holdcoPIK Fridson

The Weekly Publication of High Yield Strategy May 16, 2008 Vol. 6, No.
20
Learn more at: www.FridsonVision.com
BIG PICTURE
Dividend Deals and Subsequent Distress

Terence Flanagan, CFA Terry@FridsonVision.com Martin Fridson, CFA Martin@FridsonVision.com
The authors thank Moodys Investors Service and ThomsonReuters for their generous assistance in providing the data for this study.
Martin@FridsonVision.com
When leveraged buyout sponsors pay themselves dividends, they incur derision in the media and sharp criticism by debt holders. Many high yield investors refuse to buy dividend deals, both as a matter of principle and to send a message to private equity firms. As far as we know, however, no one has determined until now whether bonds and loans associated with LBOs that pay dividends are more prone than LBO deals in general to become distressed or default. Could it be that an investor who just says no to dividend deals is cutting off his nose to spite his face?
Background Earlier this year, Moodys Investors Service analyzed 263 private equity deals financed with rated bond or loan offerings since 2002. 1 The rating agency examined the biggest sponsors post-leveraged-buyout (LBO) financial strategies, such as dividends and acquisitions, and the attendant implications for ratings. Moodys noted that weak financial performance was the driving factor for 55% of ratings downgrades associated with LBO transactions. Dividends paid to sponsors were the next biggest factor, accounting for 35% of downgrades. The dividends that prompted downgrades were generally large 2 and taken within one year of the LBO transaction, according to Moodys analyst John Rogers.
CONTENTS
BIG PICTURE
Dividend Deals and Subsequent Distress .......................................... 1
SECURITY SELECTION
Outlook / Spread Disparity Recommendations ......................... 6 Focus Issues................................. 12 Senior versus Subordinated Spreads ........................................ 15 Debt versus Equity ...................... 17
SECTOR ALLOCATION
Industry Value Tracker ............... 21 Credit Ratings Value Tracker ..... 23
MARKET TIMING
Default Rate Predictor................. 25 Macro Tracker ............................. 27
______________________________________________________________ *Martin Fridson is Chief Executive Officer of Fridson Investment Advisors, an investment management company specializing in corporate credit opportunities that will commence investment operations next month.
ODD LOTS ...............................29 LEGAL NOTICES ....................30 Brought to You in FridsonVision.TM

John Rogers, Christina Padgett, Lori Harris, and Thomas Marshella, Private Equity: Tracking the Largest Sponsors, Moodys Global Corporate Finance (February 2008). 2 Moodys categorizes an LBO dividend as large if it is equal or greater to 80% of the equity contributed to the initial transaction. Copyright 2008 by FridsonVision LLC. All Rights Reserved.
See last page for usage restrictions and other legal terms.
1
BIG PICTURE
Our sister publication, Distressed Debt Investor, examined the correlation between the LBOs from Moodys list and subsequent distress. 3 The study concluded that LBO deals displayed a higher level of financial distress than the full sample of high yield bond issuers. That difference was statistically significant at a very high level of confidence. This report extends the previous research by examining the correlation between LBO dividend deals and subsequent distress or default. LBO dividends are often portrayed in the financial press as a function of unvarnished greed on the part of LBO sponsors. 4 Dividend carve-outs layer debt onto the operating company, the popular argument goes, increasing the likelihood of future financial distress or default. Furthermore, once equity holders recoup the bulk of their investment, they may conceive that they are now playing with Other Peoples Money. That is, they may step up the LBO companys operating risk because they retain a share of the upside but are no longer exposed to the downside. Notwithstanding these logically sound objections to dividend deals, we know of no empirical demonstration that dividend deals are more prone to credit problems than other LBO-related issues. It is clear from comments made to us by portfolio managers that they object to dividend deals in principle. They quite reasonably argue on grounds of fairness that as lenders to leveraged buyouts, they should be paid back before equity investors monetize their investment. Conceivably, though, a policy of rejecting all dividend deals could be contrary to an investors self-interest. The evidence might support the private equity firms counterargument that dividend deals are concentrated in better-quality LBOs that can sustain the resulting increase in leverage. In that case, the rational course for investors would be to treat dividend deals as investment possibilities. Analysis The unit of account in this analysis of LBO-related debt is issuer. In this study, a dividend deal is defined as either: 1. 2. A debt issue of a previously LBOd company for which the stated use of proceeds was payment of a dividend. An issue that was floated to finance an LBO and remained outstanding after the issuer paid a dividend.
A dividend increases leverage and may induce equity holders to step up the companys operating risk
Distributed by FridsonVision LLC. Martin Fridson, CEO. Terence Flanagan, Analyst. Karen Sterling, Analyst. Kristen X. Mahoney, Managing Editor. The material contained in this publication is protected by the copyright laws of the United States of America and by international treaty. Any unauthorized use, reproduction or distribution is punishable by civil and criminal penalty. See last page for usage restrictions and other legal terms.
We deem an issuer to be distressed if it has at least one bond or loan classified as distressed on our observation date. Following industry conventions, we classify a bond as distressed if its option-adjusted spread (OAS) 5 exceeds +1,000 basis points and classify a loan as distressed if its price is below 90. We examine a companys loans only if it has no bonds included in the Merrill Lynch High Yield Master II Index.
3 See LBOs Are Disproportionately Distressed, Distressed Debt Investor (January 24, 2008), pp. 1-5, and Update: LBOs Are Disproportionately Distressed, Distressed Debt Investor (February 21, 2008), pp. 5-9. 4 John Glover and Cecile Gutscher, Buyout Firms Hurt Bondholders by Gorging on Dividends, Bloomberg News (November 1, 2006). Also, Bethany McLean, Getting Too Greedy? CNNMoney.com (June 13, 2005). 5 Option-adjusted spread (OAS) is a measure of a security's extra yield over the yield of a comparable Treasury security after accounting for any options (calls, puts) or sinking funds.
Leverage World May 16, 2008
Copyright 2008 by FridsonVision LLC. All Rights Reserved.

BIG PICTURE
Exhibit 1 shows the breakdown of the 156 LBO deals from Moodys list that generated rated bonds. The present distress ratio of 28.85% 6 for LBO bonds is materially higher than the distress ratio of 18.38% for the Merrill Lynch U.S. Master II High Yield Index, consistent with our findings of January and February.
Exhibit 1: Private Equity Bond Issues Deals Since 2002 Non-Distressed Distressed Repurchased or Tendered Upgraded to Investment Grade Defaulted Total Distress Ratio H0A0 Distress Ratio as of May 12, 2008
Sources: Bloomberg, Merrill Lynch & Co.
96 42 11 4 3 156 28.85% 18.38%
Exhibit 2 shows the distressed and non-distressed breakdown for the 68 LBO-related loan issuers for which pricing was available from ThomsonReuters. Note that of the 25 distressed loan issuers, 11 are mildly distressed with a price of 88 or above, so our calculated 36.76% distress ratio likely overstates the level of distress in the loan market.
Exhibit 2: Private Equity Loan Issues Deals Since 2002 Non-Distressed Distressed Pricing Not Available Total Distress Ratio as of May 12, 2008
Sources: Moodys Investors Service, ThomsonReuters.
43 25 39 107 36.76%
To calculate the distress ratio for all LBO issuers with priced debt obligations (Exhibit 3), we combine the denominators of the bond issuers (156) and the loan issuers (68). The numerator includes all unfavorable outcomes distressed bonds and distressed loans (67) plus defaulted bonds (3), for a total of 70. This produces an overall LBO distress ratio of 31.25%.
Calculated as 42 distressed deals plus 3 defaults, divided by the total deal count of 156.

BIG PICTURE Exhibit 3: Private Equity Bond and Loan Issues Deals Since 2002 Non-Distressed Distressed Repurchased or Tendered Upgraded to Investment Grade Defaulted Total Distress Ratio 139 67 11 4 3 224 31.25%
Sources: Bloomberg, Merrill Lynch & Co., Moodys Investors Service, ThomsonReuters.
According to data provided by Moodys, LBO sponsors paid themselves dividends in 83 of the 263 deals tracked since 2002. From this subsample, Moodys data show that 54 dividends were large (see Footnote 2 above), 33 dividends were paid within one year of the LBO, and 18 dividends were both large and paid within one year of the LBO.
Contrary to the presumed expectation of high yield investors, dividend deals show a lower incidence of distress than LBO issues in general
Exhibit 4 breaks down the LBO deals in which the sponsors took a dividend. Of 67 such deals where bond or loan pricing was available, 16 are currently distressed, producing a distress ratio of 23.88%. That is more than 7 percentage points lower than the overall LBO bond and loan distress ratio. For large dividends or those taken within one year, which might be viewed as indicating that the sponsors were very eager to enrich themselves at the expense of lenders, the distressed ratios were similar, 25.00% and 23.33% respectively. For large dividends taken within one year of the LBO, which critics of private equity characterize as the most egregious manifestation of the strip-and-flip strategy, the distress ratio is just 11.76%. This is about half the ratio for all LBO dividend deals and almost two-thirds less than the ratio for all LBO deals. Note, however, that this counterintuitive result is derived from a very small sample size (17 deals) and therefore may not be statistically reliable.
Exhibit 4: LBO Dividend Deals Since 2002 Dividends Non-Distressed1 Distressed Pricing Not Available Total Distress Ratio
1
Dividends Paid < 1 Year 23 7 3 33 23.33%
Large Dividends 33 11 10 54 25.00%
Large Dividends Paid < 1 year 15 2 1 18 11.76%
51 16 16 83 23.88%
Includes other favorable outcomes for bondholders such as repurchases and upgrades to investment grade. Note that 14 dividend deals with pricing available were neither paid < one year nor large. Sources: Moodys Investors Service, Merrill Lynch & Co., ThomsonReuters.
None of the LBOs with defaulted debt Autocam, Pliant, and Linens n Things paid sponsors a dividend.

BIG PICTURE
Conclusion Our findings contradict the common presumption among high yield portfolio managers of elevated risk in bonds and loans associated with LBOs that pay dividends to their sponsors. Issuers of such debt instruments actually display a lower incidence of subsequent distress than the overall sample of LBO deals.
Portfolio managers may be sending a message but forgoing good investments
Future research may shed further light on the matter, but the evidence available at this point gives no indication that automatically rejecting all dividend deals is a sound policy. Refusing to buy such issues may send a message to private equity firms, but there is no evidence that it enhances investment returns. Indeed, portfolio managers with a no-dividend-deal rule may hurt their returns by excluding from consideration certain debt offerings that are likely to perform satisfactorily. The present study does not explain why dividend deals show no greater credit strain than LBO deals at large, despite the releveraging that they entail. One possible explanation is that true to their claims, the much-maligned private equity firms confine their dividend extractions to companies strong enough to bear them from the standpoint of capitalization and operations. A worthwhile question for future study is whether LBOs that pay dividends have stronger credit measures than non-dividend-paying LBOs.
LW

SECURITY SELECTION
Outlook/Spread Disparity Recommendations

Terence Flanagan, CFA Terry@FridsonVision.com
In our latest monthly update, we identify 11 BB issues quoted wider than their rating peers yet deemed as improving credits, and 17 BB issues quoted narrower than their rating peers yet considered weakening credits. From this group, we spotlight a specific BUY-SELL pairing that provides an attractive spread differential not readily explained by credit fundamentals. Past empirical research indicates that such BUY and SELL candidates provide opportunities for better-than-index returns.
Updated BUY and SELL Candidates The latest update of our relative value opportunities based on issuers credit outlooks identifies 11 BUY candidates and 17 SELL candidates (Exhibits 3-8), of which 3 BUYs and 4 SELLS are new since last months update. 1 The count of 28 trade candidates is 1 higher than last month but well below Januarys peak of 43. The decline in potential misvaluations is likely a function of lower market volatility compared with earlier this year. New BUY and SELL candidates are denoted in boldface type in the exhibits. We focus on senior issues in the Double-B range. BUY candidates are issues that are quoted wider than the median option-adjusted spread (OAS) 2 for their respective rating categories and have positive rating outlooks by Moodys, S&P, or both. Conversely, SELL candidates are issues quoted narrower than the median OAS for their respective rating categories, with a negative outlook assigned by at least one rating agency.
Slightly more than 5% of BB issuers turn up as potentially misvalued
Our current sample includes all 538 nonsubordinated BB issues in the Merrill Lynch High Yield Master II Index (H0A0) as of May 14, 2008. (If an issuer has more than one bond outstanding, we select the issue trading closest to 100.) From this sample, 28 issues, or 5.20%, show up as potentially over- or undervalued based on our screening criteria. We do not recommend the bonds as automatic BUYs or SELLs, but rather present the list of issues as a source for managers to concentrate their analysis on the most promising trade possibilities.
Outlook/Spread Disparity Recommendations, Leverage World (April 18, 2008), pp. 15-20. Option-adjusted spread (OAS) is a measure of a securitys extra yield over the yield of a comparable Treasury security after accounting for any options (calls, puts) or sinking funds.
2

SECURITY SELECTION
Interpublic, Noble Group BUYs have been successful
Note our highlighted BUY candidate from April, Interpublic Groups 5.4% senior unsecured notes maturing on November 15, 2009, dropped out of the BB3 BUY list as a result of its OAS tightening by 168 basis points. The other side of the proposed trade, Blyths 7.9% notes of October 2009, remains a SELL candidate. The price of the Interpublic note rose to 98.75 on May 14, from 97 on April 16, as the advertising company reported better-than-expected firstquarter results.3 The Blyth note slipped from 102.75 to 102 over the same period, meaning our trade generated a gain of 2.5 points in one month, before transaction costs. 4 Our highlighted trade idea from March has worked out as well. Our BUY candidate, Noble Groups 6.625% senior notes of 2015, rose from 87.02 on March 12 to 93.90 on May 14. Our SELL candidate, Pioneer Naturals 6.65% notes of 2017, climbed from 93.71 to 96.18. The bigger gain on the Noble BUY candidate (6.88 versus 2.47 points) compressed the spread differential between the two issues in the desired direction, from 200 basis points to 87 basis points. Long-Short Opportunity Our Outlook/Spread Disparity methodology seeks to identify, on a monthly basis, an issue pair that offers potential as a long-short relative value trade. (Note that the analysis does not preclude executing only one side of the proposed trade.) Exhibit 1 presents two like-rated, but potentially misvalued bonds, along with their rating outlooks and OAS.
BUY
Exhibit 1: Outlook/Spread BUY/SELL Pairing As of May 14, 2008 Maturity Coupon Date Warnaco Inc Ikon Office Solutions 8.875 7.75 6/15/2013 9/15/2015
Rating B1/BB Ba3/BB-
Price 103.5 102.25
Moody's Outlook POS STABLE
S&P Outlook POS NEG
Spread (bp) 426 351 75
SELL
Potential Pickup
As of May 14, 2008, Warnacos 8.875% senior notes maturing on June 15, 2013 offered a 75-basis-point pickup in spread over similarly rated Ikon Office Solutions 7.75% senior notes maturing on September 15, 2015. This differential exists despite Warnacos improving credit direction and Ikons potential rating deterioration, as evidenced by the assigned outlooks. The proposed trade reduces maturity by more than two years. Exhibit 2 shows the one-year spread-differential history for the $205 million Warnaco issue and the $250 million Ikon obligation. Warnaco traded with a modest spread give-up to Ikon for much of the first half of our 12-month period, before the differential reversed and reached as high as 186 basis points in January, largely on the basis of a substantial widening of the Warnaco issue.
3 Kathy Shwiff and Kevin Kingsbury, Interpublic Group Narrows Loss on Revenue Increase, Cost Control, Wall Street Journal (April 30, 2008) [Electronic Version]. 4 The Interpublic note rose from 97 on the April 16 as-of date to 97.25 on our April 18 publication date, narrowing the gain since publication to 2.25 points.

SECURITY SELECTION
The warnaco bond spread widened even as company reported positive news
We found no fundamental credit reason fully justified the widening of the Warnaco-Ikon spread this year compared with last year. It may reflect widespread bearish sentiment on the retail sector, as the Merrill Lynch High Yield Super Retail index (H0SR) produced a total return of -3.10% in January, worse than the -1.36% return of H0A0. The Warnaco bond spread widened to almost 640 basis points in January, even as the company said it expected to meet or exceed its previously issued earnings guidance. The Warnaco-Ikon spread differential is smaller than in January, but recently it has crept up to well above its 12-month median of 18 basis points. Given the divergent credit direction of the two issues, we believe it is reasonable to expect the differential to tighten again and perhaps reverse.
Exhibit 2: Warnaco 8.875% of 2013 versus Ikon 7.75% of 2015 Spread Differential As of May 14, 2008
250 200 150 Basis Points 100 50
Median = 18
0 -50 -100 -150 5/14/2007
7/14/2007
9/14/2007
11/14/2007 Date
1/14/2008
3/14/2008
5/14/2008
Source: Advantage Data.
Fundamental Factors New York-based Warnaco makes apparel such as jeans, intimate wear, and menswear under brand names such as Calvin Klein and Speedo. For its fiscal year ended December 29, 2007, Warnaco reported net income of $79.1 million on revenue of $1.86 billion. S&P placed Warnacos BB senior unsecured rating on positive CreditWatch on May 13, following a favorable first-quarter earnings report. The rating agency noted that Warnaco has shown sustained operating momentum for several quarters, and its credit measures have improved steadily. Moodys assigned a positive outlook to Warnaco in August 2007. Note the Warnaco is split-rated, B1 at Moodys and BB at S&P. Demand for the bond issue can be expected to increase significantly if Moodys raises its rating, as Warnaco will then be Double-B across. Ikon Office Solutions, based in Malvern, Pennsylvania, provides documentmanagement systems and services, including copiers, printers, digital network devices, and software. For its fiscal year ended September 30, 2007, Ikon reported net income of $114.5 million on revenue of $4.17 billion.
Warnacos first quarter continues a string of solid results

BIG PICTURE
On March 5, 2008, S&P cut Ikons rating to BB- from BB and assigned a negative outlook, citing a lack of revenue growth, increased leverage, and only modest market share in the global document-services market.
Exhibit 3: BB1 Above-Median Spread/Positive Outlook (BUY CANDIDATES) As of May 14, 2008 Cusip 65504RAA 881609AQ Issuer NOBLE GROUP TESORO CORP Coupon 6.625 6.25 Maturity Date 3/17/2015 11/1/2012 Rating Ba1/BB+ Ba1/BB+ Price 93.90 93.00 OAS 422 504 Moody's Outlook STABLE STABLE S&P Outlook POS POS
Exhibit 4: BB1 Below-Median Spread/Negative Outlook (SELL CANDIDATES) As of May 14, 2008 Cusip 723787AF 480081AF 101137AH Issuer PIONEER NATURAL JONES APPAREL BOSTON SCIENTIFIC Coupon 6.875 4.25 6.00 Maturity Date 5/1/2018 11/15/2009 6/15/2011 Rating Ba1/BB+ Ba1/BB+ Ba2/BB+ Price 97.08 97.75 99.00 OAS 324 343 355 Moody's Outlook NEG NEG N/A S&P Outlook STABLE NEG NEG
Exhibit 5: BB2 Above-Median Spread/Positive Outlook (BUY CANDIDATES) As of May 14, 2008 Cusip 170252AA 60741AAF 303901AN Issuer CHIVOR SA MOBILE TELESYSTEMS FAIRFAX FINANCIAL Coupon 9.75 8.00 7.75 Maturity Date 12/30/2014 1/28/2012 4/26/2012 Rating Ba2/BB Ba2/BBBa3/BB Price 110.00 102.00 100.625 OAS 431 442 457 Moody's Outlook STABLE POS STABLE S&P Outlook POS N/A POS
Exhibit 6: BB2 Below-Median Spread/Negative Outlook (SELL CANDIDATES) As of May 14, 2008 Cusip 390568AA 30212PAB 676255AL 750438AB 879006AC Issuer GREAT LAKES CHEMICAL EXPEDIA BRISTOW GROUP RADIOSHACK TEEKAY CORP Coupon 7.00 7.456 6.125 7.375 8.875 Maturity Date 7/15/2009 8/15/2018 6/15/2013 5/15/2011 7/15/2011 Rating Ba2/BB Ba2/BB Ba2/BB Ba1/BB Ba3/BB+ Price 103.00 106.00 97.75 103.00 106.88 OAS 206 311 335 348 362 Moody's Outlook NEG NEG NEG STABLE STABLE S&P Outlook N/A STABLE STABLE NEG NEG
Exhibit 7: BB3 Above-Median Spread/Positive Outlook (BUY CANDIDATES) As of May 14, 2008 Cusip 934391AF 82977RAA 500657AA 918005AY 008477AA 247367AQ Issuer WARNACO INC SISTEMA CAPITAL INVISTA AQUILA INC AGILE PROPERTY DELTA AIR LINES Coupon 8.875 8.875 9.25 9.95 9.00 7.92 Maturity Date 6/15/2013 1/28/2011 5/1/2012 2/1/2011 9/22/2013 11/18/2010 Rating B1/BB Ba3/B+ Ba3/BB Ba3/BBBa3/BB WR/BBPrice 103.50 103.19 103.50 103.07 89.25 90.35 OAS 426 482 483 591 850 984 Moody's Outlook POS POS STABLE POS STABLE N/A S&P Outlook POS N/A POS POS POS POS

SECURITY SELECTION Exhibit 8: BB3 Below-Median Spread/Negative Outlook (SELL CANDIDATES) As May 14, 2008 Cusip 440543AB 184502AK 451713AE 421933AH 09643PAA 950590AJ 69361LAH 78412FAF 87264MAA Issuer HORNBECK OFFSHORE CLEAR CHANNEL IKON OFFICE SOLUTIONS HEALTH MANAGEMENT BLYTH INC WENDY'S INTERNATIONAL PSEG ENERGY HOLDINGS SESI LLC TRW AUTOMOTIVE Coupon 6.125 7.65 7.75 6.125 7.90 6.25 8.50 6.875 7.00 Maturity Date 12/1/2014 9/15/2010 9/15/2015 4/15/2016 10/1/2009 11/15/2011 6/15/2011 6/1/2014 3/15/2014 Rating Ba3/BBBaa3/BBa3/BBNA/BBBa3/BBBa3/BBBa3/BBB1/BB Ba3/BB Price 96.25 103.32 102.25 91.50 102.00 98.00 104.54 97.00 98.00 OAS 329 346 351 382 399 400 403 405 406 Moody's Outlook NEG NEG STABLE N/A STABLE NEG NEG NEG NEG S&P Outlook STABLE NEG NEG NEG NEG NEG STABLE STABLE STABLE
Background Moodys Investors Service and Standard & Poors attach directional outlooks of Positive, Stable, Negative, or Developing to their bond ratings. Watchlistings for Upgrading, Downgrading, or Uncertain supersede outlooks. In our view, many high yield portfolio managers pay inadequate attention to the directional outlooks. Instead, some prefer to belittle the rating agencies on the grounds that the ratings correspond imperfectly to market spreads partly for the very reason that the market reflects information not addressed in the rating, but dealt with by the outlook. The insistence of managers on denying the possibility that ratings and ratings outlooks are ever useful creates a potential opportunity for rational investors who are willing to consider the empirical evidence coolly and objectively. Outlook-Spread Connection As in our previous analyses, if our hypothesis is correct that outlooks at least partly explain observed divergence between ratings and spreads, the issues trading narrower than the median should be concentrated in Positive outlooks and those trading wider than the median should be concentrated in Negative outlooks. The possibility of observing such a clear-cut pattern is constrained by the fact that generally, more than 50% of the outlooks are stable. Nevertheless, we have found the pattern typically exists clearly except in times of elevated volatility in the high yield market, as was found in our January Outlook/Spread Disparity report 5 In this months results (Exhibits 9-11), the Outlook/Spread correlation showed as expected for five of the six groups (Group 1 among BB1s, with an equal count of Positive and Negative outlooks, was the exception). Negative outlooks especially predominate among wider-than-median-OAS BB1 and BB2 credits, with ratios of 20-2 and 13-3, respectively.
Ratings outlooks are important directional signals
Outlook/Spread Disparity Recommendations, Leverage World (January 18, 2008), pp. 17-22.

10
SECURITY SELECTION Exhibit 9: Distribution of Outlooks by Market Risk Premium BB1 As of May 14, 2008 Group 1 2 Total OAS Range 145-382 383-3,680 145-3,680 # of Issuers 39 38 77 Positive 5 2 7 Stable 31 16 47 Negative 3 20 23
Exhibit 10: Distribution of Outlooks by Market Risk Premium BB2 As of May 14, 2008
Negative outlooks proliferate in abovemedian-OAS subgroups
Group 1 2 Total
OAS Range 206-428 429-1,447 206-1,447
# of Issuers 35 34 69
Positive 5 3 8
Stable 25 18 43
Negative 5 13 18
Exhibit 11: Distribution of Outlooks by Market Risk Premium BB3 As May 14, 2008 Group 1 2 Total OAS Range 170-413 414-1,176 170-1,176 # of Issuers 43 44 87 Positive 12 6 18 Stable 22 23 45 Negative 9 15 24

11
SECURITY SELECTION
Focus Issues
Spread Wider than Estimated by Financial Statement Data Amount Outstanding ($MM) 350.0 180.0 509.5 2,849.9 125.0 250.0 1,210.0 1,500.0 200.0 375.0 525.0 450.0 439.0 550.0 Spread May 09, 2008
Issuer Beazer Homes* Beazer Homes* Bon-Ton Department Stores* Idearc MTR Gaming Group Pantry RH Donnelley* RH Donnelley* Rite Aid United Rentals* United Rentals* Verasun Energy Visteon* Visteon*
Coupon 8.375% 8.625% 10.250% 8.000% 9.000% 7.750% 8.875% 8.875% 6.875% 7.000% 7.750% 9.375% 7.000% 8.250%
Maturity 4/14/2012 5/15/2011 3/15/2014 11/15/2016 6/1/2012 2/15/2014 1/15/2016 10/15/2017 8/15/2013 2/15/2014 11/15/2013 6/1/2017 3/10/2014 8/1/2010
Estimated 798 810 944 524 814 593 619 619 777 382 418 908 821 881
Actual 1,110 1,227 1,404 1,093 1,364 1,073 1,327 1,209 1,241 774 814 1,383 1,206 1,198
Difference 312 417 460 569 550 480 708 590 464 392 396 475 385 317
Spread Narrower than Estimated by Financial Statement Data Amount Outstanding ($MM) 300.0 625.0 300.0 299.5 135.0 130.0 Spread May 09, 2008
Issuer CMS Energy Healthsouth McMoran Exploration* Pinnacle Entertainment Pinnacle Entertainment Skilled Healthcare
Coupon 8.500% 10.750% 11.875% 8.250% 8.750% 11.000%
Maturity 4/15/2011 6/15/2016 11/15/2014 3/15/2012 10/1/2013 1/15/2014
Estimated 613 960 1,066 917 942 911
Actual Difference 349 611 727 533 550 610 -264 -349 -339 -384 -392 -301
* Addition since last update.

12
SECURITY SELECTION
Model Update The current version of the multiple regression formula is presented here: Spread = 299.23 + 155.52a + 48.55b + 30.21c 113.42d Where: 299.23 is a constant a = Dummy variable for CCC+ or lower rating (Yes = 1, No = 0) b = Coupon, expressed without considering percentage sign, i.e., 7.5% = 7.5, not 0.075 c = Leverage, defined as total debt divided by EBITDA d = Earnings, defined as log of trailing-twelve-months EBIT in millions of dollars Regression Statistics: Standard Error = 132.28 basis points R2 = 55.3% Adjusted R2 = 55.0% Predictor Constant a b c d t-statistic 5.88 7.68 9.59 11.11 -11.39 P-Value 0.000 0.000 0.000 0.000 0.000
The analysis indicates that each explanatory variable is significant at the 95.0% confidence level or greater. In no case is there greater than a 5.0% probability that the variables coefficient is equal to 0, which would signify that the variable has no explanatory power.
Focus Issues: Why Are They on the List? The key to exploiting the Focus Issues list is fundamental analysis of factors outside the historical financial statements. If, in the investors judgment, the factors do not fully justify the disparity between the bonds estimated and actual yields, the investor should regard the bond as an opportunity to enhance relative performance. The following comments provide the basic reason for each of this weeks additions to and departures from the list.
ISSUERS WITH ISSUES THAT ENTERED THE:

Yielding-More-than-Estimated List Beazer Homess 8-3/8s and 8-5/8s, RH Donnelleys 8-7/8s of 2016 and 87/8s of 2017, United Rentalss 7s and 7-3/4s, and Visteons 7s and 8-1/4s entered the yielding-more-than-estimated list as a result of this weeks Focus Issues model update, which expanded our universe of bonds by 57 issues.

13
SECURITY SELECTION
Bon-Ton Department Storess 10-1/4s widened and entered the yieldingmore-than-estimated list after the company announced a 5.1% decline in firstquarter year-over-year sales. In addition, the High Yield Retailers group underperformed the overall index. Yielding-Less-than-Estimated List McMoran Explorations 11-7/8s entered the yielding-less-than-estimated list as a result of this weeks Focus Issues model update, which expanded our universe of bonds by 57 issues.
ISSUERS WITH ISSUES THAT EXITED THE:

Yielding-More-than-Estimated List
Issuer Continental Airlines Dillard Department Store Ford Motor Credit Gibraltar Industries Jefferson Smurfit Coupon 8.750% 6.625% 8.625% 8.000% 7.500% Maturity 12/1/2011 1/15/2018 11/1/2010 12/1/2015 6/1/2013 Spread on Spread on 05/06 05/09 Change 1,429 672 792 838 789 1,550 703 856 789 785 121 31 64 -49 -4
Continental Airliness 8-3/4s and Ford Motor Credits 8-5/8s were excluded from our sample having failed to meet our screening criteria. Dillard Department Stores 6-5/8s exited the yielding-more-than-estimated list as a result of our models standard error widening by seven basis points. Gibraltar Industriess 8s gained 3 points and tightened, exiting the yieldingmore-than-estimated list in conjunction with the High Yield Metals group outperforming the overall index. Jefferson Smurfits 7-1/2s gained 7/8 of a point and exited the yieldingmore-than-estimated list as a result of their model estimated spread widening by 30 basis points. Yielding-Less-than-Estimated List
Issuer Teekay Shipping Coupon 8.875% Maturity 7/15/2011 Spread on 05/06 407 Spread on 05/09 415 Change 8
Teekay Shippings 8-7/8s were excluded from our sample having failed to meet our screening criteria.
LW

14
SECURITY SELECTION
Senior versus Subordinated Spreads

Exhibit 1: Pairs with Largest Difference between Subordinated and Senior Spreads Data as of May 13, 2008 Issuer Travelport* Travelport* RBS Global & Rexnord RBS Global & Rexnord Reable Therapeutics Reable Therapeutics Cooper Standard Automotive* Cooper Standard Automotive* MGM Mirage* MGM Mirage*
Addition since last update. Note: Boldfaced pairs satisfy the additional criterion of representing an extreme valuation, based on the relationship between default probability and spread. (See Methodology on following page.) 1 In basis points. 2 Option-adjusted spread. Sources: Bloomberg, Lehman Brothers.
Coupon (%) 9.875 11.875 8.875 11.750 10.875 11.750 7.000 8.375 6.000 7.625
Maturity 9/1/2014 9/1/2016 9/1/2016 8/1/2016 11/15/2014 11/15/2014 12/15/2012 12/15/2014 10/1/2009 7/15/2013
Sub? N Y N Y N Y N Y N Y
S&P Rating B CCC+ BCCC+ BCCC+ BCCC+ BB B+
Moody's Rating B3 Caa1 B3 Caa1 Caa1 Caa1 B3 Caa1 Ba2 B1
Price 96.75 90.50 96.00 96.75 100.50 93.00 92.00 83.25 99.25 90.50
YTW (%) 10.59 13.83 9.58 12.38 10.75 13.40 9.17 12.14 6.57 10.02
OAS
1,2
Pickup1 282
695 977 561 838 711 964 592 843 420 667 247 252 253 277
Exhibit 2: Pairs with Smallest Difference between Subordinated and Senior Spreads Data as of May 13, 2008 Issuer MGM Mirage* MGM Mirage Davita Davita Mohegan Tribal Gaming Mohegan Tribal Gaming Newfield Exploration Newfield Exploration Hertz Hertz
* Addition since last update. Note: Boldfaced pairs satisfy the additional criterion of representing an extreme valuation, based on the relationship between default probability and spread. (See Methodology on following page.) 1 In basis points. 2 Option-adjusted spread. Sources: Bloomberg, Lehman Brothers.
Coupon (%) 5.875 9.375 6.625 7.250 6.125 6.375 7.625 7.125 7.625 10.500
Maturity 2/27/2014 2/15/2010 3/15/2013 3/15/2015 2/15/2013 7/15/2009 3/1/2011 5/15/2018 6/1/2012 1/1/2016
Sub? N Y N Y N Y N Y N Y
S&P Rating BB B+ B+ B B+ B BB+ BBBBB
Moody's Rating Ba2 B1 B1 B2 Baa3 Ba2 Ba1 Ba3 B2 B2
Price 85.50 103.13 97.50 99.25 92.50 99.50 104.25 99.75 93.75 100.00
YTW (%) 9.16 7.43 7.24 7.39 8.05 6.82 5.95 7.16 9.52 10.49
OAS1,2 571 488 393 364 479 453 316 294 636 658
Pickup1 -83
-29
-26
-22
23

15
SECURITY SELECTION
Update MGM Mirages senior 5-7/8s of 2014 are potentially attractive relative to the companys subordinated 9-3/4s of 2010, based on the two issues optionadjusted spreads. A similar relationship existed last week between Hertzs senior 7-5/8s of 2012 and subordinated 10-1/2s of 2016. Since then, the seniors gained 1-1/4 points (24 basis points of OAS) on the subs. Methodology For investors hoping to capitalize on short-run pricing discrepancies within a single companys capital structure, a key challenge is monitoring the universe for trading opportunities. Our Senior versus Subordinated Spreads feature serves this need. The objective is to identify each week the five largest and five smallest option-adjusted spread differences among senior-and-subordinated pairs of bonds. In addition, we highlight, in bold type, senior-subordinated pairs with spreads identified as exceptionally wide or exceptionally narrow based on one valuation criterion. This analysis examines the spread as a function of the issuers default probability, as determined by the average assessment of three rating agencies. We do not advise investors to take long and short positions based purely on this information, but rather to use the lists to concentrate their analysis on the most promising trade possibilities. Analysts should bear in mind that in principle, the risk premium for subordination should increase as the probability of default increases. It is in defaults that the disadvantage of subordination becomes real, through a smaller percentage recovery of principal, vis--vis senior creditors. At present, the universe considered in the analysis consists of 96 bonds. They include all nondistressed issues within the Lehman Brothers U.S. Corporate High Yield Index that are obligations of companies represented in the index by at least one senior and at least one subordinated bond. The pricing source is the Lehman index.
LW

16
SECURITY SELECTION
Debt versus Equity

Exhibit 1: Equity Outperforming Debt (U.S.) May 6, 2008 to May 13, 2008 Coupon (%) 8.000 9.250 9.500 6.500 6.375 7.125 9.250 7.000 9.750 6.750 Stock Ticker ROCK SBH MCCC OC NSG WCAA VRX EPL OCR US US US US NO US US US US Bond Price Change 3.68% -0.62% -1.54% 0.59% -0.66% -13.86% 0.00% 0.26% 1.09% 0.27% Stock Price Change 35.61% 22.95% 21.05% 21.74% 19.54% 5.30% 18.86% 17.97% 18.06% 16.87%
Identifier 374689AC 79546VAC 58445MAJ 690742AA 75040PAJ 656533AC 92926KAB 91911XAG 29270UAF 681904AJ
Issuer Gibraltar Industries Sally Beauty Holdings Mediacom Communications Owens Corning Radio One Norske Skogindustrier WCA Waste Valeant Pharmaceuticals International Energy Partners Omnicare
Maturity 12/01/15 11/15/14 01/15/13 12/01/16 02/15/13 10/15/33 06/15/14 12/15/11 04/15/14 12/15/13
Difference -31.93% -23.57% -22.59% -21.15% -20.20% -19.16% -18.86% -17.71% -16.97% -16.60%
ROIAK US
Sources: Bloomberg, Lehman Brothers.
Exhibit 2: Debt Outperforming Equity (U.S.) May 6, 2008 to May 13, 2008 Coupon (%) 9.250 7.500 8.625 6.500 9.500 6.500 6.625 13.000 8.500 7.375 Stock Ticker SPF LNG HOV DSL GGC BZH WCI DSUP POU NP US US US US US US US US CN US Bond Price Change 1.56% -0.28% 2.60% -0.23% -4.99% -1.90% -16.67% -7.94% -0.12% 0.28% Stock Price Change -38.78% -31.09% -26.28% -26.01% -27.56% -24.38% -38.39% -26.50% -15.83% -12.95%
Identifier 85375CAK 785583AF 442488BA 261018AB 373200AQ 07556QAJ 92923CAP 240028AF 699320AC 640079AC
Issuer Standard Pacific Cheniere Energy Hovnanian Enterprises Downey Financial Georgia Gulf Beazer Homes USA WCI Communities Dayton Superior Paramount Resources Neenah Paper
Maturity 04/15/12 11/30/16 01/15/17 07/01/14 10/15/14 11/15/13 03/15/15 06/15/09 01/31/13 11/15/14
Difference 40.34% 30.81% 28.88% 25.78% 22.58% 22.48% 21.72% 18.55% 15.71% 13.22%
Update Sally Beauty Holdingss 9-1/4s of 2014 are potentially attractive after declining by 0.62% despite a 22.95% rise in the related stock. Last week, Tronoxs 9-1/2s of 2012 were in a similar position after underperforming the related stock by 23.53 percentage points. Since then, the bond outperformed the stock by 10.98 percentage points.

17
SECURITY SELECTION Exhibit 3: Equity Outperforming Debt (European) May 6, 2008 to May 13, 2008 Coupon (%) 8.500 8.000 7.000 5.000 8.375 9.750 8.250 6.375 8.750 7.875 Stock Ticker STZ PG NSG FRE AES FMG CDR ALU PPO HTZ US IM NO GR US AU SM FP US US Bond Price Change 0.25% -3.45% -4.15% 0.00% 0.00% 1.92% -1.10% 0.29% 1.05% -1.62% Stock Price Change 11.51% 7.44% 5.30% 8.95% 8.81% 8.92% 5.66% 5.94% 5.47% 2.42%
Identifier XS0111357140 XS0190027051 XS0307552355 XS0240918218 XS0125168780 XS0265075886 XS0222158767 FR0010070805 XS0205216434 XS0278565949
Issuer Constellation Brands Lighthouse International Norske Skogindustrier Fresenius Finance AES FMG Finance Codere Finance Luxembourg Alcatel-Lucent Polypore International Hertz Global Holdings
Maturity 11/15/09 04/30/14 06/26/17 01/31/13 03/01/11 09/01/13 06/15/15 04/07/14 05/15/12 01/01/14
Difference -11.26% -10.89% -9.45% -8.95% -8.81% -7.00% -6.75% -5.65% -4.42% -4.04%
Exhibit 4: Debt Outperforming Equity (European) May 6, 2008 to May 13, 2008 Coupo n (%) 7.000 4.500 7.250 9.875 8.125 8.250 6.750 8.625 8.250 5.750 Stock Ticker CSK IKB GM ITH WMG CETV REX TUI1 LTO TMS US GR US IM US US LN GR IM FP Bond Price Change 2.13% 0.20% 1.79% -2.86% 0.00% 0.00% 0.28% 1.03% 0.52% 0.00% Stock Price Change -18.44% -12.69% -9.58% -11.37% -7.77% -7.08% -6.36% -5.40% -5.29% -5.44%
Identifier XS0207844829 XS0171797219 XS0171942757 XS0203896567 XS0213135998 XS0218213816 XS0307868744 DE000TUAG059 XS0254095663 FR0010237016
Issuer Chesapeake IKB Deutsche Industriebank General Motors IT Holding Finance Warner Music Group Central European Media Enterprises Rexam TUI Lottomatica Thomson
Maturity 12/15/14 07/09/13 07/03/13 11/15/12 04/15/14 05/15/12 06/29/17 01/30/13 03/31/16 09/25/15
Difference 20.57% 12.89% 11.36% 8.52% 7.77% 7.08% 6.64% 6.43% 5.81% 5.44%
Update Codere Finance Luxembourgs 8-1/4s of 2015 are potentially attractive after declining by 1.10% despite a 5.66% rise in the related stock. Last week, Rexams 6-3/4s of 2017 were in a similar position after underperforming the related stock by 7.75 percentage points. Since then, the bond outperformed the stock by 6.64 percentage points.

18
SECURITY SELECTION
Methodology Underlying the analysis presented in Debt versus Equity is the basic premise of capital structure arbitrage. The notion is that all securities within a companys capital structure derive their value from the same set of expected future cash flows. It follows that if the companys expected cash flows increase (decrease), the value of both its bonds and its stock rise (fall). Suppose, then, that a companys bond and stock are correctly valued, relative to each other, on a given date. If the bond price then falls while the stock price rises, then bond must become undervalued, relative to the stock. Conversely, a rise in the bonds price, coincident with a drop in the stock price, renders the bond overvalued, relative to the stock. Misalignment can also result if the stock and bond move in the same direction, but they do not both move in proper proportion to the change in expected future cash flows. Like our Focus Issues and Senior versus Subordinated Spreads analyses, Debt versus Equity is meant to be a preliminary screen. Investors should not reflexively buy all bonds that appear to lag their associated stocks or sell all bonds that appear to leap ahead of their associated stocks. Rather, they should use the list as a means of concentrating scarce research resources on issues with a strong likelihood of offering profits through capitalizing on relative misvaluation. In some cases, the seeming disparity may reflect a circumstance such as the following: The stock and bond were previously misaligned. The recent, nonproportional price movements have returned the securities to their proper relative relationship. The stock and bonds were previously very misaligned. Even after the recent movement, the securities remain out of line with each other, with the error in the same direction as before. The larger absolute movement in the stock, in the same direction as the movement in the bond, merely represents an appropriately larger move in the security at the bottom of the capital structure. The short-run divergence between the stock and bond movements is justified by a fundamental development. For example, an announcement that a company will sharply increase its financial leverage often causes its stock to rise, while its bonds decline as a function of heightened default risk.
Using the Tables Our analysis covers both the U.S. (Exhibits 1 and 2) and European (Exhibits 3 and 4) high yield markets. The former includes all bonds in the Lehman Brothers U.S. Corporate High Yield Index and their corresponding stocks, while the latter looks at the Lehman Brothers Pan-European High Yield Index and the corresponding stocks. Some equity issuers are represented by more than one bond issue apiece.

19
SECURITY SELECTION
Exhibits 1 and 3 list the bonds that are most likely to be attractive as BUYs. They are the ten issues that most dramatically underperformed their corresponding stocks, in terms of simple price change, in the latest week. Exhibit 2 and 4 list the bonds that are most likely to be attractive as SELLs. They are the ten issues that most dramatically outperformed their corresponding stocks. Naturally, the data in Exhibits 1 and 2 or 3 and 4 can also be used for market-neutral trading, with a long (short) position in the bond offset by a short (long) position in the corresponding stock.
LW

20
SECTOR ALLOCATION
Industry Value Tracker

The Industry Value Tracker ranks industries within the Lehman Brothers U.S. Corporate High Yield Index according to the percentage of issues trading wider (by even one basis point) than the spreads estimated for them by the Focus Issues Model. The underlying premise is that if an industry has a pronounced concentration of undervalued (overvalued) issues, it probably reflects a group effect whereby investors are shunning (flocking to) an industry more energetically than the fundamentals warrant. Portfolio managers should not attempt to fine-tune their portfolios to minor differences in rankings. Instead, we recommend that they concentrate on overweighting or underweighting major industries (those with large numbers of outstanding issues) that appear near the top or bottom of the table.
Exhibit 1: Industry Value Tracker* Industry Cheap Automotive Technology Retailers Gaming Wirelines Paper Chemicals Consumer Cyclical Services Consumer Products Independent Energy Metals/Mining Industrial Other Oil Field Services Wireless Aerospace/Defense Health Care Environmental Media Cable Food & Beverage Electric Pipelines % Trading Wider than Estimated 75.76% 73.08% 72.50% 70.83% 60.61% 57.14% 52.94% 51.43% 50.00% 47.17% 45.45% 45.00% 40.00% 30.00% 27.27% 26.19% 25.00% 18.18% 13.04% 12.50% 0.00% Total # of Issues 33 26 40 24 33 14 17 35 28 53 11 20 20 10 11 42 12 11 23 32 35
Rich
Indicates addition since last update.

* Based on Spreads as of May 9, 2008. Sources: Advantage Data, FridsonVision LLC, Lehman Brothers.

21
SECTOR ALLOCATION
Update Environmental exited the rich zone, defined as fewer than 25% of an industrys issues quoted wider than their model-estimated spreads, consistent with underperforming the high yield index over the past week. Wireless exited the rich zone despite outperforming the high yield index. Media cable entered the rich zone consistent with outperforming the index. On the opposite side, Gaming exited the cheap zone, after performing in line with the overall index while Automotive entered the cheap zone, consistent with having underperformed the high yield index.
LW

22
SECTOR ALLOCATION
Credit Ratings Value Tracker

Update Bonds of companies rated Single-B at the senior level (including subordinated issues rated CCC+ or CCC) offer better value than bonds of companies rated Double-B at the senior level (including subordinated issues rated B+ or B). At present, however, we do not recommend actively swapping out of the higher and into the lower tier, since the valuation gap between these two main segments of the high yield universe is 4.17 percentage points, and thus lies below the 15 percentage point threshold we believe may render such action profitable. Bonds of companies rated Triple-C at the senior level currently offer the best value of all, with a percentage-wider-than-estimated ratio of 52.08%.
Exhibit 1: Credit Ratings Value Tracker* Senior-Equivalent Rating BBB BB B CCC % Trading Wider than Estimated 12.00% 43.64% 47.81% 52.08% Total # of Issues 25 291 228 48
* Based on Spreads as of May 9, 2008. Sources: Advantage Data, FridsonVision LLC.
Exhibit 2: Conversion Table Senior-Equivalent Rating BBB S&P Rating BBB BBBBB+ BB BB+ BB BBBBB+ B B+ B BBCCC+ CCC CCC+ CCC CCCNR CCCCC NR Seniority Senior Senior Subordinated Subordinated Senior Senior Senior Subordinated Subordinated Subordinated Senior Senior Senior Subordinated Subordinated Subordinated Senior Senior Senior Senior Subordinated Subordinated Subordinated
BB
CCC
Source: FridsonVision LLC.

23
SECTOR ALLOCATION
Methodology Our evaluation is not based on historical yield spreads, but instead on each rating categorys degree of concentration in issues trading wider than the spreads estimated by our Focus Issues Model. The higher the percentage shown in the middle column, the better is the indicated relative value. (See accompanying conversion table to determine a bonds senior-equivalent rating, based on its nominal rating.)
LW

24
MARKET TIMING
Default Rate Predictor

Update The percentage of distressed issues in the Merrill Lynch High Yield Master II Index amounted to 17.01% as of May 15, 2008. Applying a 23.53% one-year default probability to the distressed portion of the high yield universe, a 1.23% one-year default probability to non-distressed high yield issues, and an error correction term of +112 basis points for the up leg of the credit cycle, Leverage Worlds one-year default rate forecast for May 15, 2009 is 6.14%. This represents a decline from our April 30, 2009 forecast of 6.50%. By comparison, Moodys trailing-twelve-month U.S. speculative grade baseline default rate forecast for April 2009 is 6.87%. Methodology Leverage Worlds Default Rate Predictor issues one-year trailing-twelvemonth U.S. speculative grade default rate predictions based on historical default experience for the distressed and non-distressed subsections of the high yield universe. Empirical results showed that tighter fits with actual default rates can be achieved by using the median distressed and non-distressed default rates of 23.53% and 1.23%, respectively, as opposed to their mean-based alternatives. In light of the observation that the net of annual errors tends to be positive (actual exceeds forecast) during the part of the credit cycle when default rates climb and negative (forecast exceeds actual) when default rates fall, we include an error correction term in our default rate forecast designed to adjust for this countercyclical bias. During the up leg of the past credit cycle (1997-2001), the average discrepancy between the forecasted and actual default rates amounted to 112 basis points per year (range of 4 to 210 basis points, standard deviation of 79 basis points). Exhibit 1 shows our default rate calculation for a baseline scenario that assumes economic conditions, which will neither be ameliorated by a dramatic turnaround in credit market conditions nor exacerbated by a severe recession. Exhibit 2 depicts the closeness of fit of our default rate prediction model over the past year and resulting default rate forecasts through April 2009 at a monthby-month resolution.
Exhibit 1: One-Year Default Rate Forecast May 15, 2009 Distribution of High Yield Universe (%) Distressed Non-Distressed Error Correction Term Default Rate Forecast
*Discrepancies in the default rate forecast due to rounding. Source: FridsonVision LLC, Merrill Lynch & Co.
Annual Default Rate (%) x x 23.53 1.23 1.12 = = = =
Weighted Average (%)* 4.00 1.02 1.12 6.14
+ +
17.01 82.99

25
MARKET TIMING Exhibit 2: Actual versus Forecast April 2007 to April 2009, Monthly
9% 8% 7% Default Rate 6% 5% 4% 3% 2% 1% 0% May May Mar Nov Nov Aug Aug Mar Jul Jun Jan Jun Jul Jan Apr Apr Sep Sep Feb Dec Dec Feb Oct Oct Apr
2008 Month / Year Forecast Actual
2009
Sources: FridsonVision LLC, Merrill Lynch & Co., Moodys Investors Service. LW

26
MARKET TIMING
Macro Tracker
Update The spread-versus-Treasuries tightened by eight basis points to 622 basis points between May 8, 2008 and May 15, 2008. The U.S. High Yield Master II Index posted a total return of 0.23% (12.87% annualized) over the same period. High yield outperformed Treasury notes, mortgages and corporates, all of which posted negative returns. Within the speculative grade sector, bonds of media cable and technology performed strongly, while automotive and home construction issues underperformed the overall index. The yield curve flattened by 13 basis points. Overall, the latest changes in four of six Macro Tracker variables (Impact of Change) favor wider spreads. Methodology The Macro Tracker analyzes the high yield cycle by focusing on factors that have a demonstrable relationship with the risk premium (spread-versusTreasuries). Running commentary on these key determinants of the high yield risk premium will complement our reporting of capital flows into and out of the speculative grade sector. Exhibit 1 lists six factors included in the Macro Tracker. Exhibit 2 enables investors to gain perspective on the current value of the spread and each of its determinants by providing descriptive statistics for the historical series. Current readings appear in Exhibit 3. To facilitate comparability among the six determinants of the spread, we display the magnitude of each variables divergence from its average in terms of a common unit, namely, standard deviation. In general, a small standard-deviation divergence should have only a small impact on the spread. Rather than burden readers with the mental chore of figuring out, in each instance, whether, all else being equal, a positive divergence is consistent with a lower-than-average spread, or vice versa, we supply the answer in the Impact of Current column. Impact of Change indicates whether the rise or fall from the previous reading implies a narrower spread (Favorable) or a wider spread (Unfavorable), all else being equal.
Exhibit 1: Descriptive Information Name HIGH YIELD SPREAD-VERSUS-TREASURIES Default Rate Change in Unemployment Rate Change in Industrial Production Capacity Utilization Change in Consumer Price Index Yield Curve
* Frequency with W=Weekly and M=Monthly. Source: FridsonVision LLC.
Mnemonic SPREAD DRATE UNEMP INDPRO CAPUT CPI YCURVE
Description Master II versus 10-Yr Index U.S. % of Issuers (TTM) Year-over-Year Year-over-Year Percent of Capacity Year-over-Year 10-Yr versus 3-Mo Treasuries
Freq.* W M M M M M W
Source Merrill Lynch & Co. Moody's Investors Service Bureau of Labor Statistics Federal Reserve Federal Reserve Bureau of Labor Statistics Federal Reserve

27
MARKET TIMING Exhibit 2: Descriptive Statistics September 1986 to April 2008, Monthly Variable Average Median St. Dev. SPREAD 502 452 174 DRATE UNEMP INDPRO CAPUT CPI YCURVE 4.84% -1.10% 2.83% 80.97% 3.07% 1.57% 4.15% -5.08% 2.93% 81.20% 2.95% 1.49% 2.90% 12.18% 2.82% 2.76% 1.09% 1.19%
High 1,009 13.00% 46.15% 8.81% 85.10% 6.38% 3.68%
Low 279 0.94% -18.18% -5.72% 73.60% 1.07% -0.70%
Correlation with SPREAD 100.00% 75.82% 68.49% -62.01% -49.96% 24.63% 3.53%
Sources: Bureau of Labor Statistics, Federal Reserve, Merrill Lynch & Co., and Moodys Investors Service.
Exhibit 3: Macro Tracker As of May 15, 2008 Variable Current As of St. Dev.* Impact of Current Previous Reading Impact of Change SPREAD 0.69 630 622 5/15/2008 DRATE UNEMP INDPRO CAPUT CPI YCURVE 2.10% Apr-08 11.11% Apr-08 0.21% Apr-08 79.70% Apr-08 3.88% Apr-08 2.00% 5/15/2008 -0.94 1.00 -0.93 -0.46 0.74 0.36 Favorable Unfavorable Unfavorable Unfavorable Unfavorable Favorable 1.80% 15.91% 1.43% 80.40% 4.00% 2.13% Unfavorable Favorable Unfavorable Unfavorable Favorable Unfavorable
* Current value minus historical mean, expressed in standard deviations. Sources: Bureau of Labor Statistics, Federal Reserve, Merrill Lynch & Co., and Moodys Investors Service. LW

28
ODD LOTS
Department of Corrections
Mistaken Identity The fundamental premise of our selfless assistance to eminent media outlets is that they became eminent partly through their zealous devotion to accuracy. Surely that must be the case for Kidzone, a self-described purveyor of fun facts for kids. (Italics added.) Given the websites professed dedication to factuality, the operators will surely be delighted to be rescued from error by the Department of Corrections.
Investors know the monarchs gimmick as a poison pill
Kidz ones highly informative article on the monarch butterfly (Danaus plexippus) 1 explains that the insects diet of toxin-laden milkweed makes it a poisonous snack for would-be predators. The article also includes a photograph of a viceroy butterfly (Limenitis archippus), alongside one of a monarch, with the following comment: Hes evolved to look like the poisonous monarch to the right so that predators will avoid him too! There is just one small problem. Children reading Kidzones abbreviated account are bound to conclude unjustifiably that the viceroys evolution demonstrates Batesian mimicry. The English naturalist Henry Bates (1825-1892) theorized that a nontoxic species might evolve to resemble a toxic species, thereby warding off predators that recognize the toxic organisms markings. Subsequent researchers assumed that the viceroy, which feeds on plants of the willow family, was nontoxic. In 1991, however, zoologists David Ritland and Lincoln Brouwer demonstrated that a species of butterfly predators, red-winged blackbirds, found monarchs and viceroys equally unpalatable when presented only with their abdomens. Necessarily relying on taste and smell alone, the birds ate a much larger percentage of the queen butterflies (Danaus gilippus, relatives of the monarchs) they were offered in similar fashion. Clearly, the viceroys physical resemblance to the monarch did not explain predators aversion to it. Viceroys may instead be exemplars of Mllerian mimicry, an idea proposed in 1878 by German zoologist Fritz Mller (1834-1895). Under this mechanism, several toxic species adopt the same warning pattern. Potential predators learning is accelerated by the need to recognize only one signal to avoid. 2 The result is a reduction in the number of members of all species within the mimicry complex that get eaten. 3 Researchers have not yet fully explained the evolutionary relationship between monarchs and viceroys. One thing is clear, though: It is not desirable to leave innocent children with the impression that it represents a simple case of Batesian mimicry. The cost to Kidzone of reeducating all of the youngsters who have learned the wrong lesson will not be trivial, but we see no obvious alternative. On the bright side, the website need not expend any resources in thanking us for our unsolicited help, as stamping out error is its own reward.
LW The monarch butterfly is the state insect of Alabama, Idaho, Illinois, Minnesota, and Texas, as well as the state butterfly of Vermont and West Virginia. 2 Wikipedia elucidates, The aposematic colors are most often some combination of red, yellow, black, white, whereas palatable animals are usually cryptic. The noxious animals may display by slow flying, and in general are prominently visible. Noxious animals usually have thick, leathery cuticles through which, at certain points, they extrude noxious fluids when pecked; they will often survive a trial. 3 Readers who desire a fuller account, of which there are undoubtedly many, should see Denyse OLeary, Monarch Viceroy Puzzle, ISCID Encyclopedia of Science and Philosophy [Electronic version].
1
Limenitis archippus

29
LEGAL NOTICES
The material contained in this publication is protected by the copyright laws of the United States of America and by international treaty. Any unauthorized use, reproduction or distribution is punishable by civil and criminal penalty. The material contained in this publication is proprietary and confidential information of FridsonVision LLC and may not be sold or resold under any circumstances. Except as provided above or otherwise as expressly authorized by FridsonVision LLC pursuant to the terms of a written license agreement, no part of the material contained in this publication may be reproduced, duplicated, copied, disclosed, distributed, transcribed, adapted or transmitted in any form by any means, electronic, mechanical, magnetic, optical, manual or otherwise. Leverage World and Brought to You in FridsonVision are trademarks of FridsonVision LLC. THE MATERIAL CONTAINED IN THIS PUBLICATION IS FURNISHED AS IS WITHOUT WARRANTY OF ANY KIND AND ALL WARRANTIES EXPRESSED OR IMPLIED, ARE HEREBY EXCLUDED (INCLUDING, WITHOUT LIMITATION, ANY CONDITIONS OR WARRANTIES RELATING TO MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE). FRIDSONVISION LLC SHALL NOT BE LIABLE FOR ANY TECHNICAL OR EDITORIAL INACCURACIES OR OMISSIONS MADE HEREIN. The material contained in this publication is subject to change without notice. FridsonVision LLC assumes no obligation to keep customers informed of any inaccuracies, updates, or other changes or modifications to any of the material contained in this publication. FRIDSONVISION LLC SHALL NOT BE LIABLE FOR ANY SPECIAL, INCIDENTAL, INDIRECT OR CONSEQUENTIAL, PUNITIVE OR EXEMPLARY DAMAGES OR FOR LOST PROFIT OR REVENUE, IN CONNECTION WITH THE MATERIAL CONTAINED IN THIS PUBLICATION, EVEN IF ADVISED OF THE POSSIBILITY OF SUCH LOSS. IN NO EVENT SHALL THE TOTAL LIABILITY OF FRIDSONVISION LLC TO ANY SUBSCRIBER FOR ALL DAMAGES, LOSSES, AND CAUSES OF ACTION WHETHER IN CONTRACT, WARRANTY, TORT (INCLUDING, BUT NOT LIMITED TO, NEGLIGENCE), STRICT LIABILITY, OR OTHERWISE, EXCEED THE TOTAL AMOUNT PAID BY SUCH SUBSCRIBER TO FRIDSONVISION LLC, IF ANY, FOR THIS PUBLICATION. If you do not agree with these terms, please delete the publication.
30

holdcoPIK Fridson

Diunggah oleh

Informasi Dokumen

Deskripsi Asli:

Judul Asli

Hak Cipta

Format Tersedia

Bagikan dokumen Ini

Bagikan atau Tanam Dokumen

Opsi Berbagi

Apakah menurut Anda dokumen ini bermanfaat?

Apakah konten ini tidak pantas?

Hak Cipta:

Format Tersedia

holdcoPIK Fridson

Diunggah oleh

Hak Cipta:

Format Tersedia

The Weekly Publication of High Yield Strategy May 16, 2008 Vol. 6, No.

Learn more at: www.FridsonVision.com

Dividend Deals and Subsequent Distress

ODD LOTS ...............................29 LEGAL NOTICES ....................30 Brought to You in FridsonVision.TM

Leverage World May 16, 2008

Copyright 2008 by FridsonVision LLC. All Rights Reserved.

96 42 11 4 3 156 28.85% 18.38%

Leverage World May 16, 2008

Copyright 2008 by FridsonVision LLC. All Rights Reserved.

Dividends Paid < 1 Year 23 7 3 33 23.33%

Large Dividends 33 11 10 54 25.00%

Large Dividends Paid < 1 year 15 2 1 18 11.76%

Leverage World May 16, 2008

Copyright 2008 by FridsonVision LLC. All Rights Reserved.

Portfolio managers may be sending a message but forgoing good investments

Leverage World May 16, 2008

Copyright 2008 by FridsonVision LLC. All Rights Reserved.

Outlook/Spread Disparity Recommendations

Slightly more than 5% of BB issuers turn up as potentially misvalued

Leverage World May 16, 2008

Copyright 2008 by FridsonVision LLC. All Rights Reserved.

Interpublic, Noble Group BUYs have been successful

Rating B1/BB Ba3/BB-

Price 103.5 102.25

Moody's Outlook POS STABLE

S&P Outlook POS NEG

Spread (bp) 426 351 75

Leverage World May 16, 2008

Copyright 2008 by FridsonVision LLC. All Rights Reserved.

Source: Advantage Data.

Warnacos first quarter continues a string of solid results

Leverage World May 16, 2008

Copyright 2008 by FridsonVision LLC. All Rights Reserved.

Sources: Bloomberg, Merrill Lynch & Co.

Sources: Bloomberg, Merrill Lynch & Co.

Sources: Bloomberg, Merrill Lynch & Co.

Sources: Bloomberg, Merrill Lynch & Co.

Sources: Bloomberg, Merrill Lynch & Co.

Leverage World May 16, 2008

Copyright 2008 by FridsonVision LLC. All Rights Reserved.

Sources: Bloomberg, Merrill Lynch & Co.

Ratings outlooks are important directional signals

Leverage World May 16, 2008

Copyright 2008 by FridsonVision LLC. All Rights Reserved.

Sources: Bloomberg, Merrill Lynch & Co.

Negative outlooks proliferate in abovemedian-OAS subgroups

OAS Range 206-428 429-1,447 206-1,447

Sources: Bloomberg, Merrill Lynch & Co.

Sources: Bloomberg, Merrill Lynch & Co.

Leverage World May 16, 2008

Copyright 2008 by FridsonVision LLC. All Rights Reserved.

Coupon 8.500% 10.750% 11.875% 8.250% 8.750% 11.000%

Maturity 4/15/2011 6/15/2016 11/15/2014 3/15/2012 10/1/2013 1/15/2014

Estimated 613 960 1,066 917 942 911

* Addition since last update.

Leverage World May 16, 2008

Copyright 2008 by FridsonVision LLC. All Rights Reserved.

ISSUERS WITH ISSUES THAT ENTERED THE:

Leverage World May 16, 2008

Copyright 2008 by FridsonVision LLC. All Rights Reserved.

ISSUERS WITH ISSUES THAT EXITED THE:

Leverage World May 16, 2008