15 April 2003
The convertible bond market gained momentum towards the end of last week on the back of various new issues in Asia and the US, but has begun to flag again in the run-up to Easter. Nevertheless, the bonds issued have enjoyed steady demand from investors, many of whom appear to be looking for balanced convertibles.
The war in Iraq seems to be drawing to a close, and this is boosting the markets slightly, but the quarterly figures currently coming out of the US and Europe are much more important. Investors await the facts with baited breath, and are even more keen to see how individual companies' expectations are shaping up.
The oil sector can be expected to calm down somewhat after the war ends. Observers expect an average price per barrel of just below USD 30 for 2003 and about USD 25 for 2004. The fact that French companies risk being passed over in favour of firms from Britain and the US as far as the reconstruction of Iraq is concerned leads us to conclude that Belgelec's 1.5% bond, which is convertible into TotalFinaElf (ISIN XS0099147497), is relatively overpriced at present. At prices above EUR 170, the bond - with maturity in 2004 - offers virtually no return. However, we believe its premium of more than 38% is excessive given the short remaining term. Investors with an interest in the oil sector would do better to opt for UBS's exchangeable on Royal Dutch/Shell (ISIN XS0157159285). This bond comes from a superbly rated borrower (Aa2/AA+), and despite paying a meagre 0.50% coupon offers a return at maturity (2007) of about 1.25%. At less than 30%, the premium adds to its appeal.
In the technology sector, meanwhile, the market is focusing on the Telecom Italia/Olivetti situation. The merger between these two companies appears to be progressing rapidly, and the corresponding convertibles have recovered from the severe losses suffered about two weeks ago. Olivetti's 1.5% bond with maturity in 2010 is trading at a very enticing premium of barely 11%. We therefore think the fact that the exchange ratio might be amended to give a slightly less advantageous figure than the current 7:1 (i.e. 1 Olivetti share for 7 Telecom Italia shares) has already been priced in.
Another issue worth considering comes from the Taiwanese computer manufacturer Quanta Computer Inc. This zero-coupon bond, which matures in 2006 (ISIN USY7174JAA44), represents an interesting alternative to the share. The premium of about 30% - based on current prices in the region of 105% - is justified by the high volatility of the underlying. We think the borrower's credit quality is roughly equivalent to a BBB rating, which would put the bond's fair value at about 98%. The risk is very easy to calculate thanks to the put option in December 2003
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