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MRGE's High Yield Bonds

|Includes: Merge Healthcare Incorporated. (MRGE)

Full Disclosure: I'm short the stock.

I don't think the bond market is warming up to MRGE's debt as much as is being suggested in a recent bullish posting here on Seeking Alpha. Allow me to explain.

In contrast with what the FINRA database lists, primary source SEC filings reveal that the 11.75% bonds were not issued at 97.266 % on 11/2/2010, but rather were issued in April of that year as part of a private placement. The bonds simply began trading in the public markets in early November as they were converted from the original $200 million privately placed issue to a freely traded public issue with the attendant disappearance of an illiquidity discount. Equivalently stated, all else equal, publicly held, freely traded securities are nearly always priced at a premium relative to their privately held counterparts. The private issue's historic coupon rate and yield would reflect this. So, we would expect the bonds to trade up, to a certain degree, upon such a conversion.

I will concede that not all the reduction in yield is due to the disappearance of an illiquidity discount, but I think about 2% is reasonable, especially for junk bonds undergoing the private-to-public transition.

As mentioned in the original article, the bonds are currently yielding 8.42%. Surveying the results from a basic search for callable, non-convertible bonds with the same S&P and Moody's ratings and approximate time to maturity (May 2015 - May 2016) shows that even 8.42% is still well within junk bond territory with the results of this peer group averaging 7.1%. Pricing the bond at a premium to its private market value simply places its yield to maturity on par with other publicly traded junk credits. I don't interpret this as the bond market warming up to the debt.

(Please perform this search as the result link will not transfer.)

Below are some supporting passages and links relevant to my paragraphs above:

The original issuance terms are succinctly stated in the most recent quarterly filing:

In April 2010, we issued $200,000 of Senior Secured Notes (Notes) at 97.266% of the principal amount, which bear interest at 11.75% of principal (payable on May 1st and November 1st of each year) and will mature on May 1, 2015. The Notes were offered in a private placement pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as amended. In connection with the Notes, we incurred issuance costs of $9,015 (which are recorded in other assets on the condensed consolidated balance sheet). - pages 9-10.

The notes were then converted to a pubic issue in October of 2010 (and apparently began trading freely in the public market in early November). From the first page of the SEC filing:

We are offering to exchange all of our outstanding 11.75% Senior Secured Notes due 2015, which we refer to as the old notes, for new 11.75% Senior Secured Notes due 2015, in an exchange transaction that is being registered hereby. We refer to these new notes as the exchange notes, and together with the old notes, the notes. The terms of the exchange notes are identical to the terms of the old notes except that the transaction in which you may elect to receive the exchange notes has been registered under the Securities Act of 1933, as amended, or the Securities Act, and, therefore, the exchange notes are freely transferable.

Also, to round out my response I should note that the additional $52 million of debt that was later issued followed the same pattern: a private placement subsequently converted to a public issue.

Disclosure: I am short OTCPK:MRGE.