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Old Economy awakens

awillis@globeandmail.com

The Old Economy got its moment in the sun this week, as a couple of dirty old rust belt industrial plays raised $146-million in a pair of financings that showed the convertible debenture market is back on its feet.

The deals started Monday when conglomerate Superior Plus raised $60-million from a corner of the capital markets that went dead during the credit crunch.

Last week, Superior acquired a U.S. insulation manufacturer for $135-million (U.S.), a contrarian move that continues the company's expansion into construction-related industries. To pay for this, the company tapped the convertible market in a bought deal led by TD Securities and Scotia Capital.

These bonds are closer to equity than debt. They pay 7.5-per-cent interest and can be flipped into Superior stock at a conversion price of $13.10 a share.

Convertible debentures appeal to the hedge fund crowd, who like the idea of getting paid to wait for a stock to go up in price, and being able to hedge the position. During the credit crunch, hedge funds were forced to pull in their horns, and the convertible debenture market underperformed and all but dried up.

In recent months, convertible debentures made a comeback, in part as a way to play an economic recovery, while earning income from interest payments. A number of Canadian resource companies sold these securities.

Superior's core business is a monopoly on propane sales in much of the country. Over the past two years, it acquired companies that make dry wall and chemicals. The company used to be structured as an income trust.

On the heels of this deal, chemical maker Canexus Income Fund raised $86-million yesterday by selling convertible debentures. Scotia Capital did half the work by leading a bought deal for a total of $46-million. At the same time, the company did a $40-million private placement with parent Nexen. The oil company owns 62.7 per cent of the income trust.

The Canexus debentures pay 8-per-cent interest, and flip into Canexus equity at $5.10 per unit. Again, investors buying these securities are looking for a play on an economic recovery. The cash raised in this deal will pay for expansion of Canexus facilities in Canada and Brazil.

sleepy bond market

There's a summer drought in the Canadian corporate bond market, as companies hold off on issuing new debt despite conditions that would support a downpour.

Domestic capital markets are now in their third week without a new issue, the longest streak seen this year, according to a report Monday from Desjardins Securities.

"Despite continued tightening in spreads and strong underlying investor demand, corporate bond issuance ground to a halt," Desjardins fixed-income analyst Jean-François Godin said in a report. "With no new filings last week, the new issue pipeline continues to be light in the near term."

This lull is likely seasonal - the Street gets very quiet in late July and early August. Late spring and early summer saw the new issue market take wing, with a parade of large debt offerings from Corporate Canada. When everyone gets back to work, Mr. Godin predicts the new issue market will pick up, and traditional, company-specific analytical skills will be needed to run fixed-income portfolios, rather than a focus on macroeconomic factors.

"In our view, credit risk is the main hazard going forward whereas liquidity risk has been slowly subsiding from the height of the crisis," the Desjardins analyst said.

airline crisis

Air Canada CEO Calin Rovinescu gets full marks for crisis management.

Financial crisis? He fixed that with a $1-billion liquidity injection. Union woes? There's a new 21-month labour deal in place. Pension shortfall? He's won more time to pay it back.

And on Friday, Air Canada announced it is targeting $500-million in cost reductions and revenue enhancement, double the original goal, along with a $155-million profit for the second quarter.

As impressive as this all seems, analysts say Mr. Rovinescu's real work is still in front of him.

"We believe that Air Canada will not only have to find additional cost savings, but will also have to fundamentally change the culture of the company if it is to be viable long term," said Versant Partners analyst Cameron Doerksen. He has a "sell" rating on the stock.

Air Canada now flies with $7.5-billion of debt, wrapping in its aircraft leases, and Mr. Doerksen said: "Given its stretched balance sheet, we believe the company is potentially just a crisis away from being back in a dire financial position.

"Air Canada notes that its long-term viability will likely require a fundamental reworking of the company, including a significant shift in corporate culture. While not impossible, we see this as a very significant challenge, especially as it relates to the company's employee groups," Mr. Doerksen said.

See Andrew Willis's Streetwise Blog at ReportonBusiness.com

© 2007 The Globe and Mail. All rights reserved.

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