UBS’ contingent income autocallable notes linked to Alibaba are income play, not bullish bet

By Emma Trincal

New York, April 28 – UBS AG, London Branch’s contingent income autocallable securities due May 4, 2018 linked to Alibaba Group Holding Ltd. American Depositary Receipts target moderately bullish or bearish investors who need income, financial advisers said. But the risk-adjusted profile of the security is not for everyone, one of them noted.

The notes will pay a contingent quarterly coupon at an annual rate of 9.35% if the shares close at or above the 80% barrier level on the observation date for that quarter, according to an FWP filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if the stock closes at or above the initial price on any of the first 11 determination dates.

The payout at maturity will be par plus the final coupon unless the shares finish below the 80% barrier level, in which case investors will receive a number of Alibaba shares equal to $10 divided by the initial price or, at the issuer’s option, the cash value of those shares.

Income generator

“This is a very solid way to get income based on a bullish or moderately bearish position on Alibaba stock,” said Dean Zayed, chief executive of Brookstone Capital Management.

The shares closed at $85.07 on Tuesday, marking an 18% decline for the year. The company made its market debut in September. Since the IPO, the price has dropped 9.5%.

“The fact that the stock is hovering near its 52-week low may be a good thing for this particular note since it gives you a 20% cushion from its current price,” Zayed added.

The stock’s 52-week range is $80 to $120.

“I like the term, I like the credit quality of the issuer, and I do like the coupon,” he said.

He stressed that the limited upside simply means that the trade is designed for income, not growth.

“Investors need to keep in mind that this is not meant to be a stock play to be compared to a direct stock ownership in Alibaba but instead this is an income-oriented note that simply uses a well-known stock as the underlying.

“The fact that Alibaba does not pay a dividend is also a positive, so you are not missing out on that if you just buy the stock.

“In a yield-hungry environment, this note is rock solid as long as you're not super bearish on Alibaba.”

Risk-reward

On the other hand, Jonathan Tiemann, founder of Tiemann Investment Advisors, LLC, said the risk-return profile of the product has little appeal.

“Your upside is seriously capped really, and your downside is unlimited,” he said, pointing to the contingency of the downside barrier.

“This is a short volatility bet. With the stock down so much, you’re hoping that volatility will decrease, so you’re selling it now to capture the premium. It’s obviously possible, but it’s an odd view for an investor to take on a security.”

Investors are in a position equivalent to selling an at-the-money call that caps the upside for a 2.34% coupon per quarter. On the downside, they get “some cushioning,” but the protection ceases to exist beyond the threshold.

“Your best-case scenario really is to see the stock price down for a while but not down to the point of breaching the barrier. If you’re bullish at all, this deal isn’t all that interesting. If the price makes a big move on the upside, you get your money back and your last coupon and there’s no chance to make any more money. And if the stock appreciates by more than your coupon, you’ve been capped. You’ve missed on some of the return.

“You have to be slightly bearish in the hope that the price will continue to drift lower and lower to avoid being called but not lower by more than 20%.”

Early redemption

The trigger of the autocall is not the best outcome for investors, Tiemann said.

Even if most buyers of contingent coupon autocallable notes do not mind the early redemption as they keep on rolling into the next product, such process is costly in fees, he said.

Staying invested as long as possible, ideally until maturity, is the best outcome as it enables investors to collect the maximum amount of coupon, he added.

“So you have to be bearish but not too bearish, and you can’t be bullish because you have essentially no upside,” he said.

“I’m not too comfortable with the risk-adjusted return. While they give you some cushion, it’s not a buffer. You can have full downside risk exposure while your upside is limited by the coupon.

“What the issuer is doing is trying to capitalize on the excitement around Alibaba, which is a perfectly legitimate thing for them to try to do.

“But I’m not a big fan of the stock. I don’t know the business model, but as an investor I’m inclined to stay away from this name. It’s instructive to see how hyped the stock was around the time of the IPO and how little we’ve heard about it since.

“There are other places I would invest.”

UBS Securities LLC is the agent with Morgan Stanley Wealth Management handling distribution.

The notes will price May 1 and settle May 6.

The Cusip number is 90274T254.

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