Barclays’ autocallable notes linked to Shopify show insufficient coupon for risk, adviser says

By Emma Trincal

New York, Aug. 15 – Barclays Bank plc’s phoenix autocallable notes due Aug. 25, 2022 linked to Shopify Inc. shares give investors access to a richly priced momentum tech stock, but the payout may not be enough given the high volatility of the underlying.

Each quarter, the notes will pay a contingent coupon if the shares close at or above the barrier price, 50% of the initial share price, on the observation date for that quarter. Otherwise, no coupon will be paid for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The contingent coupon rate is expected to be 11.5% per year and will be set at pricing.

The notes will be automatically called at par if the shares close at or above the initial share price on any observation date after six months.

If the notes are not called, the payout at maturity will be par unless the shares finish below the barrier price, in which case investors will lose 1% for every 1% that the final share price is less than the initial share price.

A tech darling

Shopify operates a cloud-based commerce platform used by merchants to run businesses across all sales channels, including web, tablet and mobile storefronts, social media storefronts, and brick-and-mortar and pop-up shops.

The stock closed at $351.07 per share on Thursday, up 153.6% for the year to date.

“Why would you get exposure to a stock that’s up 150% for an 11% coupon?” asked Steve Doucette, financial adviser at Proctor Financial.

“Chances are you’ll just collect 5.75% in six months, so why take unlimited downside risk for that? It makes so little sense.”

Straight up

So far, however, Shopify has been a rocket. Its drawdowns in the past three years have been contained in time and size. For example, the stock price fell 15% in the spring of 2017, 27% in the following spring and 28% during the December sell-off.

Doucette admitted that 50% of the initial price is a low barrier. But the safety net provided by a barrier level is always a function of the underlying’s volatility, he noted.

With 50.25% implied volatility, breaching the barrier is possible.

“It’s too volatile a stock to trade for an 11% return,” he said.

“Give me more return or a less volatile stock. It’s an unbalanced risk/reward.”

It’s rich

A big mover, Shopify has gained nearly 800% in the past three years. Its current share price is near the top of its 52-week range of $117.64 to $372.36.

The stock is popular as its business model has generated strong growth.

Earlier this month, the company reported better-than-expected second-quarter 2019 results, causing the stock to pop up nearly 10% on the day.

Barron’s last week said the company was a “viable alternative to Amazon.com for merchants looking to sell online.”

But Amazon is much “cheaper” with a forward price-to-earnings ratio of 77.65 versus 600 for Shopify.

Risk/reward

To enhance the risk-adjusted return, Doucette would need to get paid at least twice the coupon amount.

“If I’m going to jump in a note for three years – because you may or may not get called – I’m not going to hold the exposure for that type of coupon,” he said.

He said that “11.25% is not an outsized equity return; 20% is.”

He brought up the 20% figure thinking of a deal he recently commented on. It was Credit Suisse AG, London Branch’s $1 million six-year worst of autocallable notes linked to Apple Inc., Amazon.com, Inc. and Uber Technologies, Inc. The coupon barrier and barrier at maturity were 65% and 60%, respectively. But the contingent coupon was 21.7%.

“At least I know these names. It may be a worst of, but it pays 21.7%,” he said.

For those concerned by the downside risk, Doucette suggested a worst of on three correlated indexes.

“You won’t get 11%. But you’ll get 6%, and it’s by far less risky.”

Upside risk

An inadequate risk/reward also meant that investors could miss a lot of the upside.

“When we come out of the bear market, this thing could rebound, and if the stock is the high-flyer it appears to be, you’re going to wish you were long the stock. I can see a client not being too happy with 11% if the stock price triples,” he said.

For institutional investors

Jeff Pietsch, head of capital markets at the Institute for Wealth Management, said the notes were not appropriate for individual investors.

“There is the risk, and there is also the fact that it’s very hard for individual investors to model the risk,” he said.

“It’s a high-flyer moving straight up. You would need to hedge it outside of the note.

“This is probably more suitable for an institutional investor as part of a larger income strategy.

“Only an institutional investor like a hedge fund can manage multiple notes. You need specific analytical tools to monitor and hedge the risk.”

Part of the problem for retail investors seeking income is that it is hard to assess probabilities of outcomes when the duration of the note is not even known and could vary from six months to three years.

“In theory you could be locked up for the entire period with no return,” he said.

“Conversely, if you get called, you have to find another product giving you the same yield. As rates have come down, it may be a challenge, and you could be looking at even riskier investments to match your yield.”

Uncommon underlying

Compared to other technology stocks, Shopify is a new-comer in structured products.

This underlying as a single stock has only been used twice in U.S. structured notes, according to data compiled by Prospect News. Both deals – also autocallable contingent coupon notes – were small in size and relatively recent.

The first one was Morgan Stanley Finance LLC’s $1.56 million deal, which priced in September 2017.

The second came from Royal Bank of Canada in an $118,000 offering in March.

Barclays is the agent.

The notes will price Aug. 21.

The Cusip number is 06747NCK8.

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