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Biotech / Medical : Biotech Valuation -- Ignore unavailable to you. Want to Upgrade?

To: tom pope who wrote (7352)	11/18/2002 1:36:44 PM
From: Biomaven	Respond to of 52153

Here's an excerpt of this week's Baron's piece on convertibles. Note the eye-popping >50% yield to put on ELN's debt. Top-Down Tolls The hefty bills for puttable convertibles come due By JENNIFER ABLAN It sounded too good to be true, and it turns out it was. In early 2000, when the stock market started to tank and the money market cut off less-than-blue-chip borrowers, companies found they still could raise money by issuing convertible securities. Not only that, they could borrow at interest rates of zero or a mere fraction of a percent. And these deals were structured to reduce the odds that the securities would be converted to common stock and dilute the equity base. To get this nearly free money, the companies had to provide something -- a "put" option, which gives the investor the right to sell the convertible back to the company at a preset price. It was an insurance policy of sorts. The companies thought they were providing the equivalent of flood insurance during a drought -- something they'd never have to pay off. That's because they assumed their stocks (and their convertibles) would resume the merry ascent of the 'Nineties. Two-plus years later, hell and high water have come, and the claims on the insurance are about to be submitted. That is, the puts on many of these convertibles can be exercised in the next two years. As a result, many of these companies either must come up with millions in cash or see their equity severely diluted -- neither of which they had expected. Many of these convertibles were issued mostly by companies that, at the time, had solid credit ratings. Among them: Interpublic Group, Mirant and Tyco International, which since have seen significant reversals of fortune. Dozens of other high-profile companies face nearly $65.5 billion in convertible put options that are coming due between now and the end of 2004. The convertible market, long the lender of last resort for companies that can't find financing at a reasonable cost, provided entree to so-called "fallen angels," including Lucent Technologies, Xerox and Nortel Networks. Convertibles became important financing vehicles when the commercial paper market shut the window to second-tier borrowers as the Nasdaq bubble burst. Now, the lifeline offered these companies in the form of these zero or nearly nil interest convertibles may become a noose for some. Such is the situation of embattled Irish drug maker Elan, which faces more than $1 billion of put options in December 2003 on its $1.64 billion (face value) zero-coupon convertibles due 2018. According to a Lehman Brothers report, Elan has only $600 million in cash and no available revolving credit facilities. The company says it plans to raise $400 million from asset sales by the end of the year. While that may cover the cost of the put, Venu Krishna, head of Lehman convertible research, asks: "Where does it leave the company? They'll have no cash." While Elan could pay the convertible holders in stock, that "signals to the stockholders that the company is in a desperate situation," explains Yaw Debrah, head of U.S. convertible research at Merrill Lynch. "It could put the stock into a free fall." Elan's shares are down from 46 early this year to around two bucks and change after disclosures of accounting improprieties. Its convertibles, rated a highly speculative Caa1 by Moody's Investors Service and an equivalent triple-C-plus by Standard & Poor's, would yield an astounding 52% if an investor were to exercise the put option next year. But that yield reflects the market's assessment of the risk that Elan can't pay as promised. Even higher yielding are the convertibles of Mirant, the debt-heavy energy merchant, with a putative yield to the 2004 put of 78%. <long snip> But Morgan Stanley's Iyer say of Tyco, Solectron and Interpublic: "Because there is some amount of concern about credit quality, these bonds are offering these kinds of yields. For those investors who share my view that these multibillion dollar companies have the commitment and wherewithal to overcome the current market of concerns about their credits, these provide pretty attractive returns." As these puts loom large for many of these convertible issuers, most will be able to pay them off, albeit with varying degrees of difficulty. If you like the company well enough to buy its common stock, their puttable converts may be worth considering. But those issues trading at a supposed 40% to 70% yield-to-put may be a wipeout. Whatever the case, the toll for this supposedly free money has turned out to be steep for these companies. Peter