Weekly Supply & Flows Update
For a holiday-shortened week, the primary market was on fire, with investment grade, high yield and emerging markets issuance of over $20 billion. The highlights were jumbo deals from Ford, Delhaize and AOL Time Warner deals. DZA issued $2.6 billion 5s, 10s and 30s. Given the fat yields on offer in a relatively defensive the deal was oversubscribed and performed well initially in the secondary market. At +305 bp over Treasuries for the 10Y tranche, DZA was offered roughly even with Baa3/BB+ Mexico. Given the carnage in the long end, investors were eager to put on duration.
Philip Morris: Seeking Low Tar Regulation
Philip Morris is back in Washington lobbying for Congressional legislation to provide the FDA with limited regulatory authority over tobacco products. In support for the new regulation, MO states that the new rules would likely bring more predictability for its U.S. tobacco business. Long-time followers of MO and the tobacco industry will remember the company's and the industry's opposition to FDA regulatory authority over cigarettes as a "medical device" in 1996. Why the change in position now? The answer lies in the type of regulatory authority being sought and the limitations placed on advertising and marketing in the aftermath of the 1998 States' Master Settlement Agreement.
The Drawbridge and the MOT
Motorola addresses enough financial and balance sheet issues on its 1Q conference call to satisfy bondholders, but still falls well short of changing the Fortress Motorola mentality. The solid MOT bond rally was justified on just the lack of a real financial crisis, but the quality of MOT's disclosure remains strained. There were considerable gaps in the coverage of some critical areas, including its financial planning process around asset sales, bond issuance, vendor financing and cash flow generation. However, we remain constructive on the company's ability to manage through this perilous period of liability management and short-term debt extension.
Delhaize America: Comfort on the Cusp?
Delhaize America's new issue entices bondholders with attractive yield and the promise of lower top line volatility vs. its BBB peers. However, intense competition makes the sector less of a safe haven and the recent strengthening of DZA's operating trends may be hard to sustain. In addition, pending foreign status once DZA becomes a wholly-owned subsidiary of Delhaize Le Lion and a complex, evolving corporate structure merit the yield penalty.
Motorola: Questions to Ponder
The company's balance sheet plans and vendor financing arrangements have come under justifiable scrutiny and Motorola, like its peer group of telecom suppliers, needs to take a hard look at reality and confront some of the challenging questions that have come up around some of these issues. Securities holders need specifics about some critical exposures of the company and clear statement about how they are managing their rather onerous short-term debt load.
Motorola: Under Siege but Countering
Motorola is not facing a liquidity crisis anywhere close to the order of that being experienced by Lucent, but it does present major balance sheet risks and high vendor financing exposure. In trying to differentiate MOT from LU, we would start by pointing out that MOT lined up its $2 billion facility with little trouble since it has ample securities held for sale that it could use to pledge if conditions grow worse or could be sold to pay down debt. In addition, the company has been selling assets and building cash.
Moody's Changes GM Outlook to Negative
Moody's affirmed GM's rating, but changed its outlook to negative from stable. Our view is that the industry has been estimating too low on the way up and may end up being too high on the way down. S&P has also targeted GM as a possible downgrade over the near term, so the risk that one of the agencies pulls the trigger is picking up as car sales do not.
The Covenant Sting: Ragtime for Bondholders
The prospect of the commercial banks getting pledged the assets of Owens Illinois' operating subsidiaries in exchange for rolling over OI's $4.5 billion in facilities is a troubling development for bondholders. It demonstrates the willingness of the bank lenders to take aggressive measures to enhance themselves in a manner that is contrary to what many reasonable people might see as the spirit and intent of the covenants. The OI situation gets particularly sticky since it also calls into question where the bondholders could end up vis-à-vis the asbestos claimants.
AHP: Reserves Too Skinny?
$56.5 million damages award in Texas raises questions on reserve adequacy, but one case does not make a trend. However, given the size of the reserve AHP has taken and the open-ended contingent liability exposure it faces, the company still has some additional obstacles to overcome in asserting that AHP is "not a litigation story". While the company does have substantial reserves and tremendous financial flexibility, we expect the litigation issue to come up frequently in the future and any holder of AHP bonds should be prepared for more court decisions that go against the company.
Edison's Preliminary Agreement with Governor Davis
Edison International and its utility subsidiary, Southern California Edison, averted a bankruptcy filing by fleshing out their preliminary agreement with Governor Davis. If all the pieces can be put in place, creditors will benefit from avoiding bankruptcy. There is still a high risk of bankruptcy, and we would sell unsecured paper into rallies. First Mortgage Bonds will be paid, but rallies in those bonds offer holders an opportunity to move on to other things.
Calpine Won't Write Off Power Sold to Pacific Gas & Electric
Contrary to what other suppliers have done, Calpine has so far refused to take a charge for the $267 million PG&E owes it for power. We would be more comfortable with a write off, but Calpine can legitimately distinguish its situation as a QF supplier with a long-term contract from other suppliers. This uncollected debt will retard CPN"s desired attainment of an investment grade rating, but it is not a serious credit issue for the company.
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