwest Airlines Corp. deal. Meanwhile, several traders from both the buyside and sellside noted signs that the market's willingness to bid up secondary levels is cooling down.

"It's beginning to feel like we've reached the limit, in terms of bidding up the market," said a buyside trader.

"Even the new issues are having to be discounted. Today, most of those either dropped slightly or didn't move much at all."

Northwest's deal was discounted to 98 and still closed off that by 0.5 point.

Even deals that buyers were excited to take part in earlier this week were flattish on Thursday.

Triarc Cos. Inc.'s new convert, which was referred to as a home run, ended the session unchanged and the CenterPoint Energy Corp. deal gained just 0.375 point.

Sinclair Broadcast Group Inc.'s quick-sale premium redemption convert, though, gained 0.75 point from the gray market close on Wednesday and 1.75 points from par where it was issued and sold.

The Sinclair convert, especially, chalked up some of its success to the hot junk bond market. Sinclair upsized its convert by $25 million to $125 million and also sold a $100 million add-on to its 8% straights due 2012 at a whopping price of 105.3359 to yield 7%.

"What really helped the [Sinclair] deal was the use of proceeds, that was very positive. They took out $200 million of high-yield debt and financed it with a $100 million of new high-yield paper with a yield of 7% and this convert," said a capital markets source at one of the Sinclair convertible underwriters.

"The momentum on that [junk bond] deal spilled into ours. Buyers were pretty enthusiastic, despite the 103% premium."

The Sinclair transactions - the junk bond and convert pricings - was a particular point of interest to some market participants, who for several weeks have been watching junk bonds price at par while converts are having to be discounted.

"It's ironic, or bizarre, or something else, when you see all these junk bonds pricing at par - or now at a big premium - and they are having to discount these converts. The difference, of course, is that convert issuers are getting all the proceeds and the banks are forfeiting fees," said a buyside source.

Onlookers are expecting any day, though, that the frenzy in junk bonds will subside.

Some point to the secondary market in junk bonds slowing substantially, although the focus has turned to a raging primary market.

Meanwhile, convertible issuance also is clipping along at a nice pace, with close to $7 billion of new paper in the first half of May, and the discounting is making some of the deals attractive - Northwest Airlines, for example.

Northwest sold $150 million of 20-year convertible cash-to-zero notes in the overnight Rule 144A market at par to yield 6.625% with a 60% initial conversion premium, via lead manager Citigroup. It was repriced at 98.

Citigroup closed the issue at 97.5 bid, 98.5 offered. Northwest shares ended down 70c, or 6.92%, to $9.41.

"Northwest looks like good terms," said Barry Nelson, portfolio manager at Advent Capital Management.

"Airlines with new funding are safe, for at least a while."

Still, even at the discount price of 98, Lehman Brothers put the Northwest convert 4.72% rich, using a credit spread of 1,800 basis points over Treasuries and a 60% stock volatility. At par, Lehman put it 6.77% rich.

But Deutsche Bank Securities put the Northwest issue, at par, right at fair value, using a credit spread of 1,500 bps over Libor and a 60% stock volatility.

In what was seen as another hint of buyers troubling the bankers, there was talk that PPL Energy Supply LLC's deal would not price after the close Thursday but would instead come before the open Friday. Sources at one of the three joint bookrunners, however, insisted that the Thursday pricing was never firm and there was no trouble in placing the issue.

In the event, PPL announced Thursday evening the deal was priced to yield 2.625% with a conversion price of $49.725 - equivalent to a 29.25% initial conversion premium - and upsized to $350 million.

The PPL Energy's $300 million deal, which will convert into parent PPL Corp. and is guaranteed by PPL, was quoted in the gray market at minus 0.5 point on the bid side to plus 0.5 point on the offer side.

PPL shares ended up $1.30, or 3.5%, to $38.47.

Sources said guidance on PPL Energy remained unchanged at 2.5 to 3.0% yield with a 27.5% to 32.5% initial conversion premium.

Valassis Communications Inc. and Magma Design Automation Inc. also floated overnighters right after the close.

Valassis launched $160 million in proceeds of 30-year discount cash-to-zero convertibles with a warrant kicker to price before Friday's open, with proceeds going to take out its existing 0% convertible before the put next summer.

The Rule 144A issue was talked to yield 1.125% to 1.625% with a 65% initial conversion premium. At the midpoint, that would put the issue price at about 70.994.

Deutsche put the new Valassis notes 0.4% rich, using a credit spread of 120 bps over Libor and a 26% stock volatility.

Valassis shares closed up 5c, or 0.19%, to $26.67 and the zeroes were flat at 58.25 bid.

Magma launched $150 million of five-year 0% convertibles with price talk of a 27% to 33% initial conversion premium, with plans similar to Silicon Valley Bancshares to use a portion of proceeds to hedge the notes with warrants to limit potential dilution.

"It's a way for the hedge funds to monetize volatility and short the stock and make money on the deal," said a buyside source who runs an outright convertible fund, referring to the issuers' strategy for the Magma and Silicon Valley convertible sales.

"It's good for the hedgies."

Magma shares closed up $1.50, or 6.18%, to $18.05.

Also in the wings is a $250 million mandatory convertible from Valero Energy Corp., which was largely overlooked on Wednesday as it was not pressing to get on the immediate calendar.

Valero plans the convert to use proceeds, along with $250 million in cash on hand, to buy a Louisiana refinery from Orion Refining Corp., which filed bankruptcy on Tuesday. The sale depends on bankruptcy court approval, however, so timing on the deal is up in the air.

Valero shares closed Thursday unchanged at $38.47.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.