BMO’s $1.57 million autocalls with contingent coupon on Alibaba offer value, contrarian says

By Emma Trincal

New York, Aug. 4 – Bank of Montreal’s $1.57 million of autocallable barrier notes with contingent coupons due July 28, 2025 linked to the common stock of Alibaba Group Holding Ltd. offer good terms on a stock that benefits from strong fundamentals and good pricing, said contrarian investor Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

The notes will pay a monthly coupon equal to 11.65% per year if the stock closes at or above its coupon barrier level, 59% of its initial price, on the relevant observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically redeemed at par plus the contingent coupon if the stock closes at or above its initial price on any monthly observation date starting after six months.

If the notes are not called and the stock finishes at or above its 59% trigger price, the payout at maturity will be par plus the final coupon. Otherwise, investors will lose 1% for each 1% decline of the stock from its initial price.

Positive prospects

“Certainly, Alibaba is out of favor – not as much as it was in October, but the stock is still unpopular. It's always a good idea to buy something people feel negative about especially with a company like Alibaba, which has very good prospects,” said Kaplan.

He liked the choice of Alibaba as the underlier for a note.

The fundamentals of the business are attractive, he noted.

“Whether you're looking at the earnings-per-share growth over the past five or 10 years, or the P/E ratio in the past five years, if you compare that to the other tech titans in the U.S. and around the world, you’ll discover that Alibaba is a pretty close to being a bargain,” he said.

“The stock is more depressed now, even though it's making more money.”

Kaplan said that he assesses the value of a security using the same metrics as Benjamin Graham, the so-called “father of value investing.”

“Whether you use the P/E, the price-to-book or the earnings growth, any of the classic criteria used by Benjamin Graham to identify value, you’ll reach the same conclusion: this is a company that’s very undervalued,” he said.

Blood in the streets

U.S. investors have been chilled by Alibaba and the Chinese tech sector, which has generated buying opportunities, he said.

“The U.S. may have the same problems if not worse problems that China. In the U.S., an overspeculation is taking place in the stock market and people are barely noticing. They continue to buy overvalued stocks on momentum.

“From an economic standpoint, a lot more people, and corporations have borrowed money in the U.S. than in China.

“The bubble that we're in has put us in a much more precarious position,” he said.

Bubbles

Kaplan said that the Chinese stock market has been down since February 2021. The drawdown in the U.S. is more recent.

“In the U.S. we had a drop last year, but we have already rebounded due to a massive speculation. I would argue the downtrend is still going on. We’re just a little bit behind China,” he said.

“China is slowly recovering because their bubble has already burst... speculation is no longer ruling the stock market anymore,” he added.

Chinese investors have turned more conservative than in the recent past.

“People over there took money out of the stock market to put it in the bank. We in the U.S. are doing the exact opposite: we’re pulling money out of the bank to pile into the stock market,” Kaplan said.

Helping hand

Chinese stocks received negative press in the second half of 2021 when the Chinese government began to crack down on its tech behemoths.

“It’s ironic. ... Alibaba has less debt, more profit growth than the U.S. tech companies. And when it comes to what the media called ‘the regulatory crackdown,’ it actually played to the benefit of Alibaba and the like because what the Chinese government is actually doing is making it harder for Chinese tech behemoths to have competitors. They restrict competition giving companies like Alibaba a wide-open field, almost creating a monopoly,” he said.

Still a good entry

Kaplan said he liked the terms of the notes, in part due to the undervaluation of the underlying stock, which increased the odds of getting paid.

“There's a reasonable chance of getting called, more likely on the first year than on the second, which is not necessarily a bad thing because you’re getting at least a decent rate of return,” he said.

“The 60% barrier is pretty conservative, especially since you’re coming in at a reasonably low price.”

The stock price scored a high adjusted for dividends in October 2020 at $319.32. In October, the stock bottomed at $58.01. When the notes priced, the closing level was $94.98. Friday’s closing price was $96.90.

“The share price has bounced back since its October low but it's still a reasonable buy,” he said.

Tradeoff

Kaplan looked at the length of the notes. The two-year term was inconsequential in his view because “chances are the notes will be called away at some point.”

Like any autocall, the structure caps the upside at the coupon rate while the risk of loss can be as high as 100% if the barrier is breached. But Kaplan said he was comfortable with this risk/return profile given the high probabilities of a call.

“There’s obviously some risk anytime you buy a note linked to a single stock. You probably should not look at this offering if you’re a first-time buyer.

“Your return is limited to 11.65%. But this is a very decent rate of return. It’s a tradeoff. Your gain won’t exceed the coupon. But you’re getting a significant amount of downside protection,” he said.

BMO Capital Markets Corp. is the agent.

The notes settled on July 28.

The Cusip number is 06369NKL4.

The fee is 2.95%.

© 2015 Prospect News.
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