I like the CETV 3.5% converts due 3/15/13 trading at about 89 for a 9% yield to maturity. There is s a good chance that the company will try to pre-fund the maturity of this convert so the overhang on the stock is lifted.

I spoke to Romana Wyllie, VP corp communications, about the company. They are looking to refinance the convert issue due 3/15/2013 prior to maturity and possibly in the next few months. The converts are the first maturity but current cash is not enough to take out the issue so CETV would have to raise new money. The company expected to be FCF break-even in 2011.

CETV Analysis

Cash = $302m

Subsidiary Debt

CZK 300m facility = $16.6m available; 0 drawn

CZK 1.5B 5.25% credit facility ($85.4m) = undrawn, available with another $54m unsecured bond repurchase

CET 21 €170m 9% senior secured = $237m

Holdco debt (all pari passu)

$475m 3.5% converts 3/15/13= $440m

€207m floaters 5/15/14 = $207m

€440m 11.625% 9/15/16 = $607m

Total debt = $1.49B

Market cap = $1.5B

Net leverage = 11x (estimated 5.3x by end 2011)

CETV operates “free to air” TV broadcast stations and owns content in central and eastern Europe including Czech Republic, Romania, Slovak Republic, Slovenia, Croatia, and Bulgaria. In January 2010, CETV sold its Ukraine operations for $400m. In April 2010, CETV bought a Bulgarian channel from News Corp for $400m. CETV owns the leading TV station in all of its markets except Croatia where it is number 2.

The company’s revenues and EBITDA is cyclical due to its reliance on advertising. Quarterly LTM EBITDA peaked at $349m in 2Q 2008 and troughed at $61m in 1Q 2010. As of 3Q 2010, it was $88m. 2010 was a tough year for the company due to negative GDP growth in half of its markets (Romania, Croatia and Bulgaria), however, all of its markets are expected to grow in 2011 at an average of about 2.5%.

Bank of America forecasts EBITDA to be $202m in 2011 and FCF to be $28m.

CETV has two share classes: 56.9m Class A (one vote per share) and 7.5m Class B (10 votes per share). Time Warner is the largest shareholder with a 30% stake. Ronald Lauder owns a 5% stake; 68% of voting stake.

The TV stations have asset value. The Ukrainian unit was sold for over $300m in early 2010 despite having negative EBITDA.

In October 2010, CETV sold €170m 9% secured notes due 11/1/17. Proceeds were used to repay $160m credit line and repurchase 34.8m converts at 88.25 and €2m floaters at 81.75, €6m of the 11.625 at 102.5. CETV also entered into a new CZK1.5B ($85.4m) credit facility that requires the company to repurchase an aggregate of $100m unsecured bonds.

CETV depends on selling advertising on its channels with about 70% sold forward 1 year. Currently, Czech Republic and Slovenia are seeing positive trends while Romania and Bulgaria are struggling. Bulgaria was -$44.8m ebitda in 2009 but should be positive in Q4 2010, helped by the acquisition.

CETV is expected to generate about $185m EBITDA in 2011. Cap ex should be about $50m. The company’s costs are local content which are more variable and acquired studio content under 2-3 year contracts that are not as variable.

Covenants

The convertible bonds do not have the major financial covenants contained in the non-convertible bonds. However, the convert indenture has a restriction on liens. The non-converts have incurrence covenants but not maintenance covenants. Incurrence covenants prevent a company from taking any action but do not require a company to maintain some minimum ratio to avoid default.

Feb 22, 2001

CETV has completed the privately negotiated exchange of a $206,252,000 aggregate principal amount of its 3.50% senior convertible notes due 2013 for a $ 206,252,000 aggregate principal amount of 5.0% senior convertible notes due 2015 and cash consideration as well as accrued interest on the 2013 notes of approximately $ 30.2M.
• New notes will bear interest at 5.0% per annum and will mature on 15-Nov, 2015
• New notes will be convertible into shares of Class A common stock upon the occurrence of certain specified events based on an initial conversion rate of 20 shares of CME’s Class A common stock per $1,000 principal amount of notes (which is equivalent to an initial conversion price of $50 per share of CME’s Class A common stock)
• New notes will be jointly and severally guaranteed on a senior basis by two of CME’s wholly-owned subsidiaries
• New notes will be secured by a security interest in shares of these two subsidiary guarantors

June 24, 2011

Central European Media Enterprises announces exchange of senior convertible notes due 2013 for senior convertible notes due 2015 ($19.76)
• Compnay announces an agreement to repurchase, in privately negotiated transactions, $52.3M aggregate principal amount of its 3.50% senior convertible notes due 2013 (the “2013 notes”). In exchange for their 2013 notes, holders will receive $52.3M aggregate principal amount of 5.0% senior convertible notes due 2015 (the “2015 notes”) and $4.6M in cash, including a net interest payment in respect of accrued interest on the 2013 notes and the 2015 notes.
• Company initially issued $206.3 million aggregate principal amount of 2015 notes 18-Feb. The 2015 notes pay interest semi-annually at 5.0% per annum, mature 15-Nov-2015, and have an initial conversion price of $50/share.

Conclusion

This trade performed well, as CETV pushed out $260m of the 3.5% converts to 2015. There are now only $130m of the converts remaining which is very manageable for the company. The 3.5% converts traded up to 96 after the announcement of the first exchange for a three month return of about 9%.

June 1, 2010

LDK has $400m of 4.75% convertible bonds with a put on 4/15/11 trading at 79 for a ytp of about 35%. I think this is an attractive yield. The company’s main problem is that it has too much short term debt ($980m) but my analysis shows that they should be able to take care of these through a combination of extending the loans, issuing new equity, and selling additional interest in their polysilicon plant.

The company has $384m cash (plus another $70m restricted), $980m of short term debt, $400m converts, and $450m of long term debt, for a total of $1.7B. This equates to a debt /equity ratio of 170%, which is too high. A better ratio would be to bring it down to 100%. To do this, the company could raise $300m in new equity and sell another 35% of its new poly plant for about $400m and push out $680m of short term debt. Given that the debt overhang is keeping a lid on the stock, the near term business environment is improving, and the financing markets are wide open (ESLR $1.20 stock just did a $175m convert), I think LDK takes steps to fix its capital structure sooner than later.

Ownership & structure
Xiaofeng Peng (CEO) owns 67% of the stock. LDK was incorporated in the Cayman Islands in May 2006 by Xiaofeng Peng to acquire Jiangxi LDK Solar from Suzhou Liuxin. In 2009, the company sold 15% of its Polysilicon project for $220m to Jiangxi ($1.5B implied value). Analysts said the company is looking to sell another 35% stake to reduce its ownership to 50%.

LDK is the holding company with two main divisions 1) LDK Silicon (polysilicon) 2) LDK Solar (Wafer, cell, module).

Bankers
LDK’s bankers are Agricultural Bank of China, Bank of China, China Development Bank, Export-Import Bank, Huarong Int’l, and several domestic Chinese banks. I could not find any detailed information on the loan terms.

Given that in early April 2010, China Development Bank gave Suntech Power STP a $7B credit line and Trina Solar TSL a $4B credit line, it appears that the Chinese Banks are very supportive of the solar industry, which is becoming a very important export market. I see no reason why China Development would not extend the loans to LDK. Xiaofeng Peng is a powerful figure in China and owns 67% of LDK.

By comparison, LDK had 2009 sales of $1B, STP had $1.7B, and TSL had $850M, so it would not be a stretch for the Chinese banks to extend maturities of $1B to LDK.

Recovery value (rough estimate)
In case LDK has to file for bankruptcy, I see the recovery value for the bonds at 25%. LDK’s polysilicon facility has a $1.275B value based on the recent transaction. The rest of LDK’s business is similar to that of ReneSola (SOL), which has a $1B enterprise value (LDK is about twice the size of SOL but I will be conservative). That gives a total value of $2.275B or $1.82B if discounted by 30%. That leaves $100m available to convert holders after paying the banks $1.43B and $290m for trade payables and admin costs. This is also assuming that the company burns through its existing cash.

Solar supply chain
The solar supply chain has 5 basic steps: 1) Polysilicon, 2)Wafers, 3) Cells, 4) Modules, 5) Systems. Solar begins with the manufacturer of polysilicon which are made into wafers, which are then processed into cells. The cells are grouped into an electric array, and assembled into weatherproof modules that can easily shipped and installed by specialized system integrators on site.

LDK began as a manufacturer of Wafers but has now also ramped up production of Polysilicon. LDK has 2.0 GW wafering capacity, the world’s largest (10.8% share), 6,000 MT (18,000 MT by end 2011) of polysilicon manufacturing capacity, and 600MW of module manufacturing capacity.
Currently, the bottleneck is in the Wafer part of the supply chain, which is LDK’s main business. This supply constraint is leading to better pricing for wafers, which greatly benefits LDK.

Properties
In the last two years, LDK has spent about $2B on capex to build out its plants, most of which are the low cost producers, so there is a lot of value in these properties.

15,000 MT polysilicon plant “Ma Hong”
3,000 MT polysilicon plant “Xia Cun”
2.0GW ingot, wafer and cell plant
Solar Cells – plans for 3Q10 start (240MW by end 2010)
LDK Solar Module – Nanchang plant, Suzhou plant (1.5 GW capacity expected end 2010)
50% JV with Q-cells for 42MW system
Pipeline projects : Systems in Italy, France, Germany, Spain

Solar industry
In 2009, the leaders were Germany 40%, Italy and Czech Republic (combined for 23%), Other Europe 10%, US 10%, Japan 8%, Rest of world (11%).
In Germany, there is a feed-in-tariff, which requires utilities to buy electricity from solar power generators at a high fixed price (20 year contracts). There will be a 15% cut to subsidies on July 1, 2010 so there is a fear that we may get a drop off in demand. However, many German projects are being pulled into 1H10 (to lock in better contracts) causing a surge in near term demand and capacity constraints in parts of the supply chain. Due to the constraints, some projects that are not related to German subsidies are being pushed into 2H2010. Combined with potential pull-ins into 2H2010 from 2011 from other counties whose subsidies get reduced on January 1, 2011, the order book for 2H 2010 is filling up quickly. There are many bears that think demand will fall off a cliff after July 1 but evidence is quickly contradicting that theory as some companies are now sold out through October 2010. As the near term environment improves, LDK will have more opportunities and flexibility to refinance its debts.

It is also possible that China could enact some kind of National feed in tariff (2010 or 2011), in which case the solar industry would benefit greatly.

Risks
1) A sharp downward move in the Euro. This could have be negative for demand in Europe.
2) A sharp rise in the Renminbi. This would be negative for LDK because it would make them less competitive with non-Chinese rivals.
3) Problems with their polysilicon facility in terms of production. SO far, all signs indicate that the new plant is running smoothly.

June 29, 2010

I spoke to Jack Lai, CFO of LDK today. These are the key points.

1) The company has $384m in cash but $980m in short term debt and $400m in converts due 4/2011. There is another $450m of long term debt. Jack says there is usually about $200m due every quarter. In the past, they have extended the loans every quarter. The loans are all from Chinese Banks who are very accommodating to extensions.

2) Jack is currently working with bankers on a potential IPO of its 85% owned poly silicon plant. Based on LDK’s sale of the initial 15% stake, the remaining 85% is valued at $1.275B. LDK would likely keep 50% and sell off another 35%.

3) Jack is aware that there are $400m converts due 4/2011. He expects the company to generate some free cash from now to the end of the year and he will use that to buy back some converts in 2010 before addressing the rest when it matures.

4) Jack says he is working on a credit line similar to what STP and TSL got. STP got a $7B credit line and TSL got $4B. Jack feels that he can get something similar.

5) Near term business is good. Germany is pulling forward business but 2H order book is filing up. They are sold out through October. Wafer pricing is 80c, firming.

August 16, 2010 -converts trade up to 91 following good report

LDK ended the quarter with $443m cash and free cash flow of $25m (cash flow from operations of $152m and capital expenditures of $127m). Wafer prices have been moving up given strong demand in solar that will probably continue to be strong at least through year end.

The company has $1.1B short term bank borrowings, $400m of converts, and $487m of long term borrowings. LDK’s plan is to continue to convert the short term loans into long term loans, which they have had no problems doing.

Given the cash on hand of $443m and now the company is FCF positive, I am more comfortable that LDK can take out the convert due 4/2011 fairly easily. It probably needs to raise about $200m to be in a good position.

LDK’s plan to raise cash is the following
1) They are in final staegs of discussions to expand its line of credit with state level institutions
2) The are negotiating with potential investors for a placement of common stock,
3) Look to provide a dividend to the holding company in cayman islands from the chinese operatiing company.

On the business side, wafer prices are going up in 3Q and 4Q. The spot market is not $1 per watt, higher than the 85c in the second quarter, Non silicon costs for the wafer busines sis 31c per watt, targeting 25c in six quarters.

They also see a big increase in poly prices and continuing to increase in the next few months. Currently, they see $60 but could go up to $80 or even $100 if demand continues to be strong. ABout 40% of LDK’s poly is going to the market and the rest being used in-house

September 16, 2010 – Converts trade up to 94.5

I spoke to Jack Lai, CFO of LDK about the converts due 4/1/11. He said the company is in negotiations to sell a stake in the poly plant for between $150m and $200m and that the deal should close within the next 30 days. LDK’s plan is to use this cash to buy back half the issue before the end of the year. The company then plans to retire the other half in early 2011 with the proceeds from a stock sale or other fund raising.
LDK currently has $443m in cash and $126m in short term pledged deposits. However, the company would like to keep this money at the company to finance potential future expansion. So to retire the convert, the company wants to raise new money.

On the business front, Jack says business is very strong for Q3 and visibility into Q4 is good as well. Contract pricing for wafers is about 85c for Q3 and Q4. This would likely drop by 10% in 1H2011. Spot pricing is higher at 90c to $1. (this is very good pricing)

The order book for Q1 is building in terms of volumes although pricing is not yet set. While most of the street is bracing for a drop off in 1Q, he says weakness in Germany is being replaces by strength in Japan, China, California, UK and France.

I believe that LDK is close to a fund raising deal and the converts, which trade at about 94, will move to the 97-98 range when a deal gets announced.

September 27, 2010 – Converts trade up to 97.5

LDK announced that it entered into a strategic financing agreement with China Development Bank for up to 60B RMB ($8.9B US) of credit facilities to LDK Solar over a year period. I spoke to Jack Lai, CFO, today and he confirmed that the company can use this credit line to retire the 4.625% converts and other short term debt. Jack sees the converts trading at 98 today and says he is looking to buy chunks of bonds (10-15m at a time) back in the open market opportunistically. He wants to cut down as much of the issue as possible. I would not rule out an early tender. Jack says he is watching the stock price and may look to sell equity if the price is right. He is also continuing to negotiate a sale of their poly plant and should be in a better bargaining position given the new Chinese credit facility.

Near term catalyst

On 3/19/10, GY amended their credit agreement to allow the company to refinance their outstanding unsecured bonds. The agreement allows GY to issue up to $438m in debt but the company has to use the proceeds to retire either the term loan or the unsecured bonds. In exchange, GY will pay L+325, 100 bps higher than the old rate for the term loan. We bought some 2.25% bonds at 92.75 (7% yield to put 11/20/11). We feel that the company is likely to take action to refinance either the 2.25% converts or the 9.5% straights, which could lead to a tender offer for the 2.25%.

I feel very comfortable about GY credit. The company is a defense contractor with long product cycle including a funded backlog that covers 1 years worth of sales. The company is free cash flow positive, fresh off a Moody’s review for upgrade and a credit agreement amendment

GY Analysis

Cash = $158m

Term loan due 2013 = $51.5m drawn ($75 capacity)

Revolver = $65m undrawn

Letter of credit = $85m drawn ($125m capacity)

2.25% sub convert due 11/20/11 = $132m

9.5% sub straights due 8/15/13 = $75m

4.0625% sub convert due 12/31/14 = $200m

Total debt = $477m

Environmental remediation and postretirement liabilities = $520m

GY should generate about $140m EBITDA in 2010 for a leverage of 3.4x.

EBITDA/Interest expense is 5.3x. These metrics are consistent with a BB rating. Moodys currently rates it B3, on review for an upgrade.

Business

GY is a manufacturer of aerospace and defense systems with a real estate segment. Aerospace  includes Aerojet-General, which makes propulsion systems (mostly for missiles) for defense and space applications. GY is one of the largest providers of such propulsion systems in the US. Customers include the major prime contractors (LMT, RTN, BA) to the US government, the department of defense, and NASA. GY also owns about 12,200 acres of land adjacent to US Highway 50 east of Sacramento. GY is seeking to change zoning rules to optimize its value. The land is estimated to be $200m at the low end.

Aerojet has been an industry leader in propulsion systems for 60 years. It is the only domestic supplier of all four propulsion types – solid, liquid, air-breathing, and electric. Competitors include Alliant Techsystems (solid, air), American Pacific (liquid, electric), Astrium (solid, liquid), Northrup (liquid), Pratt & Whitney (liquid, air, electric) and SpaceX (liquid). Aerojet is number 2 in solids behind ATK and liquids behind Pratt.

Prime contractors Raytheon and Lockheed Martin account for 31% and 26% of 2009 sales, respectively. About 51% of sales were fixed price contracts, 37% from cost reimbursable contracts, and 12% from other sales. Many products have life cycles of over 10 years. These contracts are initially small during the development phases that can last two to five years, followed by low-rate and then full rate production.

GY’s funded backlog is $811m and unfunded backlog is $379m. Funded backlog is the amount of money that has been directly appropriated by the US congress and unfunded backlog is the amount for which funding has not been appropriated.  GY’s annual sales are $800m, so funded backlog covers 1 year of sales. Most of GY’s R&D are funded by customers so the company does not have much R&D expense.

Steel Partners owns about 7% of the company and in the past have pressured the company to make strategic changes. On January 6, 2010, the company appointed a new president and CEO Scott Seymour from Northrop Grumman. In December 2009, Moody’s placed GY on review for upgrade from its current B3 rating.

March 26. 2010

Met with GY management today.

The company has $230m in cash (there is $30m restricted that has to be used to buy back debt). The 2.25% converts are the next maturity $132m. The company just amended their credit facility so that any new proceeds from a debt issue have to go directly to repaying debt. The company says they are looking hard at all options and reducing debt remains their top priority. GY hired a new CEO about 6 months ago and I believe he would like to right size the capital structure as soon as possible. This includes terming out maturities to give the company a more stable debt structure.

Prior to the credit agreement, the company could only issue a bond that had lower coupon than the debt that they were retiring. This restriction is now gone. Also in the prior agreement, GY was only able to buy back $10m of bonds. Now they can buy use any cash to buy back bonds as long as their net debt leverage ratio is below 3.0x. It is currently below that.

GY has a backlog that covers 1 years of revenues and about $20m FCF per quarter. GY is a defense company that makes missiles for government programs. They have long product cycles and 1 year visibility into their order book.

Conclusion

GY never did tender for the 2.25% converts or do a large buy back. Instead, they will wait until maturity. However, the trade still worked as the bonds traded up to 98 from 92 in just a few short months.

NIHD 2.75% converts with a put in 2010 are attractive. 157.375 vs. $71.75 conversion  price $50. 14.11pts/9.85% premium. Using credit of L+150, get bond floor of 90. Crosses par 2.75% up 25%…iv 38.7. We have definitely seen a volatility spike in this name. Currently, 1/09 50 calls 44.21-48.8 vol and 1/09 50 puts 44.31-48.71. vol 1/10 50 calls 42.42-51.8 vol 50 puts 40.47-49.46 vol although not much liquidity.

Business Description

NII Holdings (NIHD) is a cell phone operator of Nextel’s push to talk technology inLatin America. The company generates their sales and EBITDA in the following countries.

NIHD’s customers are high-end business customers with average monthly price per user (ARPU) of $58, compared to $14 for its peers. The company’s churn rate (loss of customers) is also very low at 1.6%. Along with subscriber growth, ARPU and churn are the three most important metrics to gauge the health of the company.

NIHD’s customers are 100% business users and 100% postpaid, which gives the company a strong credit, low turnover, customer base resulting in steady revenues and cash flow.

The company is the only company to offer push to talk technology in its regions but indirectly competes with bigger, more established cell phone companies who cater to the mass market. InMexico, NIHD competes with Telcel (owned by America Movil) and Movistar (owned by Telefonica Moviles). InBrazil, competitors are Vivo (owned by Telefonica and Portugal Telecom), TIM (Telecom Italia), and Claro (America Movil). InArgentina, competitors are Movistar (Telefonica) Personal (owned by TelecomArgentina) and CTI (America Movil). InPeru, competitors are Movistar (Telefonica) and America Movil.

Volatility

The stock has moved 2-6% in the last few earnings reports. In the last two months, realized vol. has picked up due to its exposure to emerging markets.

Risks

1) NIHD operates in emerging market countries with big exposures toMexicoandBrazil. Any economic problems in these countries could lead to customer defections.

2) It is worth noting that NIHD was in bankruptcy in 2001 before emerging from bankruptcy in November 2002. Back then, the company was saddled with high levels of debt from buying spectrum and building out the network and had a much smaller customer base. Since then, cell phone penetration has to nearly 70% in their served regions and spectrum and network needs are minimal.

3) NIHD needs to continue to provide good service and execute well on its business plan. Any significant service problems could cause users to go to competitors.

Financials

At $76, the company’s market cap is $13B.

NIHD has $1.4B in cash and the following debt

$1.2B NIHD 3.125% due 2012

$350M NIHD 2.75% with a 2010 put

$450M Mexican syndicated debt

The company turned FCF positive in 1Q2007. For the full year 2007, NIHD is expected to generate $100M in FCF, going up to $350M 2008.

We are using 150+L for the converts with 2010 put (3 years). NIHD is not rated but credit metrics show that NIHD is in the BBB range.

Recent events

On April 10, 2006, BOL announced that it was voluntarily suspending shipments of its Renu lens care solution pending an investigation. EYE could benefit from picking up most of the $45m of Renu sales plus sales of other BOL eye care products that the consumer may switch away from. EYE was up 6% on the day and could see more volatility as this issues sorts itself out.

EYE reports 1Q earnings on 4/27/06 before the open.

Business

EYE was formed after Allegan spun off its contact lens care and surgical business unit to become a “pure play specialty pharmaceutical company” in mid 2002. Allegan had been enjoying exceptional growth in its core Botox and high-margin ophthalmologic pharmaceuticals business, seeking to remove the slower growth EYE business. After the spin-off, EYE acquired Pfizer Surgical for $450M in mid-2004 and VISX for $1.3B in mid 2005.

EYE’s current product breakdown is

Ophthalmic surgical (Cataract, Refractive) – 52% of sales, 8% growth

This segment can be broken down into Intraocular (IOL), Viscoelastics, and Phacoemulsification produts. EYE is second with a 30% market share. Alcon is first with  50% share,

Laser Vision Correction – 21% of sales, 6% growth

The FDA approved laser eye surgery in 1995. The number of procedures peaked in 2000 and then began to fall off with the economy soon after. The procedure is economically sensitive since most patients pay out of pocket not through a third party insurer.

EYE’s Star system is the market leader with a 60% share in theUS. Alcon is second with 20%, followed by Bausch & Lomb at 10% and Nidek at 8%.

Eye Care – 26% of sales, 3% growth

This is a mature segment

Credit

EYE is rated B+ by S&P which implies a credit spread of 250 to 300 over libor.

EYE has $40M in cash and $560M in debt. The debt consists of $27M of 3.5% converts with a 4/08 put, $350M of 2.5% converts with a 1/2010 put and $150M of 1.375% converts with a 7/2011 put.

Business

PDLI has two revenue streams 1) Royalties (55%) and 2) Products (45%) but the stock trades more with Royalties because this revenue stream is much more valuable.

The company collects Royalties on 7 drugs that are on the market. These drugs use a PDLI patent technology called Humanized Antibodies.

PDLI collects 3% royalties on all drugs except for Zenapax, for which it collects 15% royalties. There are another 40 drugs in development that use PDLI technology. Tysabri will be the 8^th drug on this list. In March 2005, PDLI stock dropped 25% when Tysabri was pulled form the market.

PDLI also gets sales from products targeting hospitals.

Credit

I would use 250 over L for PDLI. The company has $284M in cash and $500M in debt The debt consists of $250M 2% converts due 2012 and $250M 2.75% converts due 2023 (2010 put).

PDLI is expected to be $27M FCF positive in 2006 after burning $11M in 2005. The credit is solid because of the company’s business model. PDLI collects a growing but steady revenue stream from royalties where there is no associated fixed cost. The company uses all of its cash on R&D but that cost is easy to cut back during bad times.

The biggest risk to the credit would be if PDLI makes an acquisition. The company acquired privately held ESP Pharma in early 2005 for $500M. All indications are that PDLI will not make another larger acquisition because it will take a couple of years to integrate the ESP.

Other risks include patent challenges to its technology or failures of one of its drugs. The company’s patent position is solid and should not be an issue. Failure of any one drug will not have a significant effect on its business because the company is diversified.

Volatility

PDLI stock could experience big moves in several ways. 1) Big move in biotechs 2) Sales upside/downside from drugs for which it collects royalties 3) Sales upside/downside of its own drugs 4) News on its pipeline drugs.

When Tysabri was pulled from the market in March 2005, PDLI was down 25%. In the past week, when the biotech index dropped 5%, PDLI dropped 8%. Because the business is diversified and contains very little fixed costs, most volatility events will probably not lead to a significantly wider credit.

On the downside, PDLI pipeline drugs are in Phase II development and will not have any volatility events until late 2007. Upcoming events include earnings on May 2 and analyst day on May 5.

Summary

I would use 350 over Libor as the spread for the $350M HLTH 1.75% convert bonds that have a 6/15/10 put. These are subordinate to the company’s $300M 3.125% convert bonds that have a 9/1/2012 put (I would use 275 for these).

I am comfortable with the credit for the following reasons:

1) At the end of 2005, HLTH will have $420M in cash and $1.9B in shares of its 85% stake in WebMD (WBMD), giving it significant liquidity. HLTH’s only debt are the two convertible securities ($650M). The company completed a stock tender offer for $500M in December 2005, partly because management is confident in its cash position and decided to lever up.

2) HLTH generates mostly recurring revenues, which gives it a steady and predictable cash flow. 57% of sales come from transaction processing where the company earns a fee for each transaction. Another 24% sales is from software license and maintenance, which is also steady.

3) HLTH is expected to generate between $100M and $150M in annual FCF for the next few years.

4) The main risk is that the company has historically made large acquisitions, having spent $70M in 2005, $200M in 2004 and $330M in 2003 on acquisitions. The company has not been able to grow much organically (5% growth) so it may continue to buy companies. HLTH is also on the small side with a $3.3B market cap

Financial Ratios

HLTH is not rated by the agencies. Its EBITDA/Interest ratio puts the company in the BBB range while its Debt/EBITDA ratio puts it in the B range. Given the company’s positives (steady business model and good liquidity) and negatives (acquisitive, small market cap), I am comfortable with a 350 spread.

Business

HLTH operates four units: WebMD portal (85% owned; 13% of revenues), Emdeon Business Services (57%), Emdeon Practice Services (24%), and Porex (6%).

HLTH spun off a 15% stake in WebMD portal (WBMD) at $15 in September 2005. The stock moved up to the current price of $40, which values HLTH’s stake at $1.9B. WebMD has stable revenues by selling advertising and sponsorships on WebMD.com (for consumers) and Medscape.com (for Physicians). The company generates good, steady cash flow from operations. HLTH has no immediate plans to sell its remaining stake but it could reduce its stake by selling shares to raise cash if needed. 

Emdeon Business Services transmits electronic transactions between healthcare payers and physicians, pharmacies, dentists, hospitals and other providers. The company is dominant in the physician market, strong in hospitals and number 2 behind NDC Health in pharmacies. The unit generates revenues by selling transactional services either per transaction or fixed monthly fee. The growth potential is from low penetration from physicians with only 40-50% of physician claims being submitted electronically compared to 100% of pharmacy and 80% of hospitals. This unit generates steady revenues and cash flows.

Emdeon Physician Services develops and markets information systems for healthcare providers. The unit generates revenue from one-time fees for licenses to software modules and recurring fees for maintenance. The software allows physicians to keep record of patients, manage accounts receivables and use Envoy to connect to providers. Sales have been disappointing but HLTH hopes that a new integrated product the connects with outside databases will drive sales in 2006.

Porex is a totally unrelated business that develops plastic components used in healthcare, industrial and consumer applications. This unit is valued at $168M on 7x EBITDA if HLTH decides to divest it.

Takeover risk

HLTH is not likely to be acquired although the situation needs to be monitored. The argument against a takeover is that Chairman Martin Wygod who owns 3% of the shares and has considerable influence on the board, is not open to selling the company. The argument for a takeover is that the stock hasn’t done much so activist shareholders may want to extract value from the company. However, HLTH’s recent $500M stock tender offer in December 2005 has satisfied shareholders in the near term.

For the 1.75% converts, we would only get hurt on a cash takeout over $13 (currently $9.60).

Summary

The 5 year CDS for the convertible issue was quoted at 325/350. I believe that the spread could tighten by 50bps to 275/300 within the next 12 months. Qwest generates strong and steady cash flows of about $1.1B per year and management is committed to continue to reduce debt and return the operating company to investment grade. Maturities of debt in the next 5 years are manageable at $5.5B.

Business

Qwest Communications consists of a regulated local telephone business (US West) and unregulated wireless and long distance businesses (Classic Qwest). The local business operates in the 14 state region of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington and Wyoming.

The local business generated 75% of the company’s revenues and over 100% of the cash flow. The unregulated businesses derive 25% of total revenues and consumes about $300M of cash per year although it is expected to be breakeven in 2006.

Positives

• The local business is a solid and steady cash flow generator.
• Qwest has been conservative with its local fiber network build-out and using excess cash to reduce debt.
• The local business operates in mostly rural areas of the US that face less competition from CLECs and Cable companies.
• Qwest finally settled its shareholders lawsuits. The settlement gave Qwest visibility of its cash needs and thus allowed Qwest to reduce its cash balance from $2.8B to $800M to repay debt.

Negatives

• The unregulated businesses continue to be a drag on cash flow.
• The local business continues to lose access lines to wireless and cable.
• Qwest may need to accelerate its capex spending for new technologies including a local fiber network build-out.
• Unlike other RBOCs, the company does not have its own wireless assets (hurts growth) or directory business (hurts cash flow)

Capital Structure

There are four entities in the Qwest Capital Structure.

1)      Qwest Regulated Operating Company (Old US West) – OpCo

2)      Qwest Holding Company – HoldCo

3)      Qwest Financing Company – FinCo

OpCo (QUS) debt ($7.8B) has the best credit because it is closest to the operating assets. Holdco is next with has two classes of debt: $2.6B that is secured by OpCo and $1.2B that is unsecured (includes converts). FinCo debt totals $3.7 and is pari passu with the Holdco unsecured notes.

Cash and Cash flow

Cash = $850M

FCF4Q2005E = $125M

FCF2006E = $1,300M

FCF2007E = $1,100M

FCF2008E = $1,100M

Debt = $15,737M

Equity = $8,300M

Debt details

 More thoughts on Qwest – 11/29/05

I continue to like Qwest credit for the convertible bonds (5 yr). Earlier, I looked at Qwest’s cash generation and determined that it was strong enough for the company to continue to de-lever and retire maturing debt. Here, I look at the asset value of Qwest based on the value of access lines and concluded that access line valuation provides strong debt coverage.

Qwest has two businesses: 1) Local telephone access lines (Old US West) and 2) Long distance assets (Classic Qwest).

The local telephone business has 15,000 access lines in the Pacific Northwest and Rockies section of the U.S. consisting of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington, and Wyoming.

Over the last few years, access lines have been mostly sold by RBOCs and bought by independents and private equity groups. Last week, Alltel said that there were 3 bidders (Citizens, CenturyTel, Valor) that would pay up to $3,425 per line ($10B total). Other deals valued access lines at between $2,334 and $3,500 per line.

The value of access lines depend on many factors including location, customer base, technology (DSL ready or not), physical condition. By all accounts, Alltel lines are at the top of the list since they serve non-competitive regions, are in top condition, and have good technology. The lowest valued deal in recent years was Carlyle Group’s acquisition of Verizon’s Hawaii operations of 790k lines for $1.65B ($2,334 per line) mainly because those lines were geographically isolated and were not in good condition.

Given Qwest’s total debt of $17B and 15,000 access lines, even a very conservative $2,000 per line estimate ($30B) would cover its entire debt. The risk is that access lines are declining at between 5%-10% per year due to cable telephony and wireless substitution. The goal for management is to offer enough new services such as DSL or Video to offset lost revenues.

The market value for Qwest access lines are probably in the $2,700-$2,800 range. In general, Qwest has the benefit of operating in many rural areas that have limited competition from cable and CLECs. However, Qwest has not invested enough to deliver DSL to its customers. Its penetration of 9% is the lowest among the RBOCs.

Given this valuation cushion, the 5 year credit for Qwest is very safe. It is the longer term debt (20-30 years) that carry the most risk.

The equity is assigning a negative value to Classic Qwest. At $5.20, Qwest has an Enterprise value (Equity + debt – cash) of $24B. At $2,000 per line, the market is assigning -$6B to Classic Qwest. While this was justifiable when Classic Qwest was losing billions per year, the cash drain is down to $150M per year. THis implies there is upside to the equity to $6.80 should Classic Qwest be valued at zero.

Additionally, Classic Qwest should see experience a better pricing environment in 2006 following SBC acquisition of AT&T and Verizon’s purchase of MCI. All indications are that SBC and VZ will manage the business for profits rather than market share, which should put a pricing umbrella over other players such as Qwest, Sprint, Level 3, and others.

Summary

I would use 200 over L as the credit spread for the convert, which has a 5 year put. The credit risk is low because SY’s software maintenance fees produce a sizable annuity-like cash flow. The primary risk is that management makes big acquisitions with that cash, which is why I am conservatively using a 200 spread. Key points are:

 1)  SY has $780M in cash and $460M in debt, a comfortable cash cushion. Additionally, the company generates a fairly consistent FCF of about $100M-150M per year. Their business model allows them to collect an annuity-like revenue stream from existing customers.

2)  SY is down to 3% market share for new license database sales, which makes it difficult for the company to compete with the scale of IBM (36% share) and Oracle (30%). However, SY has a large customer base that is willing to pay a maintenance stream for support and upgrades.

3)  The major risk for the credit is the company’s plans to make acquisitions with its $780M cash position and on-going FCF. Analysts believe management is looking to use about $200M for acquisitions over the next few years, which is a manageable number. The risk is that management decides to make larger acquisitions.

4)  Software companies typically like to maintain a sizable amount of cash on the balance sheet to show customers that they will survive long enough to support the software. It is unlikely that SY will move to a positive net debt position by spending too much on capex, R&D or acquisitions.

5) According to Sudeep, we can make 4.75 points if SY were to be acquired at $25 by March 2006. Possible acquirers are Oracle and IBM.

Business Profile

Sybase operates two divisions: 1) Enterprise Database (82% sales) 2) Wireless Middleware (18% sales)

SY’s database product is called Adaptive Server Enterprise (ASE), which began life as Sybase SQL in 1987. The product was one of the first relational databases that was capable of high-performance transaction processing but has lost considerable market share to Oracle and IBM over the years. Its share now stands at just 3% (based on new license revenues), although its maintenance revenues are considerable due to a large installed base accumulated over the many years that Sybase was a market leader.

ASE is sold on a license/maintenance model where a customer pays a license fee for the initial software implementation and a 20% annual maintenance fee for the right to receive support and upgrades. Like many other mature software companies (CA, NOVL, SEBL), SY lives off this annuity-like maintenance stream that their customers are willing to pay due to high switching costs. The company then funnels this cash to invest in the high growth Wireless Middleware products. Revenues for the database group are declining in the 3%-5% range.

Wireless middleware is a group of software products used on wireless devices. Sybase assembled these products through acquisitions of AvantGo and XcelleNet. This division is growing revenues in the 15-20% range.  

Capital structure

At the end of 3Q2005, SY had $783M in cash and $460M in debt (all converts). The converts have a put in March 2010.

Cash generation

SY generated $135M in FCF over the last 12 months. The company has generated over $100M FCF per year in 5 of the last 6 years. SY has the ability to generate significant cash due to its annuity-like maintenance stream of cash that is receives from its customer base.

Strategy

The company’s strategy is to use its $780M cash war chest and its on-going cash flow to make acquisitions in the Wireless Middleware space. The company is likely to spend $100-$200M on acquisitions over the next couple of years. Management would like to maintain a negative net debt position to make customers feel comfortable about the company’s long-term survivability. Customers want to be sure that a software supplier will be around for the long-term before committing to a purchase. 

Customer base and switching costs

Wall Street accounts for about 50% of SY’s database revenues. These firms have considerable switching costs through the use of Sybase’s stored procedures, which embed application logic in the database and are coded in Sybase’s proprietary language, Transact-SQL.

While switching costs are high for existing applications, customers rarely start new projects with Sybase. They prefer to use Oracle and IBM, who leverage their scale to invest in new features and functionality.

Potential Acquirers

SY could be attractive to strategic acquirers who can exploit the company’s high growth wireless products or large customer base. Both Oracle and IBM has a history of buying mature software companies for their installed base. In 2001, IBM acquired Informix for $1B in cash. In 2005, Oracle bought PeopleSoft for $10B in cash. Both deals were made to get the acquired company’s installed base. Management has not been openly shopping itself but they would likely be receptive to any reasonable offers.

Equity valuation & volatility

SY trades at 16X 2006 EPS of $1.22. The stock price is driven by the growth prospects of Wireless Middleware and to a lesser degree the database product. There is opportunity for some big gap moves on the stock because software companies tend to have lumpy quarters for bookings due to large license deals.

Risks

Sybase makes a big acquisition with its cash.

Management has communicated that it wants to make acquisitions in the Wireless Middleware segment. SY has made 3 large acquisitions in the last 5 years. In 2001, the company bought New Era of Networks for $340M in stock. In 2003, SY purchased AvantGo for $41M in cash. In 2004, the company acquired XcelleNet for $93M in cash. The primary risk is that SY will use more than several hundred million on an acquisition that could deplete their cash balance.

Existing customers migrate away from Sybase more quickly than expected

While it is not likely that existing customers will move away from Sybase due to high switching costs, there are scenarios where it would make sense for the to do so. Companies will switch database vendors if they upgrade an application that requires new functionality. However, even a fast declining installed base would likely not lead to risk in the near term (5 years).

Summary

The FEIC 5.5% converts due 8/15/08. trade at 100.375. The main risk for this position is FEIC’s credit risk. I reviewed the company’s business and financials and have concluded that the credit is solid.

Positives for the credit are

1) the company has $276M in cash and $220M in debt.

2) FEIC is expected to generate $30M FCF in 2H05 and about $80M in 2006

3) The company is looking to buyback the expensive 5.5% convert in the near future.

4) The company has a new product cycle and its major end market (semi) is in the beginning stages of an upturn.

Credit

FEIC has $276M in cash, $150M in 0% converts with a 6/15/08 put and $70M in 5.5% converts due 8/15/08. Both convert issues are subordinated. The company is expected to generate $30M in 2H05 and about $80M in 2006. The company has already bought back $105M of the 5.5% issue and plans to buyback the remainder at some point in the near future. The company is rated B+ by S&P.

The main risks for the credit are 1) The company makes an acquisition. 2) New products fail 3) Semi cycle is short-lived.

FEIC is unlikely to make an acquisition. The company brought in a new management team over the last year and they like the company’s existing portfolio and plan to focus on the current new product launch and improving gross margins. The company’s main new product is the Titan electron microscope which is the best in the market and already has several pre-launch orders. There is risk that the semi cycle could turn down unexpectedly but FEIC should still benefit from the technology investments that come during downturns. FEIC is expected to be FCF positive during the next downturn, which will likely be in 2007.

Business Segments

FEIC sells high resolution imaging tools including electron microscopes and focused ion beams. These products are sold into three key markets: Semiconductor 47% of sales, Industry and Institute 46%, and Data Storage 7%. FEIC is in beginning stages of a new product cycle with their TITAN transmission electron microscope, which is expected to sell 20 units in 2006 at an ASP of $4M. Early buyers include a Mexican Oil company for their material science unit and Samsung for their 65nm line.

Industry & Institute

Customers include universities, public and privately sponsored institutes, and commercial research laboratories. These research & development customers tend to have less cyclical buying patterns than those in manufacturing. This division is expected to grow sales consistently at 15% annually for the next few years. 

Semiconductor

FEIC sells electron and ion beam products to semiconductor manufacturers for defect analysis found between layers. These products will become more important as line widths for transistors shrink from 130 nm to 90nm and 65nm because the percentage of defects found within the layers compared to the surface rises. Sales to semiconductor manufacturers are very cyclical and are typically leveraged to the semi R&D cycle, which tends to lag the capacity cycle by 1 or 2 quarters. The current semi cycle will begin an upturn in 3Q with +5% q/q growth and should get stronger over the next few quarters. Competitors include AMAT, JEOL andHitachi.

Data Storage

FEIC sells electron systems and wafer analysis tools to the data storage industry to increase yields. Customers include Seagate, Western Digital, IBM andHitachi. Sales in this division are extremely lump from quarter to quarter.

Positives

• A new product cycle, which includes the Titan transmission electron microscope and expected upgrades of market-expanding, low cost, dual-beam microscopes.
• Favorable technology trends internal to the semiconductor (rising sub-surface defect rate) and data storage market (transition to perpendicular recording) each requires a greater volume of high-resolution imaging capacity.
• Product application in materials and life science will evolve from single-tool research settings into high-tool count production environments.

Negatives

• FEIC is subject to the lumpy buying patterns of data storage customers and the classical cyclical demand of semiconductors. However, the semi-cycle is in the beginning stages of an upturn.