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Because of the high volatility being experienced in the equity markets, convertibles are trading with high premiums over conversion value as their underlying common stock prices decline. In fact, as of August 13, 2010, the average convertible traded with a 52% premium over conversion value and a 17% premium over investment value. Such conversion premiums limit the convertibles’ participation in the stock price movements. But, despite rather lackluster economic conditions, we can still find a few companies whose stocks are performing well and the convertibles issued by these companies are also doing well.
 
Convertibles are almost always issued with some premium over conversion value, expressed as a percentage. This is to prevent immediate conversion and give the issuer some breathing room before it has to settle the debt. However, as the underlying common stock advances, this premium gradually disappears until it reaches zero. That’s when the stock price is the same as the effective conversion price.

As the premium narrows, the convertible’s sensitivity to the movement of the underlying stock intensifies. So, the smaller the premium over conversion value, the greater the convertible’s participation in the stock’s activity. At a 0% premium, the convertible will mirror the upside of the stock. That is, if the stock moves up 20%, the convertible will move up 20%. On the downside, the convertible will not generally participate fully in any decline in the stock, and the degree to which it falls depends on the magnitude of its premium over investment value.

The screen produced below displays convertibles with conversion premiums that allow full participation in any gain in their underlying common stocks, with some degree of downside protection. In addition, the convertibles are highly ranked for year-ahead performance, offered a current yield advantage over the stock of 2.0% or more, and the underlying common stock was ranked for average or better performance over the next six to 12 months. For liquidity purposes, we included only convertibles with outstanding principal amounts of at least $100 million.

 

Issue

Recent

Conv

Leverage

Current

Common

Convertible Securities

Size

Price**

Rank

+50%

-50%

Yld Adv

Price

Rank

Informatica 3s2026             

230

149.72

1

50

-30

2.0

$29.95

2

WebMD Corp 3.125s2025          

300

146.34

1

50

-30

2.1

$51.33

2

Valeant Pharma 4s2013          

240

182.96

-

50

-40

2.2

$58.01

-

Reinsurance Group $2.875       

4.5*

$60.43

2

45

-15

3.8

$46.92

3

Continental Air 5s2023         

175

118.27

-

45

-21

4.2

$22.63

-

Kansas City Southern $51.25    

.21*

$1,170.00

2

45

-40

4.4

$34.46

2

O'Reilly (CSK Auto) 4.63s25 Stp

100

120.13

1

50

-18

5.6

$46.97

1

Mylan Laboratories $65.00      

2.139*

$1,061.31

2

45

-15

6.1

$17.45

3

* Number of shares outstanding
** Prices as of August 12, 2010

Selected Convertible Profiles:

Informatica Corporation (INFA) is a leading provider of e-business infrastructure and analytical software that enables its customers to automate the integration, analysis and delivery of critical corporate information. Its products include PowerCenter, PowerExchange, and Data Explorer, and it employs more than 4,000 people. As of our August 13, 2010 pricing date, Informatica 3% convertible notes due 2026 traded with a 1% premium over conversion value. It is poised to mirror the common stock on the upside, with limited exposure (60%) if the stock should decline. In addition, it offered a 1.9% current yield, while the stock pays no dividend. Moreover call protection is intact until March 15, 2011. If present trends continue, the company could force conversion as soon as it can legally do so.

Mylan Laboratories (MYL) (formerly Mylan Labs Inc.) manufactures prescription generic drugs (mostly antibiotic, anti-inflammatory, cardiovascular, and central nervous system agents) and brand-name dermatological products. The company has 133 prescription products in 40 therapeutic areas. Brand-name sales accounted for about 20% of 2009 revenues. Mylan has two outstanding convertible issues in our service; the $65.00 convertible preferred stock and the 1.25% convertible notes due 2012. The notes did not make the list because its rank was a 3 (expected to match market performance). The preferred shares are not callable, and trade with only a 4% premium over conversion value. They currently yield 6.1% and are convertible into 58.548 shares of common. The shares are expected to rise 45% as much as the common, but fall only 13% if the stock rise or fall by 50%.