Sire Ns: Convertibles With A Tricky Shift

The word "siren" can evoke a wailing police car or a sweet-voiced temptress. Now, it's also an acronym for a newfangled type of bond: the Step-up Income Redeemable Equity Note. Invented by First Boston, SIRENs are intermediate-term, convertible bonds that have two coupons. They pay below-market interest for a few years, then "step up" to a higher rate until maturity. Investors can convert the bonds, whenever they want, into common stock at a price determined by the issuer.

A good deal or a dog? Like other convertibles, SIRENs are a defensive investment. If the common stock does well, you turn a profit but don't make as much as if you had bought common shares. If the stock collapses and you don't convert the SIREN, your capital is safe, but you'll earn less income than with a plain-vanilla bond. First Boston thinks people will accept the initially low interest rate to bet on a growing company without taking a big risk. Both the first SIREN issue, for insurer Horace Mann Educators Corp. in mid-December, and the second, floated Jan. 20 for crafts retailer Michaels Stores, got about average ratings for convertible bonds.

But the fly in the ointment is the call provision. Issuers can call the bond at the time of the step-up, paying a slight premium over par. You still have 30 days to convert to common stock. If the stock doesn't rise and your SIREN is called, you've sacrificed two or three years of market-rate yield and have little to show for it.

Take the Michaels Stores issue. The notes are due in 2003, paying 4.75% until January, 1996, and 6.75% to maturity. Each SIREN, bought at $1,000, is redeemable at $38 per share for 26.32 common shares. When the SIRENs were issued, the stock was around 31. Say it goes up 50%, to 4612, by the time of the step-up. If you convert, your $1,000 SIREN is worth about $1,224. Add in three years of interest, or $142.50, and your total return is about 37%.

SAFETY NET. Should the stock go through the floor instead, all is not lost. If the SIREN is called, Michaels Stores will pay you $1,040 for your bond. If it's not, you have a seven-year security paying 6.75%. And if you need to sell early, First Boston calculates that even in a worst-case scenario, you'll get close to 90% of par.

Of course, SIRENs were designed to save issuers money, not to make individuals rich. Says Gerald Guild, fixed-income manager at Advest: "The only way you would like it is if the company fails and you're a bondholder instead of a stockholder." That may be extreme. But get a bond expert to do some math before you decide whether SIRENs sound a warning or a serenade.

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