Catch-Up Could Make Spread More Palatable: The Weekly Publication of High Yield Strategy February 27, 2004 Vol. 2, No. 9

TM
The Weekly Publication of High Yield Strategy February 27, 2004 Vol. 2, No. 9
Contact us at: BIG PICTURE…

LeverageWorld@FridsonVision.com
Catch-up Could Make

Learn more at:
www.FridsonVision.com Spread More Palatable
The financial press can legitimately claim to have been ahead of the curve
regarding the widening of high yield spreads at the beginning of this week.
Shortly before the selloff began, several publications highlighted 2003’s
dramatic contraction in the interest rate differential between noninvestment
grade bonds and Treasuries.1
Barron’s quoted a portfolio manager who warned of the “huge sucking

sound” that would be heard when hedge funds began to withdraw speculative
capital that they poured into the high yield sector in anticipation of the rebound
that occurred between October 2002 and January 2004. Sizable price drops
followed the Barron’s story almost immediately, with particular emphasis on the
Martin@FridsonVision.com low-rated, large-capitalization names that the hedge funds had favored. That
made the PM a better prophet than Ross Perot, who coined the phrase “giant
CONTENTS sucking sound” to dramatize his prediction that the North American Free Trade
Agreement (NAFTA) would produce a massive U.S. job loss as it took effect in
1994.2
BIG PICTURE
Catch-up Could Make Spread More The Non-Disaster Scenario
Palatable ....................................... 1
As usual, there was another side to the story. Although the magnitude of the
SECURITY SELECTION peak-to-trough spread-compression – from +1,063 basis points (October 10,
Rich/Cheap: 2002) to +340 (January 26, 2004)3 – may have looked worrisome to some
Airgas / Georgia Gulf.................... 7 readers, the statistic by itself was no reason for concern. A contraction of almost
Focus Issues: exactly equivalent magnitude occurred between January 3, 1991 and September
9, 1994.4 Over the succeeding two-year period, the high yield sector produced
Additions: ↑ Aztar, Unisys
an annualized total return of 13.51%. In short, the last time the high yield sector
↓ Amkor Technology, Echostar rose as dramatically as it did in the latest bull market, it went on to beat its long-
Communications ......................... 11 run average return by almost 400 basis points per annum.5
Senior versus Subordinated
Valuation: Faced with this precedent, one can hardly argue that a 723-basis-point
contraction automatically rules out good returns going forward. Moreover, as a
Mandalay Resort Group.............. 14
result of a selloff that began in late January, as well as this week’s movement,
SECTOR ALLOCATION the spread-versus-Treasuries has widened back out to +383. Somewhere, there
Industry Value Tracker ............... 16 is probably an inveterate optimist who thinks the high yield sector looks cheap!
Credit Ratings Value Tracker...... 17
1
See Jennifer Ablan, “Overpriced Junk: After a Big Rally, Yields Don’t Match the Risk,” Barron’s
MARKET TIMING (February 23, 2004), p. 26, Christopher O’Leary, “A Time Bomb in High Yield?” Investment
High Yield Sector Value Dealers’ Digest (February 16, 2004), pp. 28-33, and Richard Lehmann, “Outlook for High-Yield
Bonds in 2004,” www.forbes.com (February 19, 2004).
Tracker........................................ 18 2
See Doug Abraham, “Most Experts Agree: No ‘Giant Sucking Sound,’” www.thedesertsun.com
LEGAL NOTICES ...................19 (June 17, 2001). For a current assessment, see Christopher Swann, “Economists See Nafta as Being
Beneficial for U.S. Jobs,” Financial Times (February 24, 2004), p. 3.
3
Measured by the Merrill Lynch High Yield Master II Index versus ten-year Treasuries.
4
The spread change over this interval was from +1,052 to +327, or 725 basis points.
Brought to You in FridsonVision.TM 5
For all full years from inception through the end of 2003, the mean annual return of the Master II
Index was 9.65%.
Copyright 2004 by FridsonVision LLC. All Rights Reserved.

See last page for usage restrictions and other legal terms.
BIG PICTURE…
Too Much, Too Fast?
Much as we hate to rain on anybody’s parade, however, we feel obliged to

point out two important differences between the 1991-1994 tightening and the
2002-2004 reprise. First, the more recent episode was far more compressed – 16
months versus 44 months for the earlier spread-tightening period. Second,
according to our econometric model of the spread-versus-Treasuries,6 the ending
spread of +327 basis points on September 9, 1994 was a nominal 10 basis points
wider than warranted by then-prevailing measures of default risk, market
liquidity, and monetary conditions. By contrast, the January 26, 2004 spread of
+340 was 195 basis points tighter than the model’s estimated spread. This
means that the previously mentioned two-year period of better-than-average
returns (September 9, 1994 to September 9, 1996) began with the high yield
sector priced at its fair value, whereas the sector is richly priced at present, even
after widening out by 43 basis points from its recent minimum spread.
A reasonable interpretation of this evidence is that the high yield market has
The risk may catch gotten ahead of itself. At some later point in the present economic recovery,
up with the risk perhaps, default risk, market liquidity, and monetary factors will justify a spread
of less than 400 basis points over ten-year Treasuries. A valuation in that range
premium is premature, however, if one accepts the verdict of the Leverage World spread
model.
This is not necessarily a gloomy judgment. There are, after all, several
different ways to close the gap between the actual risk premium (spread-versus-
Treasuries) and the risk premium warranted by the present risk:
1. The risk can decline until it is in line with the risk premium.
2. The risk premium can increase until it is in line with the risk.
3. The risk can decline and the risk premium can increase, until the two
converge.
Other combinations are possible, but if we focus on these three, we observe

that Outcome #1 is the most desirable from the viewpoint of investors with long
Distributed by FridsonVision LLC.
Martin Fridson, CEO. positions in high yield. How likely is this scenario? In order for the spread’s
Greg Braylovskiy, Analyst. estimated value to decline from its present +569 basis points, the explanatory
The material contained in this publication is variables must, in aggregate, move in the directions that are consistent with a
protected by the copyright laws of the United
States of America and by international treaty. tighter spread. Exhibit 1 shows the current value of each variable, excluding
Any unauthorized use, reproduction or the dummy variable discussed below. The table also shows the all-time
distribution is punishable by civil and criminal
penalty. See last page for usage restrictions and (September 1986 to present) Most Favorable value, that is, the value implying
other legal terms.
the tightest spread.
Exhibit 1: Values of Leverage World Model Variables
Cash as % of High Yield Slope of Treasury

Default Rate High Yield Mutual Fund Treasury Yield Yield (10-
on High Yield CPI (Year-over- Mutual Fund Flows as % of Unemployment Curve (3 Months Year
Bonds Year Change) Assets Fund Assets* Rate to 10 Years) Maturity)
Current 5.06% 0.20% 5.36% -2.04% 5.60% 3.12% 4.05%
Most Favorable 1.40% 0.10% 3.71% 5.41% 3.80% 3.67% 9.52%
* Latest four weeks.
Source: FridsonVision LLC.
6
See “Record Short-Term Overvaluation for High Yield” in “Sample Research” section of
www.LeverageWorld.com.
Leverage World –February 27, 2004 Copyright 2004 by FridsonVision LLC. All Rights Reserved. 2
BIG PICTURE…
By observation, all variables have room for improvement. The Consumer

Price Index change and the slope of the Treasury yield curve offer very limited
potential for a reduction in the required spread, but the default rate, mutual fund
flows, and the unemployment rate could get considerably better. For example, a
drop in the default rate to the series low of 1.40% would reduce the Leverage
World Model’s estimated spread by 111 basis points. (Contrary to what many
investors suppose, empirical evidence indicates that a higher Treasury yield
would imply a narrower spread-versus-Treasuries, but we doubt investors would
regard a rise in the Treasury yield to the 9.52% series high as a bullish
development.)
The other extremely important risk factor, however, is the liquidity-

constraining impact of dealers’ sharply reduced commitment of capital to
secondary market-making since the Russian default and Long-Term Capital
Management crisis of 1998.7 The Leverage World Model accounts for this
dramatic environmental change through a dummy variable. All months up to
and including July 1998 are coded “0” and all subsequent months are coded “1.”
The dummy variable’s coefficient is derived by letting the computer fit a
multiple regression to the data. It indicates that with other risk factors equalized
for a given pre-August 1998 and post-August 1998 month, the expected spread
is 187 basis points wider in the latter period.
In order for the present spread to be judged fair value, according to the
Leverage World Model methodology, the estimated spread would have to be
within one standard deviation (55 basis points) of the actual spread (+383). That
is, the estimated spread would have to be +438 or less. Given the 187-basis-
point value of the market-making dummy variable, the other variables would
have to indicate a spread of 438 – 187 = 251 basis points.
This would not be unprecedented. In June 1994, before the market-making

dummy variable became a factor, the remaining variables indicated an estimated
spread of only +223. Accordingly, risk may decline sufficiently during the
present cycle to justify the present risk premium. It is likely, however, that
investors will experience some sizable setbacks along the way.
7
Bulls will probably point out that high yield secondary market liquidity has been excellent for most
of the past year-and-a-half, notwithstanding our claim that dealers have curtailed their market-
making. We would reply that the explanation is simple. With huge amounts of capital coming into
the market, there has been little need for dealers to use their capital to facilitate trades. Demand has
so far outstripped supply that almost any bond put up for sale by an investor has immediately found
an end buyer, thereby minimizing the intermediaries’ need to inventory bonds while waiting for a
buyer to materialize.
The story has been much different, however, whenever hedge funds have begun to unwind their high
yield positions. With no meaningful dealer capacity to absorb the secondary supply, prices have
fallen several points in an instant. In short, we see spreads as highly vulnerable in the event of a
switch from net capital inflows to net capital outflows. At that point, it seems logical to assume,
investors will expect to be compensated for the renewed difficulty of selling when they want to sell.
Accordingly, we see no justification for dropping the dummy variable from the Leverage World
Model.
BIG PICTURE…
Another Sign of Premature Contraction
We can corroborate the verdict of Leverage World’s explanatory variables,

i.e., that the spread-versus-Treasuries is running ahead of the ongoing decline in
risk, by observing the relationship depicted in Exhibit 2. In the last cycle, the
Triple-C component of Merrill Lynch’s High Yield Master Index8 declined from
a peak of 17.9% in 1991 to a low of 4.8% in 1994. This ratio is affected by
several factors, including defaults by Triple-Cs, retirements, fallen angels
entering the Double-B category, Double-Bs rising to investment grade, and the
quality mix of new issues. One key factor, though, the upgrading of Triple-Cs
to Single-B, clearly constitutes a cyclical trend toward reduced credit risk.
Appropriately, the risk premium (spread-versus-Treasuries) declined along with
the Triple-C/Total Index ratio during 1991-1994.
Exhibit 2: Spread and Quality Mix

Annually, 1988-2004
1,000 25
20
750
15
500
10
250
5
0 0
1988 1990 1992 1994 1996 1998 2000 2002 2004*
Yield Spread: Merrill Lynch High Yield Master II Index

versus Ten-Year Treasuries (in Basis Points)
Triple-Cs as Percentage of Master (by Issues)
*As of February 26, 2004.

Source: Merrill Lynch & Co.
As the graph shows, the spread began to fall sharply one year before the
Triple-C/Total Index ratio began to decline. Accordingly, it would not be
surprising to see the spread leading the ratings mix improvement this time
around. In fact, though, the Triple-C component is already down (to 18.8%)
from its 22.4% peak. At +383, the spread is running far ahead of the drop in the
Triple-C/Total Index ratio. When the ratio was at a comparable level in the last
cycle (17.9% in 1991), the spread was at +675. In all likelihood, the two series
will come into line eventually. For the moment, though, the spread is acting as
if the market were much further along in the credit cycle.
8
No ratings breakdown is available prior to December 31, 1996 for the Master II Index. We
measure by number of issues to eliminate the distortion in the market-value percentage that arises
from wide price swings on Triple-C issues.
BIG PICTURE…
Measuring Spread-Tightening
Finally, readers should be aware that spread-tightening may be reported in

coming months without high yield investors benefiting in total return terms.
Naturally, that would happen if yields were to rise on both the high yield index
and ten-year Treasuries, but by a larger amount on the latter than on the former.
In that case, the high yield index would perform well on a relative basis, but its
absolute yield rise could produce a dismayingly low total return. There would
be little confusion in investors’ minds about what had happened, however.
An alternative scenario, on the other hand, could create a false sense of life
getting better for high yield investors. In the simple, illustrative example
depicted in Exhibit 3, the high yield index consists of just three issues of
equivalent market value and maturities of seven, nine, and twelve years. The
high yield index’s yield is:
Exhibit 3: Index Spread Based on Issue-Specific Spreads (Illustration)
10
Y Z
8 X
6
Percent
0
5 6 7 8 9 10 11 12
Maturity (Years)
Treasuries
X, Y, Z Individual High Yield Bonds
(7.50% + 8.25% + 8.50%) ÷ 3 = 8.08%
The spread-versus-Treasuries, as we have defined it throughout this article, is

the index’s spread versus the yield on ten-year Treasuries, the actively quoted
maturity that most closely matches the average maturity of the bonds in the
index:
8.08% - 4.25% = 3.83% (= 383 basis points)
Some published spreads, however, are defined as the weighted average of

each issue’s spread versus Treasuries:
[(7.50% - 3.50%) + (8.25% - 4.25%) + (8.50% - 4.50%)] ÷ 3 = 400 basis

points
From a public relations standpoint, +400 sounds better than +383, even
though both versions of the spread describe the same set of facts. Defining the
spread differently does not make the market cheaper, but it makes it sound
cheaper.
BIG PICTURE…
The more important point, however, is the effect of a flattening of the

Treasury curve, with no change in the yields on the bonds in the index, as shown
in Exhibit 4. The spread as we define it (versus the ten-year Treasury yield)
remains 8.08% - 4.25% = 383 basis points. By contrast, the alternatively
defined spread shrinks to:
[(7.50% - 4.25%) + (8.25% - 4.25%) + (8.50% - 4.50%)] ÷3 = 375 basis points
Exhibit 4: Spread After Yield Curve Shift (Illustration)
10
Y Z
8 X
Percent 6
0
5 6 7 8 9 10 11 12
Maturity (Years)
Treasuries
X, Y, Z Individual High Yield Bonds
By the alternative definition, the spread-versus-Treasuries has narrowed from

+400 to +375. Investors have reaped no capital gain, however. The yields on
their bonds have remained constant, so the prices have changed only to the
minimal extent associated with the approach of redemption at par. In short, the
“improvement” in high yield investors’ situation is illusory. As a matter of fact,
one could argue that investors are worse off than before. In the world of
econometric modeling, the flattening of the yield curve implies reduced
prospects for economic growth. If Gross Domestic Product growth falls below a
threshold of 1.5% to 2.0%, all other things being equal, default rates are
statistically likely to rise.
The bottom line is that investors will have to watch the numbers closely in
coming months to maintain a correct understanding of the risk-versus-reward
tradeoff. As esoteric as it sounds, the variation in definitions of the spread-
versus-Treasuries may influence portfolio managers’ perceptions of improving
or deteriorating value. Fortunately, the producers of Leverage World derive
intellectual pleasure from unraveling the intricacies of indexes. Accordingly,
readers can count on receiving periodic updates on the real trends underlying the
statistics.
LW
SECURITY SELECTION…
THE PRESENT 106-BASIS-POINT DIFFERENCE IN SPREADS BETWEEN

THE AIRGAS 7-3/4% OF 2006 AND THE GEORGIA GULF 7-5/8% OF
2005 REPRESENTS THE MOST ATTRACTIVE SWAP POSSIBILITY
AMONG NONDISTRESSED, HIGH YIELD, CHEMICAL ISSUES, BASED
ON OUR FINANCIAL VALUATION MODEL. AIRGAS IS IN THE
PROCESS OF AUGMENTING ITS ALREADY DOMINANT POSITION IN
THE PACKAGED GAS BUSINESS. MEANWHILE GEORGIA GULF
FACES CONSIDERABLE UNCERTAINTY OVER PROSPECTS FOR ITS
CORE PRODUCT, POLYVINYL CHLORIDE, AS WELL AS WEAKNESSES
IN OTHER AREAS.
Chemicals: Airgas and Georgia Gulf
Our Rich/Cheap methodology identifies on a weekly basis an industry pair

that offers potential as a long-short relative value trade.1 (Note that the analysis
does not preclude executing only one side of the proposed swap.) This week’s
analysis concentrates on the Chemicals industry. Exhibit 1 presents two
potentially misvalued bonds with their Focus Issues Model estimates and actual
spreads. If we were to judge solely by the model-generated numbers, the Airgas
(NYSE: ARG) 7-3/4% unsecured notes due September 15, 2006 would be 177
basis points too wide versus the Georgia Gulf (NYSE: GGC) 7-5/8% unsecured
notes due November 25, 2005.
Exhibit 1: Focus Issues Model Estimates and Actual Spreads*

(Basis Points)
Potential Relative
BUY Ratings Price Estimated Actual Value Pickup
Airgas 7.75% 9/15/2006 Ba1/BB 105.625 297 345
Georgia Gulf 7.625% 11/25/2005 Ba3/BBB- 106.125 368 239
SELL Difference -71 106 177
* Spreads as of February 25, 2004.
Sources: Advantage Data, FridsonVision LLC.
As of February 25, 2004, the spread of the ARG notes was 106 basis points
wider than the GGC issue’s. Based on differences in coupon, coverage ratio,
and EBIT (neither issue is rated below B-), a yield giveup of 71 would be
predicted. Exhibit 2 graphs the relationship between the spreads of this industry
pair since February 2002. Note that the two issues have closely tracked each
other with GGC’s bond trading at a wider spread from March 2003 to June
2003. Moreover, the current difference between the spreads is one of the largest
in the entire time period.
1
See “Rich/Cheap,” Leverage World (August 1, 2003), pp. 1-5.
Exhibit 2: Spread for ARG and GGC notes
Source: Advantage Data.
Fundamental Factors
GGC’s bond has experienced significant spread-tightening and price

appreciation following the release of the company’s financial results for the first
quarter of 2003. Investors concentrated on the company’s better-than-expected
earnings and on the extremely positive projections for the rest of the year.
However, those expectations failed to materialize and sell-side equity analysts
following GGC were forced to reduce their 2003 earnings estimates several
times throughout the year. Nevertheless, both the company’s equity and its
bonds have continued to gain in price, largely on hopes that improving
economic conditions will eventually have a substantial positive effect on the
cyclical Chemicals group. Meanwhile, the spread on ARG’s bond has also
tightened since May, but at a much slower pace, despite the company having no
problem with meeting the average earnings estimate in the last three quarters.
Two major fundamental factors suggest that the divergence in spreads will
disappear or decrease significantly:
· While Georgia Gulf has recently stated that it expects a strong market for its
main product, polyvinyl chloride (PVC), in 2004, last year’s results show
that this market is highly volatile and difficult to predict. The company
continues to face high energy and raw materials costs, and there is no
guarantee that it will be able to pass on those costs to its customers through
price increases. For example, there were instances in 2003 in which
customers refused to accept a price hike. Furthermore, recovery in PVC
volumes has been less than stellar. Finally, the company’s Aromatics
division, which accounted for nearly 25% of revenues in the fourth quarter
of 2003, has continued to struggle, unable to deliver material positive
earnings.
· Airgas has recently announced that it obtained an amendment to its credit

agreement, which would allow it to proceed with the acquisition of the
BOC’s U.S. packaged gas business. This acquisition would boost ARG’s
market share to 25% of this highly segmented market, further cementing its
dominant position and enhancing its geographical coverage. The company
has an excellent record in integration of acquired businesses as evidenced
by its addition of Air Products in 2002. Furthermore, the company has been
able to offset weakness in its core gas business by increasing its sales of
welding hardgoods.
Airgas
Description
ARG, headquartered in Radnor, Pennsylvania, is the largest distributor of

specialty, industrial, and medical gas in the United States. The company was
founded in 1982 through a private acquisition of Connecticut Oxygen, put
together by current Chief Executive Officer Peter McCausland. For the full year
ending in March of 2003, ARG recorded sales of $1.8 billion, while posting net
income of $68 million. Currently, the company has about $400 million of high
yield debt outstanding, with nearly half of it maturing by the end of 2006.
Airgas last accessed the high yield debt market in July 2001 with a $225 million
issue.
Overview
ARG executed a classic roll-up strategy in the United States gas distribution
market. Created on the base of a single distributor, the company soon started to
snap up small local and regional competitors, often with annual sales of less than
$5 million. By 1994, the company was large enough to approach companies
that held dominant positions in their respective regions. In the next three years,
Airgas doubled its revenues and became a clear market leader. Now, the
company is further increasing its reach with the purchase of BOC’s business and
several smaller acquisitions. While its core gas distribution market has been
slow to turn around, Airgas has maintained profitability and diversified its
sources of revenue. A pickup in industrial demand for gases in 2004 would
have an extremely positive effect on the company.
Recent Developments
On January 27, 2004, Airgas announced that it has signed a non-binding letter
of intent to acquire most of the assets of the BOC’s U.S. packaged gas business.
This business generated about $240 million in revenues during the past year.
The acquisition is expected to close by mid-2004. On January 28, 2004, the
company reported solid financial results for the fiscal third quarter of 2004.
Earnings per share of $0.28 represented a 22% increase from the preceding-year
period and were in line with expectations. Revenues rose by 4% to $452
million, driven by strength in hardgoods sales.
Georgia Gulf
Description
GGC, headquartered in Atlanta, Georgia, is one of the largest producers of

chlorovinyls in the United States. The company was created in 1985 through a
spin-off of Georgia-Pacific’s commodity chemicals division. For the full year
2003, GGC recorded sales of $1.4 billion, while posting net income of $13
million. Currently, the company has about $200 million of high yield debt
outstanding, with half of it maturing in 2005. Georgia Gulf last tapped the high
yield debt market in November 2003 with a $100 million issue.
Overview
Georgia Gulf relies heavily on passing on to its customers the full cost
increases on inputs it uses in production. Inability to do so would create a great
hardship as the company discovered during previous episodes of record natural
gas prices in 1996-1997 and in 2001. Earnings per share fell from $4.73 in 1995
to $1.85 in 1996, and the company lost $0.21 per share during the first quarter of
2001 compared to a profit of $1.00 in the preceding-year period. Furthermore,
the current period of natural gas prices substantially exceeding the historical
average has lasted longer than previous instances. With costs on almost all of
the inputs at or near historic highs, the company is saddled with depressed
margins.
Recent Developments
On February 4, 2004, Georgia Gulf reported mixed financial results for the
fourth quarter and full year 2003. For the fourth quarter, earnings per share
were $0.20 after excluding an after-tax charge of $0.26 per share related to the
early retirement of debt undertaken in November 2003. Revenues rose by
16.8% to $372.5 million, largely reflecting a price increase necessitated by
higher natural gas and raw materials costs. For the same reason, sales rose by
16.7% to $1.4 billion for the full year. Overall, the company was unable to turn
revenues into profits, particularly because of the continued weakness in its
Aromatics division.
Chemicals Industry Trends
According to index data provided by Lehman Brothers, the high yield

Chemicals sector returned 21.71% in 2003. This is slightly more than the total
return of the broad Basic Industry sector, at 17.34%. (The sector also includes
the Paper and Metals & Mining industries.) In addition, the 21.71% figure falls
short of the overall U.S. Corporate High Yield Index’s 28.97% 2003 return.
This relative underperformance is partially explained by the index’s
concentration in higher quality issues. The Chemicals index started 2002 with
average an credit rating between Ba3 and B1, while the overall high yield index
was between B1 and B2. Furthermore, the industry’s return was hurt by
economy recovering more slowly than anticipated.
LW
Focus Issues
Spread Wider than Estimated
by Financial Statement Data Spread February 25, 2004

Issuer Coupon Maturity Estimated Actual Difference
Aztar* 8.875% 05/15/2007 367 566 199
Boyds Collection 9.000% 05/15/2008 413 621 208
Calpine 8.750% 07/15/2013 313 647 334
Chesapeake Corp 7.200% 03/15/2005 335 533 198
Extended Stay America 9.150% 03/15/2008 381 571 190
General Binding 9.375% 06/01/2008 438 661 223
Hollywood Entertainment 9.625% 03/15/2011 354 599 245
Intermet 9.750% 06/15/2009 465 858 393
Mediacom Communications 8.500% 04/15/2008 386 609 223
Nash Finch 8.500% 05/01/2008 377 694 317
Nature's Bounty 8.625% 09/15/2007 337 565 228
Philippine Long Distance 7.850% 03/06/2007 324 546 222
Pogo Producing 10.375% 02/15/2009 301 607 306
Rogers Wireless 8.800% 10/01/2007 307 504 197
Rural Cellular 9.750% 01/15/2010 543 800 257
Shopko Stores 9.000% 11/15/2004 381 640 259
Standard Commercial 8.875% 08/01/2005 389 633 244
Unisys* 7.875% 04/01/2008 267 461 194
Spread Narrower than Estimated

by Financial Statement Data Spread February 25, 2004
Issuer Coupon Maturity Estimated Actual Difference
Amkor Technology* 10.500% 05/01/2009 685 411 -274
Avista 9.750% 06/01/2008 396 195 -201
Cummins 9.500% 12/01/2010 411 222 -189
Echostar Communications* 10.375% 10/01/2007 454 256 -198
Frontier Oil 11.750% 11/15/2009 525 303 -222
Plains All American Pipeline 7.750% 10/15/2012 349 158 -191
* Addition since last update.
Model Update
The current version of the multiple regression formula is presented here:
Spread = 240.52 + 124.85a + 35.655b – 3.766c – 80.079d
Where:
240.52 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 = Coverage, defined as EBITDA divided by interest expense
d = Earnings, defined as log of trailing-twelve-months EBIT in millions of
dollars
Regression Statistics:
Standard Error = 94.43 basis points

R2 = 53.9%
Adjusted R2 = 53.6%
Predictor t-statistic P-Value VIF

Constant 7.08 0.000
a 6.07 0.000 1.1
b 12.08 0.000 1.2
c -3.17 0.002 1.1
d -10.92 0.000 1.2
The analysis indicates that each explanatory variable is significant at the 99% confidence level or
greater. In no case is there greater than a 1% probability that variable’s coefficient is equal to 0,
which would signify that the variable has no explanatory power. Low values of variance inflation
factors (VIF) suggest that multicollinearity is not present in this model.
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 investor’s judgment, the
factors do not fully justify the disparity between the bond’s 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
week’s additions to and departures from the list.
Issuers with Issues That Entered the:

Yielding-More-than-Estimated List
Aztar’s 8-7/8s widened on concerns over the company’s weak results in the
fourth quarter of 2003.
Unisys’ 7-7/8s widened slightly to join the Focus Issues list as it lost ground
along with the overall high yield market.
Yielding-Less-than-Estimated List
Amkor Technology’s 10-1/2s tightened in conjunction with the High Yield

Technology group outperforming the high yield index during the past week.
Echostar Communications’s 10-3/8s tightened as one of its cable

competitors, Mediacom Communications, said that Echostar’s aggressive roll-
out of satellite-delivered packages of local broadcast stations is presenting
problems.
Issuers with Issues That Exited the:

Yielding-More-than-Estimated List
Spread on Spread on
Issuer Coupon Maturity 2/18 2/25 Change
Pantry 10.250% 10/15/2007 670 633 -37
Pantry’s 10-1/4s gained 5/8 of a point as the company commenced a

redemption of all $200 million outstanding of the note.
Yielding-Less-than-Estimated List
Spread Spread
Issuer Coupon Maturity on 2/18 on 2/25 Change
Crown Castle International 9.375% 08/01/2011 361 397 36
Juno Lighting 11.875% 07/01/2009 340 539 199
Crown Castle International’s 9-3/8s lost a point as the company posted a

loss in the fourth quarter of 2003 that was much wider than in the preceding
year.
Juno Lighting’s 11-7/8s lost 7/8 of a point without any apparent fundamental
cause, even though the High Yield Building Materials index outperformed the
overall index.
LW
Senior versus Subordinated Valuation

Pairs with Senior Issue as a Better Value Spread February 25, 2004*
Issue Senior/Subordinated Estimated Actual Difference Pickup
Amkor Technology 7.75% 5/15/2013 Senior 462 331 -131
Amkor Technology 10.5% 5/1/2009 Subordinated 685 411 -274 -143
Mandalay Resort Group 6.375% 12/15/2011 Senior 239 233 -6

Mandalay Resort Group 10.25% 8/1/2007 Subordinated 377 252 -125 -119
MGM Mirage 7.25% 8/1/2017 Senior 263 256 -7

MGM Mirage 9.75% 6/1/2007 Subordinated 352 232 -120 -113
American Greetings 6.1% 8/1/2028 Senior 253 320 67

American Greetings 11.75% 7/15/2008 Subordinated 454 413 -41 -108
CSC Holdings 7.25% 7/15/2008 Senior 273 306 33

CSC Holdings 10.5% 5/15/2016 Subordinated 389 337 -52 -85
Pairs with Subordinated Issue as a Better Value Spread February 25, 2004*
Issue Senior/Subordinated Estimated Actual Difference Pickup
Navistar International 9.375% 6/1/2006 Senior 411 252 -159
Navistar International 8% 2/1/2008 Subordinated 362 445 83 242
CSC Holdings 7.625% 7/15/2018 Senior 286 237 -49

CSC Holdings 9.875% 2/15/2013 Subordinated 367 514 147 197
Dura Automotive Systems 8.625%

4/15/2012 Senior 357 393 36
Dura Automotive Systems 9% 5/1/2009 Subordinated 381 565 184 148
Constellation Brands 8.625% 8/1/2006 Senior 319 214 -105

Constellation Brands 8.125% 1/15/2012 Subordinated 301 296 -5 100
Rogers Communications 10% 3/15/2005 Senior 350 226 -124

Rogers Communications 11% 12/1/2015 Subordinated 386 343 -43 81
*Calculation subject to rounding
Note: In certain cases, a comparatively high coupon will cause a senior issue to have a wider expected spread than its subordinated counterpart.
Featured Pair: Mandalay Resort Group’s 6-3/8s vs. 10-1/4s
If we were to judge solely by the model-generated numbers, the Mandalay

Resort Group (NYSE: MBG) 6-3/8% senior notes due December 15, 2011
would be 119 basis points too wide versus the MBG 10-1/4% senior
subordinated notes due August 1, 2007. As of February 25, 2004, the spread of
the 6-3/8% notes was only 19 basis points narrower than the subordinated
issue’s. Based on the Focus Issues Model, a yield giveup of 138 would be
predicted.
Exhibit 1 graphs the relationship between the spreads of this senior vs.
subordinated pair during the last six months. Note that for the majority of the
period the 10-1/4s traded at a substantially wider spread than the 6-3/8s and
were much closer to being in line with the model’s estimates. However, in mid-
February, the spread began to narrow and actually reached single digits for
several days in a row. While the subordinated issue has widened slightly in the
last couple of days, the senior issue continues to represent a far superior value.
Exhibit 1: Spread for Mandalay Resort Group notes
Source: Advantage Data.

LW
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. (For an explanation of this model, see “Focus Issues
Methodology” and “Performance of Focus Issues” in the Sample Research
section of www.LeverageWorld.com.) 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*

Total # of
Industry % Trading Wider than Estimated Issues
Environmental 78.57% 14
Cheap Home Construction 75.00% 12
Packaging 72.22% 18
Consumer Cyclical Services 61.90% 21
Retailers 61.67% 60
Paper 59.52% 42
Technology 58.82% 17
Media Cable 57.14% 21
Independent Energy 53.57% 28
Consumer Products 46.67% 15
Automotive 45.45% 22
Food/Beverage 43.75% 16
Oil Field Services 40.00% 10
Wireless 40.00% 20
Industrial Other 37.50% 16
Health Care 30.77% 52
Chemicals 30.77% 26
Electric 26.67% 15
Lodging 26.32% 19
Rich Media Non-Cable 25.00% 28
Construction Machinery 18.18% 11
Gaming 13.51% 37
Diversified Manufacturing 0.00% 14
* Based on Spreads as of February 25, 2004.
Sources: Advantage Data, FridsonVision LLC, Lehman Brothers.
Update
Home Construction has moved to the borderline of extreme valuation, with

75% of issues trading cheaper than their model-estimated spreads. Chemicals
left the extremely rich industries, as its ratio of wider-than-estimated issues rose
from 19.23% to 30.77%. Last week’s cheapest industry, Environmental,
outperformed the Lehman Brothers U.S. Corporate High Yield Index by a total
return margin of -0.08% to -0.36%.
LW
SECTOR ALLOCATION…
Credit Ratings Value Tracker

These rankings are not based on historical yield spreads, but instead on each
rating category’s degree of concentration in issues trading wider than the
spreads estimated by our Focus Issues Model.1 (See accompanying conversion
table to determine a bond’s senior-equivalent rating, based on its nominal
rating.)
Exhibit 1: Credit Ratings Value Tracker*

Senior-Equivalent Rating % Trading Wider than Estimated Total # of Issues
BBB 29.55% 88
BB 42.05% 371
B 58.39% 149
CCC 46.67% 15
* Based on Spreads as of February 25, 2004.
Sources: Advantage Data, FridsonVision LLC.
Exhibit 2: Conversion Table

Senior-Equivalent Rating S&P Rating Seniority
BBB Senior
BBB- Senior
BBB
BB+ Subordinated
BB Subordinated
BB+ Senior
BB Senior
BB- Senior
BB
BB- Subordinated
B+ Subordinated
B Subordinated
B+ Senior
B Senior
B- Senior
B
B- Subordinated
CCC+ Subordinated
CCC Subordinated
CCC+ Senior
CCC Senior
CCC- Senior
CCC NR Senior
CCC- Subordinated
CC Subordinated
NR Subordinated
Source: FridsonVision LLC.
Update
Over the past week, relative value became increasingly concentrated in bonds
of Single-B companies. (See Exhibit 2, Conversion Table.) That group’s ratio
of issues trading wider than their model-estimated spreads increased from
55.48% to 58.39%. At this point, it is well worth portfolio managers’ while to
shift assets to bonds of Single-B companies from bonds of Double-B companies
and Triple-B companies (“5Bs” and subordinated issues rated BB+ or BB).
LW
1
See “Focus Issues Methodology” in the Sample Research section of www.LeverageWorld.com.
MARKET TIMING…
High Yield Sector Value Tracker

The High Yield Value Tracker is based on the Leverage World Model.1 This
econometric model explains 91% of the historical variance in the spread
between the Merrill Lynch High Yield Master II Index and ten-year Treasuries.
From indicators of default risk, market liquidity, and monetary conditions, the
model estimates the currently appropriate spread. The accompanying diagram
depicts the difference between the model's current estimate and the actual spread
observed in the market, expressed in standard deviations. (One standard
deviation equals 55 basis points.) Divergences of less than one standard
deviation are deemed immaterial
The High Yield Value Tracker's usefulness as a market-timing tool is

indicated by the following average annualized monthly returns, calculated over
the period 1986-2002:
Period Mean Return # of Observations

Undervaluation 19.63% 30
Overvaluation 4.26% 33
ALL PERIODS 8.45% 196
Actual minus Estimated Spread-versus-Treasuries*

Units: Standard Deviations
* Based on February 26, 2004 data.

Sources: Economagic.com, Investment Company Institute, Merrill Lynch & Co., Moody’s Investors
Service.
Update
The high yield sector remains richly priced relative to prevailing default risk,
secondary market liquidity, and monetary conditions.
LW
1
For a description of the Leverage World model of the spread-versus-Treasuries, see “Record Short-
Run Overvaluation for High Yield” in the Sample Research section of www.LeverageWorld.com.
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Catch-Up Could Make Spread More Palatable: The Weekly Publication of High Yield Strategy February 27, 2004 Vol. 2, No. 9

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Catch-Up Could Make Spread More Palatable: The Weekly Publication of High Yield Strategy February 27, 2004 Vol. 2, No. 9

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TM

Contact us at: BIG PICTURE…

Catch-up Could Make

Barron’s quoted a portfolio manager who warned of the “huge sucking

Copyright 2004 by FridsonVision LLC. All Rights Reserved.

Too Much, Too Fast?

Much as we hate to rain on anybody’s parade, however, we feel obliged to

Other combinations are possible, but if we focus on these three, we observe

Exhibit 1: Values of Leverage World Model Variables

Cash as % of High Yield Slope of Treasury

By observation, all variables have room for improvement. The Consumer

The other extremely important risk factor, however, is the liquidity-

This would not be unprecedented. In June 1994, before the market-making

Another Sign of Premature Contraction

We can corroborate the verdict of Leverage World’s explanatory variables,

Exhibit 2: Spread and Quality Mix

Yield Spread: Merrill Lynch High Yield Master II Index

*As of February 26, 2004.

Finally, readers should be aware that spread-tightening may be reported in

Exhibit 3: Index Spread Based on Issue-Specific Spreads (Illustration)

(7.50% + 8.25% + 8.50%) ÷ 3 = 8.08%

The spread-versus-Treasuries, as we have defined it throughout this article, is

8.08% - 4.25% = 3.83% (= 383 basis points)

Some published spreads, however, are defined as the weighted average of

[(7.50% - 3.50%) + (8.25% - 4.25%) + (8.50% - 4.50%)] ÷ 3 = 400 basis

The more important point, however, is the effect of a flattening of the

[(7.50% - 4.25%) + (8.25% - 4.25%) + (8.50% - 4.50%)] ÷3 = 375 basis points

Exhibit 4: Spread After Yield Curve Shift (Illustration)

By the alternative definition, the spread-versus-Treasuries has narrowed from

THE PRESENT 106-BASIS-POINT DIFFERENCE IN SPREADS BETWEEN

Chemicals: Airgas and Georgia Gulf

Our Rich/Cheap methodology identifies on a weekly basis an industry pair

Exhibit 1: Focus Issues Model Estimates and Actual Spreads*

Source: Advantage Data.

GGC’s bond has experienced significant spread-tightening and price

· Airgas has recently announced that it obtained an amendment to its credit

ARG, headquartered in Radnor, Pennsylvania, is the largest distributor of

GGC, headquartered in Atlanta, Georgia, is one of the largest producers of

Chemicals Industry Trends

According to index data provided by Lehman Brothers, the high yield

by Financial Statement Data Spread February 25, 2004

Spread Narrower than Estimated

The current version of the multiple regression formula is presented here:

Spread = 240.52 + 124.85a + 35.655b – 3.766c – 80.079d

Standard Error = 94.43 basis points

Predictor t-statistic P-Value VIF

Focus Issues: Why Are They on the List?

Issuers with Issues That Entered the:

Amkor Technology’s 10-1/2s tightened in conjunction with the High Yield

Echostar Communications’s 10-3/8s tightened as one of its cable

Issuers with Issues That Exited the:

Pantry’s 10-1/4s gained 5/8 of a point as the company commenced a

Crown Castle International’s 9-3/8s lost a point as the company posted a

Senior versus Subordinated Valuation

Mandalay Resort Group 6.375% 12/15/2011 Senior 239 233 -6

MGM Mirage 7.25% 8/1/2017 Senior 263 256 -7

American Greetings 6.1% 8/1/2028 Senior 253 320 67

CSC Holdings 7.25% 7/15/2008 Senior 273 306 33

CSC Holdings 7.625% 7/15/2018 Senior 286 237 -49

Dura Automotive Systems 8.625%

Constellation Brands 8.625% 8/1/2006 Senior 319 214 -105

Rogers Communications 10% 3/15/2005 Senior 350 226 -124

Featured Pair: Mandalay Resort Group’s 6-3/8s vs. 10-1/4s