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The Hedge Fund Report: Convertible Overhang

Hedge funds that practice convertible arbitrage continue to bleed assets and remain one of the poorest performers of any category this year. But here's a secret, according to a hedge fund manager: Convertible issuance is back.

Convertible financings have rebounded because interest rates are up and it costs less for companies to issue these stock-and-bond hybrids than traditional corporate paper. Also, while companies may be sitting on a lot of cash, they've still found uses for borrowed money in the area of share buybacks, acquisitions, and to fund research and development.

With that in mind, says the manager, investors should be wary of certain names that have shown a propensity for convertible offerings in the past. He mentioned First Data (FDC), Radian (RDN) and Weatherford International (WFT). If a company sets a convertible sale, arbitragers are sure to short the underlying stock.

Tough Legacy

Life is full of surprises when you're Biovail (BVF). Uncertainty around the Ontario pharmaceutical firm has created a feeding ground for hedge funds that see the stock as a pure "event" play. Biovail got a boost earlier this month when it announced a marketing partnership with Johnson & Johnson (JNJ) for the sale of Tramadol ER, a pain reliever.

"The partnering is fantastic news. They found the best partner," says David Maris, a Banc of America Securities analyst who is neutral on the stock. New York-based Deerfield Management, a specialized life science hedge fund, is long the stock and held 3.77 million shares, according to its most recent 13H filing.

On the downside, Biovail, which manufactures Wellbutrin XL, is facing generic competition. OrbiMed Advisors, a hedge fund specializing in life science products, sold its 2.1 million-share position based on the generic risk, according to a source familiar with the sale. York Capital Management also sold almost a million shares, according to regulatory filings. Both trades looked prescient Thursday when Biovail tanked 13% to $22.30 after Anchen Pharmaceuticals obtained tentative approval for its generic version of Wellbutrin XL.

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