Convertible Week in Review – 3 June 1999
2
Equity Coverage Reinstated
Federal Mogul 7.0% Pfd.
We are reinstating coverage of Federal Mogul (FMO/$47-
7/16; C-1-1-8) with an investment opinion of Buy. Lack
of clarity in recent results has pressured the share price.
We believe investor concern related to acquisition costs
and revenue growth have been overdone. At 9.9x our
1999 EPS forecast the stock is the best value in our
universe. Our price objective is $71 based on 14.8x P/E,
which is more in-line with comparable suppliers.
Through acquisition, FMO is now the leading independent
supplier with the capability to supply complete sealing and
engine systems. Substantial market share growth potential
exists in engine and sealing systems. FMO has only 5%
and 8% share of global engine and sealing systems content
per vehicle, respectively. The acquisition of Cooper
automotive gives FMO the ability to offer a bundled
package of aftermarket products/brands and achieve sales,
marketing, and distribution synergies. Brake systems are
new potential growth area with FMO's proprietary, twin-disc
technology. Acquisitions and synergy savings support
our near-term EPS growth outlook. New systems contracts
should contribute to EPS in 3-5 years. (J. Casesa 6/2/99).
At $56-3/8, the FMO convert has a 22.4% conversion
premium and a 6.2% current yield. We estimate that this
represents an 0.9% discount to theoretical value, using
model inputs of 40% annualized stock volatility and a
credit spread of 420 bps over the ten year Treasury. Our
one year total return projections are +15.0%/-9.7% in
response to a price move by the common of +/-25%. Hard
call protection extends to 12/6/00 and the issue is rated
B1/B+ by Moody's/S&P. Despite having only a modest
valuation discount, the FMO preferred offers a positive
risk/reward ratio, 1.5 years of call protection and
conversion into a Buy-rated stock. We recommend it as a
relatively conservative way to participate in the anticipated
growth of Federal Mogul. (6/2/99).
Equity Update
Amazon.com 4.75% 2/1/09
Although the Barron's article on Amazon.com
(AMZN/$118-3/4; D-2-1-9) raised few new concerns, we
expect it to contribute to the negative sentiment regarding
the sector in general and AMZN in particular—and cause
further near term weakness in the stock.
Barron's revisited most of the persistent concerns about
Amazon.com, including the lack of profitability, increasing
investments in bricks and mortar, competition, valuation,
and slowing growth. Although all of these are logical
concerns, they aren't new. As previously described, the
only issues that are of real concern to us with regard to
Amazon.com's stock performance are 1) slowing growth
and 2) the challenge of expanding into additional product
categories. We believe that Amazon.com's investor base is
in transition, with momentum investors exiting the stock.
Because we do not expect to see the company's sequential
growth stabilize or accelerate until Q4, we expect this
weakness to continue. (H. Blodget 6/1/99).
Pre-opening, the AMZN 4-3/.4s are quoted at 90-5/8 vs.
$111-1/2 for the common for a 26.8% conversion premium
and a 5.2% current yield. At this level, we estimate that
the bond is 4.6% cheap to theoretical value, using model
inputs of 40% annualized stock volatility and a credit
spread of 540 bps over the ten year Treasury. Our one
year total return projections are +16.4%/-8.0% in response
to a price move by the common of +/-25%. Provisional
call protection extends to 2/5/02 (NC unless the common is
at least $234.08) and the bond is rated Caa3/CCC+ by
Moody's/S&P. Investors will receive a make-whole
payment of $212.60 per $1,000 face amount if the bond is
called during the provisional period. We have included the
AMZN convert in our Convertible Model Portfolio as an
Equity alternative. The valuation discount has increased as
the stock price has come down. In view of this plus a 2:1
risk/reward ratio and our Accumulate/Buy rating on the
stock, we continue to recommend it. (6/1/99).
[FMO] MLPF&S was a manager of the most recent public offering of securities of this company within the last three years.
[AMZN] The securities of the company are not listed but trade over-the-counter in the United States. In the US, retail sales and/or distribution of this report may be made only in states where these securities are exempt from
registration or have been qualified for sale. MLPF&S or its affiliates usually make a market in the securities of this company.
*144A. This security may only be offered or sold to persons in the U.S. who are Qualified Institutional Buyers ("QIB's") within the meaning of Rule 144A under the Securities Act of 1933, as amended.
Opinion Key [X-a-b-c]: Investment Risk Rating(X): A - Low, B - Average, C - Above Average, D - High. Appreciation Potential Rating (a: Int. Term - 0-12 mo.; b: Long Term - >1 yr.): 1 - Buy, 2 - Accumulate, 3 - Neutral, 4 -Reduce,
5 - Sell, 6 - No Rating. Income Rating(c): 7 - Same/Higher, 8 - Same/Lower, 9 - No Cash Dividend.
Copyright 1999 Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S). This report has been issued and approved for publication in the United Kingdom by Merrill Lynch, Pierce, Fenner & Smith Limited, which is
regulated by SFA, and has been considered and issued in Australia by Merrill Lynch Equities (Australia) Limited (ACN 006 276 795), a licensed securities dealer under the Australian Corporations Law. The information herein was
obtained from various sources; we do not guarantee its accuracy or completeness. Additional information available.
Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities or any options, futures or other derivatives related to such securities ("related investments").
MLPF&S and its affiliates may trade for their own accounts as odd-lot dealer, market maker, block positioner, specialist and/or arbitrageur in any securities of this issuer(s) or in related investments, and may be on the opposite side
of public orders. MLPF&S, its affiliates, directors, officers, employees and employee benefit programs may have a long or short position in any securities of this issuer(s) or in related investments. MLPF&S or its affiliates may from
time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this report.
This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific
person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that
statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each security's price or value may rise or fall. Accordingly, investors may receive
back less than originally invested. Past performance is not necessarily a guide to future performance.
Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in securities such as ADRs, whose values are influenced
by the currency of the underlying security, effectively assume currency risk.
Convertible bonds are traded over-the-counter. Retail sales and/or distribution of this report may be made only in states where these securities are exempt from registration or have been qualified for sale. MLPF&S may make a
market in the convertible bonds of this company. To calculate theoretical values and return profiles, Merrill Lynch uses a proprietary arbitrage model to value the convertible as a combination of embedded options. The model is
sensitive to, amongst other factors, the following inputs: stock volatility dividend yield, interest rate levels, and credit spread, all of which we hold constant. Further, we assume a similar discount/premium persists over the entire
investment horizon. Our theoretical valuation in no way constitutes a fundamental opinion, nor does a theoretical discount necessarily constitute a recommendation.
To calculate theoretical values and return profiles, Merrill Lynch uses a proprietary arbitrage model to value the convertible as a combination of embedded options. The model is sensitive to, amongst other factors, the following
inputs: stock volatility, dividend yield, interest rate levels, and credit spread, all of which we hold constant. Further, we assume a similar discount/premium persists over the entire investment horizon. Our theoretical valuation in no
way constitutes a fundamental opinion, nor does a theoretical discount necessarily constitute a recommendation. |
