H&R Block soft; Bausch & Lomb, Advanced Medical weak; Macy's, Dillard's higher; Sterling rises

By Ronda Fears

Memphis, July 6 - The market had pretty much given up on a rival bid from Advanced Medical Optics Inc. for Bausch & Lomb Inc., traders acknowledged, and then it tossed up a $4.3 billion counteroffer to private equity firm Warburg Pincus' $3.7 billion deal Bausch & Lomb signed on May 16.

Advanced Medical Optics' cash-and-stock bid that emerged late Thursday also was a surprise in that it offered up more than half in cash, traders said. But because nearly half of it is stock, Advanced Medical Optics shares declined on the event.

Meanwhile, Warburg Pincus was widely anticipated to be preparing a higher bid, according to several traders, but Bausch & Lomb was weaker for much of the session, again attributed to escalating deal risk getting priced into the market these days. In addition to funding risk, there are antitrust issues with a Bausch & Lomb linkup with Advanced Medical Optics, as well as a lengthy 12 months anticipated to close the deal.

H&R Block Inc., however, was weaker as traders said rumors began circulating that the sale of its subprime mortgage unit, Option One Mortgage Corp., to Cerberus Capital Management might be in jeopardy because of shortfalls in required warehouse lending minimums.

Sterling Financial Corp. saw strong gains, though, as traders speculated a deal could be imminent, possibly at a hefty premium for the Lancaster, Pa., regional bank, by Manufacturers & Traders Trust Co.

Elsewhere, Macy's Inc. continued to surge amid buyout speculation with the stock (NYSE: M) advancing $2.22, or 5.58%, to $41.99. Dillard's Inc. also continued to trade higher, a week after one if its investors - Barington Capital Group with a 3.2% stake - asked for a meeting with company executives to discuss ways to improve its performance; the stock (NYSE: DDS) gained 48 cents, or 1.33%, to $36.47.

Traders said Macy's and Dillard's were lifted on improved views of takeovers in the retail sector by the rival bid that emerged for Jones Apparel Group's Barney's New York division. Fast Retailing, of Japan, has submitted a $900 million bid to trump an $825 million offer by Istithmar, a Dubai-owned private equity firm. And, the sale of Barney's is increasingly seen as a precursor to putting Jones Apparel on the map as a takeover target, one trader said. Jones Apparel (NYSE: JNY) added 11 cents, or 0.38%, to $28.71.

In the metals group, the ongoing battle over and between Alcoa Inc. and Alcan Inc., for which the former has made a hostile bid, remains engaged. The Telegraph in London reports Rio Tinto is "understood to have engaged Credit Suisse and Deutsche Bank to advise it on a range of options, including a bid for Alcan." A bid for Alcoa is possible, as well, but thought less likely. Companhia Vale do Rio Doce still is widely considered to be looking at making a play for Alcoa or Alcan, one trader said.

Alcan (NYSE: AL) rose $1.38, or 1.62%, to $86.48. Alcoa (NYSE: AA) added 31 cents, or 0.75%, to $41.66. CVRD (NYSE: RIO) advanced 56 cents, or 1.18%, to $48.03. Meanwhile, Rio Tinto (NYSE: RTP) lost $2.45, or 0.75%, to $322.20.

Eye on Bausch & Lomb

Advanced Medical has tossed out a $75-per-share bid - $45 in cash and $30 in stock - 16% more than Warburg's $65 all-cash bid, but it wasn't universally considered a better bid, traders said. Thus, along with increasing deal risk in the market and antitrust issues with the rival offer, both stocks were weaker on the event.

Advanced Medical Optics (NYSE: EYE) closed off by 4 cents, or 0.11%, at $35.85 after trading in a wide range intraday of $33.90 to $36.

Bausch & Lomb (NYSE: BOL) traded in a band of $71.30 to $72.05 before settling unchanged at $72 flat.

"You have to look beyond the face of the dollar amount. A lot of folks would rather have a cash deal and take the money and run. When there is a mix, then you have to consider whether you want to own that other stock. EYE just had a big product recall and they lowered estimates because of that. The stock is not as attractive now as it was before that happened," said a risk arb trader at a New York hedge fund.

"You also have to consider, does the $45 cash, $30 stock offer take into account the debt that Bausch & Lomb has, and the breakup fee too? On top of that, EYE doesn't have the cash. It will borrow, assume too much debt and run negative for years. Another unappealing aspect of getting EYE stock is that the $30 stock you get for each BOL share will dilute your ownership because the whole transaction is dilutive to EYE shareholders."

Bausch & Lomb has traded above the $65 offer from Warburg Pincus since Advanced Medical Optics announced publicly that it was considering a bid for the well-known maker of eyecare products, but a day after that announcement there was a major recall of one of Advanced Medical Optics' eyecare products. Bausch & Lomb has suffered from numerous recalls of its eyecare products in recent times, too.

Advanced Medical wants Bausch for its contact lens and eyeglasses lines, which would complement its own product line of eye solutions and laser vision correction tools.

But onlookers widely expect that if an Advanced Medical Optics linkup with Bausch & Lomb were to go forward, it would require some divestitures to appease regulators.

Advanced Medical Optics provided some allowances because of the long time frame for its deal, which was estimated at up to 12 months, including interest of 7.2% from six months of signing a definitive agreement. But one trader noted that it wanted a $130 million reverse breakup fee, compared with $40 million for Warburg Pincus.

"There are a lot of nuances in the EYE deal that make it not as attractive as going private, even though the dollar figure is bigger," agreed a buyside market source. "I think that's why we saw some sellers of Bausch & Lomb today; they were taking almost 7 points more than the Warburg Pincus deal and happy to get away."

H&R Block wavers

H&R Block could be in trouble with regard to the sale of its subprime mortgage unit, as one of the contingencies linked to the deal require a minimum of $8 billion in warehouse lending lines of credit, including $2 billion of unused capacity as of the closing date, which some observers think has been breached or is close to being breached.

H&R Block shares (NYSE: HRB) slipped by 4 cents on Friday, or 0.18%, to $22.51.

As of July 3, one market source said the unit was considered to be comfortably above that minimum, with $10 billion of warehouse lines.

However, $2 billion was uncommitted and Lehman Brothers was rumored to have decided recently not to renew its $1.5 billion line, he said. Additionally, a $1.5 billion warehouse line from Citigroup Inc. is set to expire this month, along with a covenant waiver related to profitability ratios on a $750 million line from UBS AG.

On the supporting end, he said Bank of America Corp. agreed to increase its line temporarily by $250 million, or only until the sale to Cerberus closes - Oct. 31 or sooner.

Kathleen Shanley, an analyst with bond research firm Gimme Credit LLC, said in a report Thursday that the Lehman loss itself could jeopardize the Option One sale, or at the least leave "Option One skirting dangerously close to the line ... with little margin for error."

H&R Block also is likely facing a proxy battle with activist stockholder Breeden Capital Management LLC. In a statement last week, the company said it had met with Breeden but did not elaborate. Breeden has aired plans to nominate three candidates to H&R Block's board of directors in order to bring "fresh perspective and new energy" to the board, and some onlookers think H&R Block might be put on the auction block.

Sterling Financial shines

Sterling Financial, which put itself on the auction block in early June after revealing in late May an ongoing investigation of a loan scheme by employees at an affiliate, could be getting a buyout bid soon and likely from Manufacturers & Traders Trust, which has provided it an $80 million credit agreement.

Sterling shares (Nasdaq: SLFI) gained 29 cents, or 2.83%, to close Friday at $10.54.

The Lancaster, Pa., regional bank said last week that it has made progress on its capital restoration plan by signing an $80 million credit agreement with Manufacturers & Traders Trust, earmarking the proceeds to reinforce operating capital of its primary subsidiary, BLC Bank, NA, and repay outstanding debt of its Equipment Finance LLC affiliate.

"My guess is that M&T has extended this temporary infusion of capital as part of an agreement to have a right of first refusal for the purchase of Sterling," one trader said.

Another market source thinks Sterling could be near a deal as well, and also thinks Manufacturers & Traders Trust is a natural buyer.

"On the fraud at the equipment finance subsidiary, I think the $165 million worst case number is probably too severe; that's without insurance recovery or collateral recovery. I think it could be more like $100 million-ish," he said.

"Getting $30 million of base earnings power without the finance unit means it's trading at 10 times that number. I think downside is slight and the company could go for around $15 share. I think this [company] will be sold shortly."

Sterling's capital restoration plan consists of several steps. The first step was the consolidation of bank charters, accomplished on May 25, which allows Sterling to use capital more efficiently. Subsequent steps included the halting of dividends for a period of time and infusing capital into BLC Bank.

In addition, Sterling continues to explore other strategic options, including raising capital for Sterling, the sale of one or more business units, or the sale of the company. These steps are designed to restore capital levels and to begin to rebuild shareholder value following the discovery of a sophisticated loan scheme at its equipment finance affiliate.

Bally lifted by alternate plan

Bally Total Fitness Holding Corp. received a proposal from a group of shareholders - four private equity funds - for an alternative to the company's proposed Chapter 11 plan of reorganization. And while details of their plan were not circulated, traders said the stock surged on anticipation of an equity payout.

"These are equity guys with the plan, so everyone figures there will be something for the equity," one trader said.

Bally shares (Pink Sheets: BFTH) shot up 36.5 cents, or 82.95%, to close Friday at 80.5 cents.

The shareholders have agreed to complete their due diligence by July 20.

The company is soliciting consents to its pre-packaged plan of reorganization, as to which holders of 63% of its senior notes and more than 80% of its senior subordinated notes have signed a restructuring support agreement.

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