Morgan Stanley's $32.56 million autocallables linked to Apple drew heavy bid for rich stock

By Emma Trincal

New York, April 25 - Morgan Stanley's $32.56 million of contingent income autocallable securities due April 20, 2015 linked to the common stock of Apple Inc. topped the list of largest deals last week due to the combined popularity of the Apple name and the hybrid nature of the structure, sources said.

However, the volatile stock and the three-year term make this investment rather risky, they also noted.

If Apple stock closes above the downside threshold level - 75% of the initial share price - on a quarterly determination date, investors will receive a contingent payment of 3.25%, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, no contingent payment will be made for that period.

If the closing share price is greater than the initial share price on any of the first 11 quarterly determination dates, the notes will be automatically redeemed at par plus the contingent payment.

If the notes are not called and the final share price is greater than or equal to the downside threshold level, the payout at maturity will be par plus the contingent payment.

If the final share price is less than the downside threshold level, the payout will be a number of Apple shares equal to the principal amount of notes divided by the initial share price or, at Morgan Stanley's option, the cash value of those shares.

Roller coaster

"Apple is very popular, and there is a reason for that," a sellsider said.

"People have faith in the company. There's plenty of cash to survive, and the company dominates the tablet market. They'll probably maintain their share in the cell phone market, and they're still doing well in computers."

The deal priced on April 16. The initial share price is $580.68, or 8.7% lower than the all-time high price of $636.23 recorded on April 9, he noted.

"We're now at $610.00. You're locked in at a pretty good price," he said.

"But it's good if it stays where we are. Look at what happened over the past few days."

The stock fell by 12% from its peak earlier this month to $560.28 on Tuesday, a period of just two weeks.

On Wednesday, however, bulls had the upper hand again as shares soared by 9% after Apple reported growing demand for the iPhone in China.

"We've seen a pretty significant loss in just two weeks and then back up. This is a pretty volatile stock. It's not so hard to breach the 75% threshold," the sellsider noted.

In terms of potential coupon, the notes are attractively priced he said. The 3.25% contingent payment more than compensates for the loss of dividends, he noted, with the recently announced dividend yielding 1.74%.

"This is a solid note, but there is risk. In addition, the client is willing to take Morgan Stanley credit. The bank's CDSs are trading pretty high.

"Morgan Stanley is able to do more creative deals because of their need for funding. But it's a three-year structure, and there's some risk to that. You could end up with the Apple stock, which is OK if you want to be long that name," he said.

Andrew Valentine Pool, main trader at Regatta Research & Money Management, said that the risk is difficult to assess.

"That's a tough one," he said.

On the positive side, the threshold price is near the 200-day moving average.

"But it also plays a trick on you because this stock has been going gangbuster this past few months and it tends to skew the moving average."

The threshold would be triggered if the stock dropped below $435.

"Three months ago, the stock was below that threshold. That's not a long time ago. I would be very cautious," he said.

Best of both structures

Another factor that may have made the offering popular among investors is the structure itself, the sellsider said.

The notes offer traits of a typical reverse convertible but with an autocallable feature.

Other differences are beneficial to the investor, such as the final-day barrier (European-type option) striking at maturity instead of at any time during the life of the notes as it is the case with the American-type options employed in reverse convertibles, he said.

"The deal was popular for two reasons: the autocall and the European barrier," he said.

"The autocallable feature is very nice. It eliminates the discretion. You know why you get called.

"The European barrier is very attractive. Investors don't have to worry in the interim if it breaches. That takes care of the big issue people have with reverse convertibles in general. And when the barrier is breached any time during the term, it's almost impossible to get back. When things happen at the end of the life, you're much less penalized."

Morgan Stanley & Co. LLC was the agent, and Morgan Stanley Smith Barney LLC handled distribution.

The fees paid on the notes (Cusip: 61760T744) were 2.25%.

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