The Hedge Fund Report: A Taste for GM Convertibles

A put feature on one note makes its 18% yield look relatively safe.
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General Motors

(GM) - Get Report

offers a world of opportunity for yield seekers, whether they are after the 10% stock dividend or some high-yielding bonds. But with the bankruptcy risk recently underlined by Standard & Poor's, buying GM securities is not for the faint of heart. What's the best play?

One hedge fund manager points to the advantage of owning the GM 4.50% convertible bond due in 2032, known by the handle GXM. "GXM is the best value in all of GM's capital structure," says James White of Excelsior Capital. "It is the best bang for your buck."

As with any convertible, the 2032 bond can be converted into common shares for a certain price. But the real value of this paper lies in the fact that its investors own an option to sell ("put") the bond back to GM at $25 in March 2007. That gives holders of GXM an effective 18% "yield-to-put."

"We believe that GM has enough liquidity to make it to March '07," White says, noting that GM's stock, which closed at $20.05 on Friday, will likely never appreciate to the bond's $70 conversion price.

White sees no logic in owning the company's straight debt, which carry lower yields and longer maturities. Looking at the stock, he says that while a 10% return is attractive, the dividend will probably be cut as institutional investors push for a restructuring.

Half a Bet

In the ever-changing battle between

Boston Scientific

(BSX) - Get Report

and

Johnson & Johnson

(JNJ) - Get Report

for

Guidant

(GDT)

, how do merger arbitragers play the uncertainty? Many have ignored the jousting, caring only that Guidant looks certain to be sold.

As a result, "a lot of people are just long Guidant," says hedge fund manager Nancy Havens, who runs merger arbitrage shop Havens Advisors. That would explain why Boston Scientific and Johnson & Johnson have not seen their stock prices drop substantially since the bidding war that began in December.

To make money, merger arbitrage players buy the stock of the target company and usually short the security of the acquirer. They hope to capture the price spread between current prices and their value after completion of the merger. "A lot of people are not short due to the uncertainty and a lot of money is made on the long side," Havens says.

Another option employed by arbitragers is to split the shorts: half in Boston Scientific and half in Johnson & Johnson, Havens says.

Right now, the market seems to anticipate a win for Boston Scientific, says another manager, which is why there is not a lot of selling pressure on Johnson & Johnson.

But Boston Sci has been relatively immune, too, because the exact exchange ratio for the stock component of its offer remains unknown. This ratio will be determined during a pricing period the Boston Scientific agreement defines as 20 trading days ending three days before the closing of the transaction. Since the shareholder vote is scheduled for Jan. 31, this manager predicts that the merger, if Boston Scientific prevails, is not likely to close before the second half of March. It's at that time that short-sellers may emerge, pushing Boston Scientific's stock price down, he says.

Key Turn

Jumping into the hedge fund fray, Cleveland-based

KeyCorp

(KEY) - Get Report

is buying Austin Capital Management, a $900 million Texas-based fund of funds. The transaction was done through Victory Capital Management, the $56 billion asset management subsidiary of KeyCorp, which like most hometown banks does not have any hedge fund capacity.

Larger banks initiated the trend; years ago,

Bank of New York

(BK) - Get Report

acquired Ivy Asset Management. More recently,

UBS

(UBS) - Get Report

sold fund of funds GAM to Julius Baer and

J.P. Morgan

(JPM) - Get Report

bought Highbridge Capital. It's a trend.

BKF Capital Group

(BKF) - Get Report

, the $4.5 billion investment management firm, has been going through troubling changes since last summer, when it lost a proxy battle with activist investors. Since June 23, when the activists won three seats, the stock fell by 60% to $14.51 from $37.90.

Last week, Harvey Bazaar joined the company's board while Anson Beard and James Tisch resigned. Since September, the company has lost its CEO, John Levin, who was replaced by John Siciliano, and its chief financial officer, Glenn Aigen, who was replaced by Clarke Gary.

But the most significant change was the unwinding of John A. Levin & Co., the event-driven business. The decision, coupled with an accounting restatement, precipitated a 30% stock decline on Oct. 19.

Notwithstanding those changes, business continues as usual for BKF's chief executive. "What has been going on over the past few months is a very orderly transition," Siciliano said. "It's part of a plan that goes back to my shareholders letter in November."

Aluminum Lift

Hedge funds and commodity trading advisers are pushing up aluminum prices, according to a research report by Wayne Atwell and Carlos de Alba, two Morgan Stanley analysts.

Last year, hedge funds bought copper, but now futures are too high, leading hedge funds to find a cheaper alternative. Aluminum began to rally with the rise in energy costs as it is the most energy-sensitive metal to produce. Limited supply is also a factor. "I don't see any new capacity on the rise in the next two years," says a hedge fund manager who owned aluminum last year and says he sold it too soon.