Citadel Bond Draws Big Hedge Fund Bid

Some think the convertible issue will become redeemable because of the ABC Radio merger.
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Hedge funds are frantically bidding up convertible bonds issued by

Citadel Broadcasting

(CDL) - Get Report

, hoping to cash in on its recently announced merger with

Walt Disney's

(DIS) - Get Report

ABC Radio Network.

Under a deal announced last month, Disney is merging the radio assets with Citadel in a transaction worth about $2.7 billion in cash and stock. After the completion of the merger, Disney is expected to own 52% of the new company renamed Citadel Communications, while Citadel's shareholders would own the remaining 48%.

The bidding frenzy revolves around one issue of debt: a $330 million convertible bond with a 1.875% coupon and a 2011 maturity.

Prior to the announcement of the deal, this bond traded at roughly 75.50 ($75.50 per $100 face value). Now it's going for about 84.50.

Convertible hedge funds have been pretty active in the trade, according to some participants.

Why the bidding? It's because if the transaction materializes, the indenture of the convertible bond may trigger a "put" provision, which means that bondholders of Citadel would have the right to sell their bonds back to the company at par, or 100.

Obviously, if the bond can be redeemed at 100% of face value, the trade could still be very profitable. "This is a big story right now," says John Wagner, who runs Camden Asset Management, a convertible bond hedge fund. He declined to say if he was involved in the trade.

Citadel didn't return calls seeking comment. Disney declined to comment.

Traders bidding up the bond believe the put will be triggered on the basis of the bond covenant, in what is called a "change-of-control put." The reasoning is that with Disney holding 52% of Citadel, Citadel could be deemed to have a new owner.

"Each time there is a change of control these days, most indentures have a provision that allow the bondholders to put back the bonds at par or at a modest premium," says Cliff Neimeth, head of the merger and acquisition practice at the New York-based law firm Greenberg Traurig.

Those covenants date back from the days of the leverage buyouts craze of the 1980s, during which LBOs would trigger stiff credit downgrades, sometimes putting a company into junk territory, says Wagner. In order to protect themselves from the sudden loss of creditworthiness on their securities, bondholders asked for guarantees that they could be made whole in the event of a "fundamental change," among other things.

The put trigger is not a done deal. First of all, while it appears, according to a lawyer, that there is such put offer in the Citadel's indenture, no one is really sure what to make of it. "It is subject to interpretation. My guess is that there is going to be a fight between the bondholders and Citadel. Bondholders will claim that the put offer is triggered, while Citadel will say no. The writing is ambiguous."

"There is a lot of confusion on this deal," said James White, managing partner at hedge fund Excelsior Capital Management, who is sitting on the sidelines. "It depends on what the lawyers say. You would think that there is a change-of-control put. If it was not for the agreement, this bond should not be trading more than 78-80." He bases his calculation on the implied volatility of the paper.

White reasons that if there is no put offer, the bond will go back to 78. On the other hand, if the bond can be sold at 100, the profit will be 15 points from its current level. "You risk 7 points to make 15 points," says White. "I've got to look at it; maybe it's worth taking a 7-point risk. But it's kind of confusing to me. And that's why the bond is trading at 85, not at 98," he says.

The Citidel/Disney transaction is expected to be completed by year-end. But prior to that, it has to be reviewed by the antitrust agencies and approved by the Federal Communications Commission and a tax opinion from counsels.

In the meantime, the outcome of the trade is in the hands of the lawyers, says Christophe Thomas, head of convertible trading at hedge fund Marathon Asset Management.

Disney's shares price rose by 10% from $24.96 on Feb. 6, when the deal was announced, to yesterday's close at $27.54.