On United Industrial Corp.'s Tender Offer: I'd Pass

Mid Cap Watch List member United Industrial Corporation (UIC) announced that holders of the 3.75% Convertible Senior Notes due 2024 (”Senior Notes”) can convert their Senior Notes into shares of UIC common stock during the calendar quarter from July 1, 2007 through September 30, 2007.

A holder electing to convert Senior Notes will receive either cash or 25.4863 shares of UIC common stock (or a combination of cash and common stock) per $1,000 principal amount of Senior Notes. Conversion is at the option of the holder. Payment in cash and/or UIC common stock is at the option of UIC. This event is triggered by UIC’s stock price remaining above $47.09 (120 percent of the initial conversion price) for at least 20 consecutive trading days during the last 30 trading days of the quarter ended June 30, 2007.

If the Senior Notes are converted into common stock, holders will forfeit their right to receive 3.75% annual interest on the Senior Notes and will instead be entitled to receive future dividends (if any) on UIC common stock. Such dividends are currently $0.40 per share per year, equivalent to an annual dividend yield of 0.67% based on the closing stock price on June 29, 2007.

With UIC shares currently trading at $62.24, conversion would yield $1,586 worth of value for each $1,000 bond. The $0.40 annual dividend would result in a cash flow of $10.19 per year, compared with the current $37.50 from the bond interest. Investors in a high tax bracket would also benefit from the lower tax on dividends than on interest income, which would narrow the differential.

On the other hand, investors who choose not to convert will continue to have the higher annual payments for another 17 years, and will have an effective limit to any stock market losses should the share price decline. If I were a bondholder, the only reason I’d be likely to convert would be if I thought the shares were as high as they could go. Otherwise, I’d just hang on to the higher annual payments and the valuable long-term call option.

UIC 1-yr chart: