UBS' $10 million 18% worst-of income autocallables linked to Facebook, Tesla show high risk

By Emma Trincal

New York, Sept. 18 - UBS AG, London Branch's $10 million of worst-of income autocallable securities due Dec. 17, 2013 linked to the common stocks of Facebook, Inc. and Tesla Motors, Inc. pay a high coupon over a short period of time, but sources said that the two underlying stocks are associated with higher-than-usual levels of risk due to their speculative nature.

The interest rate is 18% per year, payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par of $10 if both stocks close at or above their initial prices on Oct. 15 or Nov. 12.

If the notes are not called and each stock finishes at or above its downside threshold price, 65% of its initial share price, the payout at maturity will be par. Otherwise, investors will receive a number of shares of the worst-performing stock equal to $10 divided by that stock's initial share price or, at the issuer's option, a cash amount equal to the value of those shares.

High risk, high coupon

"These two are in quite divergent industries. The worst-of structure will certainly produce a high coupon because you have the risk of being exposed to two different stocks in two different, uncorrelated sectors," a market participant said.

"If you feel comfortable with both of these companies in their respective industries, the coupon is certainly very appealing."

Investors are exposed to the price risk of each stock at maturity, not to the average of the two, warned the prospectus, which explained in the risk section that, unlike a basket-linked note, the downside risk incurred by the buyer of a worst-of product, such as this one, is not mitigated and diversified among the components of the basket.

While it only takes one stock to trigger the worst-of payout, both stocks need to close above their initial prices in order to trigger the call, according to the prospectus.

"A worst-of will give you more return because the risk is greater. With two stocks, you are more likely to see one of them breaching the barrier," the market participant said.

"This risk increases when you're dealing with two non-correlated sectors, which is obviously the case with this product."

Tesla Motors, a consumer cyclical sector stock, develops, manufactures and sells electric cars. Facebook, a technology stock, is a social media service.

"I hear a lot of talk around Tesla. It's a cult stock, a very speculative play. Valuation is a little out there, way ahead of the fundamentals. Tesla is the most speculative play of the two, but Facebook is also a very risky bet. Facebook has only been a public company for a little over a year. There's limited track record," the market participant said.

"And you have this very short maturity, three months, which is highly unusual for an autocallable worst-of structure. It must have been obviously a one-off, client-driven structure. I don't think [the issuer] would have come up with that structure on their own with that short of a term. It wouldn't be something that a firm would market as a calendar offering.

"The 18% is eye-catching. But when putting these two stocks together in a worst-of, that's what you get: You can produce a big barrier and a big coupon, and that's the deal you have here," he said.

'School project'

Marc Gerstein, research consultant at Portfolio123, said that the two stocks used in the deal are much too speculative to even be analyzed on a fundamental basis.

"It's a gamble. You want to take your shot, take your shot," Gerstein said.

"You take Facebook and Tesla, either stock could be up or down 35% in the next three months. Eighteen percent sounds nice. It certainly looks good, but there is no way to analyze any of these stocks.

"I'm not inherently objecting to the use of two stocks as opposed to one. It makes your analysis a little bit more difficult, but that's OK. But give me Caterpillar and Intel, for instance. There is also very little correlation between the two, but I wouldn't object to a note tied to those two.

"My problem is the choice of stocks they made: Tesla, Facebook. Their performance is driven by sentiment, nothing else. In a reverse convertible, you need a stock you can formulate a rational opinion on. Facebook, Tesla are way out of any kind of a normal range. They're trading on popularity and emotion, not on fundamentals. They are trading at nothing resembling value that you can predict."

Shares of Tesla have surged by 391% so far this year while Facebook's stock price gained 70%.

The implied volatility for Tesla is 50%. It is 40% for Facebook and 12.5% for the S&P 500 index.

"Facebook's price-to-sales ratio is18. The price-to-book is 8.8, and the price-to-earnings, 47. All those ratios are way out of line," he said.

"It's too far out of a reasonable range. No one has the tools to analyze that. It can't be done. Doing it is a school project, not something a serious investor should consider."

The notes (Cusip: 90271M393) priced Sept. 12.

UBS Securities LLC was the agent. Morgan Stanley Smith Barney LLC handled distribution.

The fee was 1%.

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