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Convertibles are made up of two parts: a fixed-income portion (bond-like) and a warrant (a call option on the underlying common stock). Thus, the value of a convertible depends on the sum of both parts. The bond value is the value of the convertible at maturity without the warrant feature discounted to the present value. This depends on many variables such as the size of the coupon, the company’s investment quality and financial strength, and the amount of time to maturity. The warrant portion gets its value from the activities of the underlying common stock; the more the stock advances, the higher the value of the warrant, and vice versa.

Common stocks ranked 1 or 2 by our sister publications, The Value Line Investment Survey and The Value Line Investment Survey Small and MidCap Edition, are deemed to have the potential to outperform the market averages in the coming six to 12 months. Convertibles are assigned ranks based on the attractiveness of their total return potential. However, the rank of the underlying common stock does contribute significantly to the ranking of the convertible. So, if the underlying stock is ranked for above-average year-ahead performance, the convertible’s potential total return is likely to be above average. However, because convertibles are less risky and generally provide greater income, they do not often share fully in gains in the stock.

As the conversion value approaches the price of the convertible, the premium at which the convertible trades tends to disappear gradually. The lower the premium over conversion value, the greater the convertible’s participation in the upside of the underlying stock. Convertibles trading above par generally tend to have the lowest premium over conversion value. And the smaller the premium, the more likely the convertible is to mirror the performance of the underlying stock. Thus, convertibles with low premiums over conversion value enable portfolios to reap the returns of the underlying common stock, at much less risk, and in the process, gather income that is usually higher than that available from the stock.

We screened our database for favorably leveraged convertibles, trading at premiums over conversion value of 20% or less, and whose underlying common stocks are ranked for above-average performance. These convertibles display greater sensitivity to their respective underlying common stocks, and have the potential to rise more than they would fall, if the stock rises or falls 25%. Below is a partial list.

 

Recent

Leverage

Conv

Conv

 

Common

Convertible Securities

Price

+25%

-25%

 Yld(%)

Prem (%)

Industry

Price

Yld (%)

Thoratec 1.3798s2034           

$126.18

30

-22

1.1

-4

MedSup

$44.79

 NIL

Core Labs 0.25s2011 (144A)      

$152.47

25

-19

0.2

-1

OlfdSv

$146.27

 NIL

Danaher Corp. 0s1/21           

$113.82

25

-25

Nil

0

Mltyfm

$78.67

0.2

Kansas City Southern $51.25    

$1,304.43

25

-21

3.9

0

RR   

$39.22

 NIL

Priceline.com 0.5s2011         

$454.97

25

-25

0.1

0

Intnet

$183.91

 NIL

Priceline.com 0.75s2013        

$455.01

25

-25

0.2

0

Intnet

$183.91

 NIL

Skyworks Sol 1.5s2012          

$171.46

25

-21

0.9

0

Semicn

$16.31

 NIL

TEVA Pharm 0.25s2024 B         

$150.86

24

-23

0.2

0

Drug 

$52.97

1

US Airways Group 7.25s2014     

$219.40

24

-23

3.3

1

AirTrn

$9.93

 NIL

Valeant Pharma 4s2013          

$149.41

22

-19

2.7

2

Drug 

$46.11

 NIL

Macrovision 2.625s2011         

$137.39

22

-15

1.9

2

Entmnt

$37.99

 NIL

Thermo Electron 3.25s2024   

$131.55

23

-13

2.5

2

MedSup

$51.95

 NIL

           * Prices as of June 11, 2010


Selected Convertible Profiles:

Thermo Electron (TMO) is a leader in the research and development of both air-driven and an electrical implantable left ventricular-assist system (LVAS). Each system is designed to perform substantially all or part of the pumping function of the left ventricle of the natural heart for patients suffering from cardiovascular disease. Unlike total artificial heart systems, which require removal of the natural heart, an LVAS allows the natural heart to be left in place, preserving the heart's biological control mechanisms. Thermo Electron has developed two systems for patients requiring long-term cardiac support: an implantable pneumatic LVAS that is powered by an external electrically-driven air-pump, and an electric LVAS that is driven by an implanted electric motor and powered by a lightweight battery pack worn by the patient. These systems are designed to enhance the patients' quality of life by allowing them to become ambulatory and resume functioning in society. The electric version of the LVAS is currently being used in clinical trials. With a mere 2% premium over conversion value, the Thermo Electron 3.25% convertible notes due 2024 (originally issued by Fisher Scientific) are trading deep in the money, and could be called away on March 1, 2011, when it can legally do so to force conversion. In the meantime, the convertible is poised to share in as much as 90% of any gains in the underlying common stock, while yielding 2.5% more.

Thoratec Corp. (THOR) develops proprietary medical devices used for circulatory support and for vascular graft applications. The company markets the Thoratec Ventricular Assist Device System in the United States and internationally for use as a bridge to heart transplant, and for use in the recovery of the heart after open-heart surgery. It has also developed small diameter vascular grafts for use in hemodialysis access and coronary artery bypass surgery. In August, Thoratec received FDA approval for an Investigational Device Exemption supplement allowing for enrollment of up to 30 additional patients as part of a nonradomized continued access protocol in the Rematch trial. The Rematch study enrolled 128 patients who were not eligible for heart transplants because of their ages or other diseases. Thoratec’s 1.3798% convertible notes due 2034, trade just above conversion value. What that means is the convertible is now a surrogate for the underlying common stock as it will share full in any rise in the stock. Additionally, the notes pay interest, while the stock pays no dividend. The company could force conversion into common shares on or after May 16, 2011, if the stock price remains at or above $33.94 a share.