Deutsche Bank's airbag performance notes linked to Exxon Mobil offer bullish bet on energy

By Emma Trincal

New York, May 27 - Deutsche Bank AG, London Branch's 0% airbag performance securities due June 19, 2019 linked to the common stock of Exxon Mobil Corp. offer uncapped leverage and contingent protection based on the performance of the world's largest oil company, making the product a likely play for energy bulls, sources said.

If the stock return is positive, the payout at maturity will be par plus 150% to 160% of the stock return. The exact participation rate will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

If the stock return is negative but the final share price is not less than the conversion price, 80% of the initial share price, the payout will be par. If the final share price is less than 80%, the payout will be a number of Exxon Mobil shares equal to $1,000 divided by the conversion price.

'Energy bellwether'

Dean Zayed, chief executive officer of Brookstone Capital Management, said the notes represent a bullish play on the sector.

"Since Exxon Mobil is an energy bellwether, this deal represents an optimistic view of energy as a sector over the next five years as well as confidence in Exxon's continued leadership," Zayed said.

"The terms are attractive. You don't collect the dividend, so that's not positive, but you get great leveraged upside and a solid barrier."

The underlying stock is a good fit for a five-year investment in the sector, he said.

"Looking at Exxon's performance during 2008 ... it was down substantially less than the broad market, showing its incredible resilience as a stock you can own just about forever. This plays nice with the 20% barrier since the stock rarely has larger corrections than that."

The share price of Exxon Mobil outperformed the market by 20% in 2008, finishing the year down 14.6% versus a 37.6% decline for the S&P 500 index.

This year, energy is the second best performing sector with a 9% return following utilities, up 13%, according to Morningstar.

"The USA is experiencing an energy renaissance now, and I think this is a trend that will persist for some time. This note is a solid play on the renaissance theme continuing to play out," he said.

Leverage on a stock

Another interesting aspect of the structure is the use of leverage on a single stock. Most enhanced return notes are linked to indexes or funds, he noted.

"I haven't seen many leveraged deals on stocks, but I do think this can be an interesting trend and investors will gravitate towards them if the terms are competitive," he said.

Foregoing dividends

Jonathan Tiemann, founder of Tiemann Investment Advisors, LLC, focused his analysis on the fact that investors in the notes do not receive dividends, as it is the case with most structured products.

"But with this particular stock, it's not a good thing because you're giving up a lot," he said.

"This stock pays a 2.7% dividend yield. That's 13.5% over the course of five years and ... let's just say 15% if you take into account the reinvestment of dividends. That's a big chunk of your return that you're not getting right there."

On the downside, investors enjoy the benefit of the 20% buffer. But depending on the amount of the losses, they may in some instances be better off owning the shares directly, he said.

Odd bearish view

"If you don't lose more than 20%, you get your money back and principal back but not with any sort of time value. Meanwhile, you're not collecting anything. There is no compounding involved. You're just getting your money back, dollar for dollar. You lose five years' opportunity to make any money off the dividends. If the stock ends up flat, you've had five years of no growth, you've forfeited five years' worth of dividends," he said.

As an example, if the stock performance were flat at maturity, an investor in the shares would gain 15% from the dividends while the notes would add nothing, he said.

"On the downside, the 20% buffer may offset the loss of dividends but not at all levels," he added.

"For instance, investors in the stock would outperform the notes for a price decline of less than 15% because of the dividend advantage. They would also do better with bigger losses after a 40% drop. It's only in the middle that the notes do a better job at cushioning your losses.

"It's a weird risk-reward range. You're better off with the stock when you have small or very large price declines. The notes may really help only somewhere in the middle. That doesn't represent a typical view. You're not mildly bearish; you're not very bearish either."

Mildly bullish

Tiemann also calculated the breakeven return on the upside when comparing the notes to an unlevered, dividend-paying, long-only position.

"You have to remember again that while the notes offer 1.5 times leverage, you're still missing 15% in dividends," he said.

"You have to figure out how much the stock needs to rise in order for the notes to beat the stock.

"It takes a little bit of appreciation to break even."

In a flat or slightly bullish market, the notes would significantly underperform, he said.

"If the stock is up 5% at maturity, the notes will give you 7.5% versus 18.5% with the stock when taking into account dividends. If it was up 20%, you would still be better off with the stock. It would take a share price appreciation of 30% to break even," he said.

If the stock finished up 30%, the notes would pay 45%, which would be the equivalent of the total return generated by the long-only position.

"You will do better with the notes when the stock is up by more than 30%," he said.

"The more bullish you are, the better. I'm tempted to think that if you're that bullish, you could get the same result trading the stock on margin for leverage. But it's fair to say that the notes offer one advantage here ... they're leveraging the upside only, not the downside. That's a plus."

Yet, Tiemann said he would not consider the product.

Fuzzy picture

"It's too hard to sketch the market view that would be consistent with this instrument," he said.

"On the downside, you can't be just a little bit bearish or very bearish. It's got to be in an intermediate range.

"On the upside, you'd [be] better off being very bullish. It's difficult to figure out a view that would be consistent with owning the securities.

"In addition to that, you still have all the considerations that apply to any structured note: lack of reasonable expectation of immediate liquidity and issuer's credit. These are always considerations that need to be overcome and priced in your analysis before you can purchase a structured note."

UBS Financial Services Inc. and Deutsche Bank Securities Inc. are the agents.

The notes are expected to price June 13 and settle June 18.

The Cusip number is 25155Q110.

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