LONDON (Dow Jones)--Cash-strapped Irish drug company Elan Corp. PLC (ELN) could enter a so-called death spiral if the company issues additional shares to meet a looming $817 million obligation.
Elan said late Monday it will ask shareholders to approve the issue of 120 million new shares, or 34% of its current share capital, even though it has no imminent plans to issue the equity.
Some hedge funds, however, believe the shares are headed their way in December, when the company needs to pay back holders of a convertible bond. That could provoke a death spiral, in which the creation of new stock sparks a fall in the share price, forcing Elan to offer bond holders more equity to meet their obligation, thus leading to further declines.
"I don't think that Elan can pay this convertible off in cash; that would leave the company almost insolvent," said one U.S. hedge fund manager, who declined to be named. "Therefore they have no other option but to pay these bonds back in shares, and the market doesn't seem to be factoring that in."
A London-based hedge fund manager was more blunt: "It's a classic death spiral."
Holders of the convertible bond will have the option on Dec. 14 to put their debt - or redeem the bonds before maturity - and receive 61% of its value in shares, cash, or a mixture of both. The company has $817 million of such bonds to redeem.
With Elan's shares having fallen 95% since the bond was issued in 1998, and the company's credit quality having deteriorated during that time, bond holders are most likely to want to exercise the put option.
Sunny Uberoi, a spokesman for Elan, said it is premature to talk about how the company will redeem the debt. Uberoi, however, pointed out that Elan has $1.4 billion in cash and is on track to complete its asset-disposal program.
S&P, Analysts Divided Over Prospects Ratings agency Standard & Poor's, which rates Elan at B-, is less optimistic.
"The success of its ongoing restructuring program and the strength of its cash flows from operations remain highly uncertain," S&P said last month. Elan also must repay $840 million of debt coming due in 2004 and 2005.
Ian Hunter, a pharmaceutical analyst at Goodbody Stockbrokers in Dublin, said that if Elan sells another business it will have the cash to pay off the convertible bond in December, run the business through 2004 and develop Antegren, a potential treatment for multiple sclerosis and Crohn's disease.
But hedge funds have accused equity investors and analysts of ignoring the bond's inherent dangers. Ratings agencies, on the other hand, can't be accused of ignoring the threat. Moody's Investors Service, which rates Elan at deep in junk bond territory at Caa2, warned in an opinion update this month that Elan's ability to pay the put in cash is unclear, as is its desire to satisfy the option with stock.
That could prompt a debt restructuring in the medium term, the agency warned.
Before that can even happen, hedge funds are shorting, or borrowing and selling on the shares, in anticipation of the dilution caused by share creation, and the share price fall that will result.
"Guys will be shorting the stock right now. When the price drops by half, the company will have to get authority to issue more for the December put and the stock will never be able to appreciate," said the London-based hedge fund manager.
Moreover, hedge funds aren't natural long-term holders of stock and are likely to want to sell their shares, almost immediately leading to further pressure on Elan.
The London-based manager also believes a restructuring is possible, giving the bond a lower conversion price, which would mean that the stock would not have to rise as high before conversion became profitable for holders.
Elan has struggled financially since its accounting practices were called into question a year ago. Since then, the U.S. Securities and Exchange Commission has opened a probe and Elan has replaced its top management and embarked on a radical restructuring program.
So far, the company has raised $1.4 billion in asset disposals and is well on its way to achieving its $1.5 billion target by year's end.
-By Alistair MacDonald and Henry J. Pulizzi; Dow Jones Newswires; 44 207 842 9270; alistair.macdonald@dowjones.com; henry.pulizzi@dowjones.com
(Debra Marks in Dublin contributed to this article.)
(END) Dow Jones Newswires
February 26, 2003 13:25 ET (18:25 GMT) |
