Barclays’ six-month 12% reverse convertibles linked to GoPro show high single-stock risk

By Emma Trincal

New York, April 17 – Barclays Bank plc’s 12% reverse convertible notes due Oct. 22, 2015 linked to GoPro, Inc. expose investors to a high level of market risk due to the combination of a riskier barrier type and a highly volatile underlying stock, said Tim Vile, structured products analyst at Future Value Consultants.

The barrier is structured around an American option, which means that it can be triggered on any trading day, he explained. The barrier, called “knock-in,” is set at 70% of the initial share price, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par unless the final share price is less than the initial price and the stock falls below the knock-in barrier during the life of the notes, in which case the payout will be par plus the stock return or, at the issuer’s option, a number of GoPro shares equal to $1,000 divided by the initial share price, the filing said.

Young stock

“The stock price has been choppy since October. It’s very unpredictable. This stock started trading in June of last year. We’re back at those levels right now,” he said.

GoPro develops and manufactures wearable and gear-mountable cameras. The company filed for an IPO last year. It was listed on the Nasdaq in June.

“We do not have a lot of history. There is less than a year in track record,” he said.

The share price closed at $44.62 on Friday. It is down by more than 30% this year. However, the price has gained more than 42% over the past 12 months.

Vile pointed to the wide moves of the stock’s price since the shares began trading publicly on June 26, 2014 at an initial price of $24.00, closing at $31.34 on that day.

From its debut to its $93.79 high on Oct. 6, the stock more than tripled. Since the high, however, it has fallen by more than 52%.

“Investors should be aware of the speculative nature of a brand new stock. This is an IPO that doesn’t have 10 months in performance history,” he said.

Coupon

The notes pay a fixed interest rate of 12% a year payable monthly, which is the equivalent of about 1% per payment.

But the fixed-income element is a small risk-mitigation factor, he said.

“What makes the product particularly risky is the combination of an American barrier and a stock that can move up and down that much,” he said.

“The stock has a one-month implied volatility of 50%. With an American barrier that can be triggered on any trading day, you multiply the odds of a 30% drop.”

In less than four months, the stock has already lost 35.55%, according to a chart beginning on Dec. 26.

“It is a very risky product,” he added.

“A factor that helps somehow lessen the risk is your fixed coupon. You’re still getting 6% after six months. The income is guaranteed. Even if the stock drops, you still have that tiny cushion.

“However, it isn’t much. An investor in the notes would have to be very confident that the stock will perform well over the next six months or at least won’t incur a major drop, especially with a barrier that can be breached anytime.

“It’s not like there is no protection. But with such highly volatile stock and this type of knock-in, only a very bullish investor who would know the stock should enter the trade.”

Market risk

The risk level is reflected in the market riskmap, according to Future Value Consultants’ research report on the notes.

The firm calculates the market risk and the credit risk and adds the two components to generate the “riskmap,” which measures on a scale of zero to 10 the risk associated with a product with 10 as the highest level of risk possible.

The notes received a market riskmap of 5.71 versus an average score of 1.58 for the product type, which is the reverse convertible category.

“It’s a very risky product given the American barrier and the nature of the stock used as the underlying asset,” he said.

“Between those two factors I can’t really speculate on what really drives up the market risk. It’s both. A European barrier would reduce the risk, but chances [are] it would still be pretty high.

“And while you do have the coupon to stop some of the losses, it’s only a 6% cushion.

“Investors should be aware of the risk of losing principal.”

The 0.29 credit risk on the other hand is low compared to the average credit riskmap of 0.35 for the product type, he noted.

“You have a strong issuer and a very short maturity. Both factors are going to limit the credit risk,” he said.

By adding the two risk components, the product has a riskmap of 6.0 versus a 1.93 average for the product type.

“The nature of risk with this note is to be exposed to market losses. Credit risk is not really an issue,” he said.

Return score

Future Value Consultants rates the risk-adjusted return of a note on a zero-to-10 scale with its return score.

The research firm computes the return score based on the best among five pre-set market scenarios. In this case, the score derives from a low-volatility market assumption.

“A lower return score means that the risk-adjusted return is less than average,” he said.

“The high riskmap definitely brings the return score down.

“The 6% coupon for the term is not really high. We could argue that for such level of risk, investors may not get enough return. A higher coupon would have improved the score, all things being equal.”

Price score

Future Value computes the value of a product on a scale of zero to 10 with its price score.

This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

Vile noticed the “pretty big gap” between the product’s price score of 4.50 and the average of 8 for the category.

“This score gives an indication of how much a product is costing to the investor. It looks like it is not cheap,” he said.

“One explanation is the short duration. It never helps the price score since we calculate the fees on an annualized [basis]. When the notes are longer, you spread the cost.

“This pretty low score suggests that investors are paying quite a lot of fees for a product that does not invest for a long time. If they roll their investment into a new short-term reverse convertible, it may end up being costly.

“The notes do not create a high value for investors.”

Overall score

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

The overall score for the notes is 4.91 versus a 7.51 average score for the product type.

“Both the return score and the price score are lower than average, bringing down the overall. The price score certainly makes things worse,” he said.

“However, if an investor is willing to take that kind of risk and wants a short-term product, they can still get a good return. But the risk-adjusted return and the value should be looked at carefully.”

The notes (Cusip: 06741WAN0) are expected to settle on Wednesday.

Barclays is the agent.

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