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The conversion feature of a convertible security (the call option) hardly has any value if the common stock underlying that convertible trades below the effective conversion price. Convertibles in this situation are usually referred to as “busted” convertibles because they trade at high premiums over conversion value. These “busted” convertibles will trade near, or at, their investment value (bond value) and thus, have virtually no sensitivity to the movements of their underlying common stock.

Still, many fixed-income investors find these so called “busted” convertibles attractive alternatives to other corporate bonds because of their potential for capital appreciation should the issuing company’s fortunes turn around. Investors with a bullish outlook over the long term generally buy these convertibles with two objectives in mind: (i) receiving a generous yield; and (ii) gaining appreciation in the value of the convertible, assuming the underlying stock advances.

We screened the Value Line database of 575 securities (bonds and preferred stocks) for a list of “busted” convertibles; convertibles trading with premiums over conversion value greater than 50%. Below is a partial list, which includes convertibles with a current yield of at least 10%.

   

<----------------Convertible--------------->

<------Common------->

Convertible Securities

Price

Yld(%)

YTM(%)

Prem (%)

 

Industry

Price

Yield

Ticker

Alaska Commun 6.25s2018 (144A) 

62.14

10.1

16.6

117

TelSrv

$2.94

29.3

ALSK

United Continental (Air) $3.00 

$29.50

10.2

 PFD

76

AirTrn

$19.15

 NIL

UAL 

Network Equipment 7.25s2014    

65.13

11.1

31.1

999

TelSrv

$1.23

 NIL

NWK 

Lucent Tech Cap $77.50         

$680.00

11.4

 PFD

747

TelEqp

$1.99

 NIL

ALU 

Hutchinson Technology 8.5s2026 

68.03

12.5

14.2

324

PrcIns

$1.38

 NIL

HTCH

ATP Oil & Gas $8.00 B          

$58.28

13.7

 PFD

75

OlfdSv

$7.38

 NIL

ATPG

NorthStar Rlty 11.5s2013(144A) 

76.55

15.0

36.7

72

REIT 

$5.07

7.9

NRF 

China Med Tech 6.25s2016 (144A)

41.11

15.2

32.0

65

MedSup

$3.63

 NIL

CMED

Amer Oriental Bio 5s2015 (144A)

31.76

15.7

51.6

 NMF

MedSup

$0.93

 NIL

AOB 

Penson Worldwide 8s2014 (144A) 

40.64

19.7

64.3

256

FinSvc

$1.12

 NIL

PNSN

* Prices as of January 19, 2012

 

Highlighted Convertibles:

Alaska Communications Systems Group, Inc. (ALSK) provides leading integrated communications services in Alaska. Its wireline and wireless networks extend throughout the 49th State and into the Continental United States via two undersea fiber optic cable systems. The wireline business is one of the most comprehensive in Alaska. The wireless segment includes a state-wide third-generation (3G) network.

Results for the third quarter were not impressive, but showed improvement. Sales edged up to $90.3 million from $89.8 million a year earlier, and the per-share loss narrowed to $0.02, from $0.07. This was the second-consecutive quarterly deficit for the company, having lost $0.08 a share in the second quarter. For the nine months ended September 30, 2011, sales totaled $261.8 million and the bottom-line deficit was $0.04. Still, Value Line’s analysis indicates that 2011’s full-year results could be written in black ink, with a profit of $0.01 a share, as there was an increase in wireless subscribers, and the introduction of 4G LTE technology appears to be on schedule.

Alaska Communications is heavily leveraged and is struggling financially. As a result, management cut the common stock dividend by about 75% in December 2011, to ease cash payouts. The stock’s main attraction is the high dividend yield, and it lost a significant amount of value on the news of the dividend cut. The 6.25% convertible notes offer higher income and better downside protection.

The current yield offered by the convertible note is about 10%, and its yield to maturity is 16.6%. In addition, should the stock price advance above $10.28 a share, holders could be handsomely rewarded.

Hutchinson Technology (HTCH) is the leading manufacturer of suspension assemblies for (magnetic) hard-disk drives. The company also developed a medical device that uses an optical technology to measure local oxygen saturation of hemoglobin in tissue.

Hutchinson finished fiscal 2011 (ended September 25, 2011) with mixed results. Although sales rose 3% during the fourth quarter, the per-share loss was more than expected. That brought fiscal 2011 figures well below those of the previous fiscal year. Sales of $278 million were far below the $347 million reported in fiscal 2010. The per-share loss increased to $2.01 from $1.85 a year earlier.

The company suffered a setback in October, when severe flooding in Thailand halted production at its assembly plant there. This situation created substantial disruption and uncertainty for the disk drive industry, and is resulting in competitive pricing for suspension assemblies.

The stock is ranked by Value Line to track the broader market averages in the coming six to 12 months, but its high volatility (Beta is 1.85) could deter risk-averse investors. The company’s 8.5% convertible notes due 2026, which are not callable before January 15, 2015, are more price stable and serve as an alternative to the stock.

In addition, the convertible offers a generous 12.5% current yield advantage over the common and a 14.2% yield to maturity. And if the common stock price equals or exceeds $12.90 a share between January 15, 2013 and January 14, 2015, holders could be forced to convert into common shares. The convertible is also putable on January 15, 2015, offering a yield to put of 25.6% to the nearest put date.


ATP Oil & Gas (ATPG) engages in the acquisition, development, and production of oil and natural gas properties in the Gulf of Mexico, the United Kingdom, and the Dutch Sectors of the North Sea. As of December 31, 2010, ATPG had estimated net proved reserves of approximately 126.4 million barrels of crude oil or other liquid hydrocarbons equivalent (MMBoe), of which approximately 83.9 MMboe were in the Gulf of Mexico and 42.5 MMBoe were in the North Sea. The company also owns leasehold and other interests in 51 offshore blocks, and 88 wells, including 24 subsea wells in the Gulf of Mexico. The company also has interests in 13 blocks and three company-operated subsea wells in the North Sea. ATP Oil & Gas had reserves of approximately 75 million barrels of oil and 307.8 billion cubic feet of natural gas.

Over the past eight years, ATPG only reported an operating profit in 2007 and 2008. The company, however, has seen some improvements in its sales during the first nine months of 2011. Revenue rose 72%, to $509 million from the year ago period. The per-share loss, however, widened to $3.32 from $2.14 in 2010.

The common stock is very volatile, with a Beta of 2.05, and the company pays no dividend. The company’s Series B $8.00 convertible preferred shares, which are higher than the common in the company’s hierarchy, offer a generous 13.7% current yield. That, plus the free conversion feature make these preferreds a worthwhile addition to yield-oriented portfolios, with capital gain potential if the common rises.



At the time of this article's writing, the author did not have positions in any of the companies mentioned.