BlueMountain Buys Lexmark Stake as Swaps Drop: Corporate Finance

BlueMountain Capital Management LLC, the $13.6 billion hedge-fund firm led by Andrew Feldstein, is targeting Lexmark International Inc. for its biggest equity wager as the printer maker bolsters its creditworthiness.

The investment manager led by the former JPMorgan Chase & Co. executive who helped create the credit-default swaps market disclosed a 5.6 percent active stake in Lexmark in an April 26 regulatory filing. Contracts tied to its debt have dropped 237.4 basis points this year to 279.7 basis points, more than eight times the average 29 basis-point decline at investment-grade technology companies, according to data compiled by Bloomberg.

BlueMountain, which last year helped JPMorgan unwind trades that led to a loss of more than $6.2 billion, is wagering on a business that reported six straight quarters of falling sales as computer users become less reliant on printed documents. Lexington, Kentucky-based Lexmark has made eight acquisitions since 2009 as it seeks to broaden its business to include corporate data and logistics management in such fields as health care and education, while exiting the inkjet business.

“They are transitioning to a future path for their growth that looks bright,” said Adrian Helfert, a senior vice president at Smith Breeden Associates, which oversees about $6.4 billion of investments, including Lexmark bonds. “There’s a reach for yield out there and people who provide it and this is one of the companies that have been benefiting from that.”

Lexmark’s Aware

BlueMountain may seek to discuss “strategic alternatives” with Lexmark and other stockholders, according to the filing. The hedge fund bought 3.56 million shares, worth about $107 million, with the stock at $30.19 at 12:11 p.m. in New York.

Lexmark is aware of BlueMountain’s investment and is “focused on delivering value to all stockholders,” company spokesman Jerry Grasso wrote in an e-mail yesterday. Grasso declined to comment further on how the stake would affect bondholders or the company’s strategy.

Doug Hesney, a spokesman for New York-based BlueMountain, declined to comment.

Lexmark’s bond prices have increased an average 3.6 percent this year, making them the best performers through yesterday among the top 50 issuers in the Bank of America Merrill Lynch U.S. Technology & Electronics Index, which is up 0.1 percent.

IBM Spinoff

The company offered to redeem $350 million of maturing 5.9 percent notes in March, and it sold $400 million of 5.125 percent notes due March 2020. The new bonds traded yesterday at 104 cents on the dollar to yield 4.44 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority, up from 99.998 cents on the dollar at issue. That narrowed their spread to similar-maturity Treasury bonds to 334.1 basis points from 389.4 basis points. A basis point is 0.01 percentage point.

Lexmark, which was spun off in 1991 by International Business Machines Corp., has spent about $555 million on acquisitions since it purchased Perceptive Software Inc. three years ago to help solidify its focus on software and print services. Competitors such as Hewlett-Packard Co. and Xerox Corp. are making similar transitions as traditional printing businesses suffer.

“A lot of people are trying to do the same thing because the equipment business is going nowhere,” Molly Toll-Reed, a credit analyst at Standard & Poor’s in New York, said in a telephone interview. “So they have plenty of competition, and they are a relatively small competitor, but they are focused.”

Xerox Yield

Xerox is rated Baa2 by Moody’s Investors Service and an equivalent BBB at Fitch Ratings, one level above the BBB- rating from S&P that it shares with Lexmark. Lexmark’s $300 million of 6.65 percent notes due June 2018, which traded at 113 cents on the dollar on April 18, yield 144 basis points more than Xerox’s $1 billion of similar maturity, 6.35 percent debt.

Sales at Lexmark will drop by as much 10 percent this year from 2012, as inkjet revenue declines of more than 40 percent offset gains in print services and software, Chairman and Chief Executive Officer Paul Rooke said in an April 23 conference call with analysts and investors to discuss first-quarter earnings.

Investors are now paying the equivalent of $279,700 annually to protect $10 million of debt from losses for five years, down from the $517,100 they paid at the end of 2012.

Xerox swaps cost $152,400 for the same protection, while Hewlett-Packard, rated Baa1 by Moody’s and BBB+ at S&P, is at $186,900.

‘Slow-Burn Profile’

“Lexmark’s credit-default swaps have been on a tear of late, but it still remains substantially wider than the credit agencies’ views of the company’s risk,” Joel Levington, a managing director at Brookfield Investment Management Inc. in New York, wrote in an e-mail. The company has a “slow-burn profile” and is able to obtain financing in “a very liquid marketplace.”

Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. The price of the contracts typically falls as investor confidence improves and rises at it deteriorates.

BlueMountain was in a spinoff from BlueCrest Capital Management LLP by Harvard Law School friends Stephen Siderow and Feldstein, who helped create the credit-derivatives market while he worked for JPMorgan in the 1990s.

The firm has had just one losing year since it was started in 2003. Of its four absolute return funds, more than 80 percent are devoted to credit investments, according to an April manager overview.

Swaps Arbitrage

The hedge fund has returned an average of about 10 percent a year, largely by spotting abnormalities in price relationships in credit swaps. BlueMountain exploits those tiny, intermittent differences in price, such as those among bonds and the swaps that insure them, and uses custom algorithms to arbitrage swaps and the indexes that London-based Markit Group Ltd. owns and manages.

American International Group Inc., the insurer that repaid a U.S. bailout last year, in March reported a 6.7 percent passive stake in Lexmark, according to a regulatory filing.

“Anytime you get an activist digging into the company it becomes positive for shareholders because typically the activist is always on the side of the investor,” Angelo Zino, an S&P equity analyst in New York who has a buy rating on the stock, said in a telephone interview. “There’s something else to the Lexmark story, and maybe that’s why you get BlueMountain and AIG coming in and building stakes. Maybe they see something that other investors don’t see.”

‘A Survivor’

The company’s shares have rallied 79 percent since a low of $16.77 on July 24, more than triple the 26 percent increase in the S&P Midcap 400 Index. Lexmark spent $78.6 million in dividend payouts and $190 million buying back stock in 2012, according to data compiled by Bloomberg. Its stock now yields 4 percent, the data show.

“I’m not sure what an activist would really be pushing for that the company isn’t already achieving,” Brian Alexander, a St. Petersburg, Florida-based equity analyst with Raymond James & Associates said in a telephone interview. “Some companies talk about returning capital, but in the case of Lexmark, they’ve actually done both in a fairly balanced and consistent way. That’s what confounds me about this.”

The investment by BlueMountain comes after the printer maker said it would sell about 1,500 inkjet-related patents for about $100 million to Funai Electric Co. on April 1.

“They’re the most improved kind of because they were one of the worst performers before,” Noel Hebert, chief investment officer at Concannon Wealth Management, which oversees about $250 million of assets from Bethlehem, Pennsylvania, and doesn’t said in a telephone interview. “Everybody is scrambling so hard to find value somewhere, and it’s a cheap option. People started looking around and said, ’You know what, they’re probably a survivor, even though I don’t like their business fundamentals.’”

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