Article of possible interest concerning bonds.
Coupons Save the Day for 'Busted' Convertibles: Rates of Return
New York, Oct. 13 (Bloomberg) -- As the stocks of companies such as Advanced Micro Devices Inc., PhyCor Inc. and Hilton Hotels Corp. plunge, their convertible bonds offer investors fat yields while they wait for stock prices to rebound.
While convertibles didn't escape the slump that hit stocks and junk bonds, their interest payments kept some issues from falling as much as the stocks they might be converted to. Now, investors say convertibles are a chance to buy bonds with market- level rates and pick-up an option to buy shares for free.
PhyCor's 4.50 percent convertibles due 2003, for example, fell 55 percent since mid-July to 38 and a 31 percent yield. With its stock down 73 percent in the same period to 4 1/2, the option to convert the bonds to shares at $38.67 has little value. When the Nashville, Tennessee company sold the securities in 1996 its stock was $30 and the share option was valuable enough that it paid only 4 1/2 percent on the bonds.
''You're hoping in addition to getting your money back at maturity, you'll receive an attractive yield-to-maturity and a virtually free option to buy equity,'' said Hart Woodson, senior vice president and portfolio manager of Gabelli Global Convertible Securities Fund. ''And if the stock goes up, you get a double benefit.''
To be sure, stocks show scant sign of returning to the July highs, as investors worry that slower world growth will hurt U.S. corporate earnings. And in the junk bond market, yield spreads over Treasuries remain the highest in eight years -- causing convertible bond prices to fall even more, once investors decide the chances to convert to stock are remote.
Terrible Third Quarter
Convertibles weren't spared. Their return in the third quarter was the second-worst performance ever, Merrill Lynch & Co. said in a recent report. With stock prices falling far below conversion levels, one out of two convertibles falls into the ''busted'' category according to Bear, Stearns & Co. A busted convertible bond is one that trades as if it was a pure bond because the embedded equity option is so far out-of-the-money that it's considered broken, or busted.
David White, managing director at BancBoston Robertson Stephens, said there are several convertibles sold only a couple of months ago at par that are now trading at 40 to 50 cents on the dollar. ''Many are priced as if the company is going bankrupt,'' he said. ''For the investor that does their homework, the chance to gain 15-to-20 percent yields is very attractive. And then to participate in any kind of equity rebound to compound those returns over the next three to seven years will be tremendous.''
Advanced Micro Devices
White said he likes Advanced Micro's 6 percent convertibles because they are quoted about 69 for a yield of 13 percent and a conversion premium of about 60 percent. ''The company will be a survivor,'' he said, and when the stock moves up, ''it should move up rapidly.''
The Sunnyvale, California-based maker of computer chips has struggled with manufacturing problems in its flagship line, resulting in four straight quarter of losses. Advanced Micro's stock lost half its value from this year's high of 30 1/2.
While Woodson from Gabelli said the state of the economy is a wildcard in the convertible market, that is no different than the stock market. It makes sense to ''get paid and wait'' for a rebound in stocks, he said.
Woodson said he likes the convertible issues of industrial and aerospace parts suppliers Hexcel Corp. and Coltec Industries Inc. ''These guys have been crushed'' in the stock market, with Hexcel's stock falling almost 60 percent in the past three months. The chance of a takeover may help these companies, he said.
If Coltec is taken over, a change-of-control clause on its 5.25 percent convertible preferred securities gives holders the right to sell the securities back to the company at 50 cents on the dollar, or an increase of about 15 cents from their current price, Woodson said.
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Telephone Companies
He also favors the convertibles or warrants of local telephone carriers WinStar Communications Inc., Intermedia Communications Inc. and ICG Communications Inc. ''They're not cash flow positive, but they will be good businesses,'' he said. What's more, Winstar and ICG raised a lot of money in the junk bond market earlier, so they've funded their capital expenditures for the next couple of years, he said.
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His list of picks also includes convertibles of oil service companies Diamond Offshore Drilling Inc. and Weatherford Enterra Inc.
Greatest Opportunity?
Michael Rosen, portfolio manager at Oppenheimer Funds in New York, is also a fan of convertibles at the current levels.
''This is either the greatest opportunity in the convertible market or the U.S. is going to see more bankruptcies than its seen since 1929,'' he said. ''Some are trading at such extreme valuations, that it indicates the companies aren't going to survive. I'm not saying all of these are stellar, high-quality companies, but many have positive earnings, cash flow and don't face big capital expenditures'' in the near future, he said.
Rosen declined to name specific companies he is buying, but he said he's looking at technology, healthcare and other industries in the midst of extreme change. |
