Citigroup's 10.25%-12.25% ELKS linked to Facebook aimed at bulls with high risk tolerance

By Emma Trincal

New York, March 5 - Citigroup Inc.'s 10.25% to 12.25% annualized single observation Equity LinKed Securities due Sept. 19, 2013 linked to the common stock of Facebook, Inc. may appeal to risk-takers who believe that the worst days of the stock sell-off are over, sources said.

But investors remain cautious about the strategy, which is the equivalent of selling a put, as the performance of the stock continues to disappoint.

The payout at maturity will be par of $10 unless Facebook shares fall below 80% of the initial price on the Sept. 16, 2013 valuation day, in which case the payout will be a number of shares of Facebook stock equal to $10 divided by the initial share price or, at the issuer's option, a cash amount equal to the value of those shares, according to a 424B2 filing with the Securities and Exchange Commission.

Interest will be payable monthly.

Some investors are betting that the stock is poised for a rebound. Facebook stock lost more than 30% from its botched IPO in May through the end of last year. This has been followed by wide swings since the beginning of 2013, and the share price is up 3.35% year to date.

But sources remained skeptical regarding the volatility and the valuation of the stock as well as the monetization of the social networking company's business model.

Wild ride

"The issue is has the stock settled down into a range or are we going to see the same volatility as last year?" said Donald McCoy, financial adviser at Planners Financial Services.

"It started in the higher 30s when it came out, then went down in the mid-20s, then dropped significantly over the summer down to the teens."

Facebook's debut on Wall Street was painful for investors, he noted.

On the second day of trading, the stock had already dropped by 11%, and in early June, the shares had declined by nearly two-thirds of their initial $38.00 value.

"It's been up and down and up and down. Maybe now it's trending off again," McCoy said.

This year, the stock has already dropped to $27.52 from its Jan. 28 peak, a 15.25% decline.

"If you bought it now, how likely is it to go down below $21.00, which is approximately the 20% decline range that you have?

"Well, if you look at the past year, it's been a fair amount of times below $21.00," he said.

Of more concern to McCoy was the poor performance of the stock in the midst of last year's and this year's rallies.

"If it's off when the market is going up, what happens if we're really taking a hit? It's not like it will hold up more than anybody else," he said.

"You're getting an additional 5% protection from the coupon. Once you pass that, you're losing principal.

"How much principal am I willing to risk hoping that Facebook won't drop more than 25% in six months?

"I don't have a high degree of confidence that if we see a market correction Facebook wouldn't take a bigger hit.

"It would be a definite pass for me. You're probably going to make 5% in six months, but I don't like the risk you're taking in order to get there. You can probably find another way of getting some pretty decent income with less volatility."

McCoy said that he would not expect a 5% or 6% return in six months with a less risky investment.

"But I can certainly get 2% or 3% over that time with a lot less risk," he said.

"This is a very volatile stock that has lost a lot over a very short period of time.

"I'd feel better putting my money in something like Altria for six months for the dividends. If the stock goes down 19%, I can always sell."

Altria Group Inc. has an annual dividend yield of 5.14%.

Not many deals

Since Facebook began trading, issuers have brought to market only two structured notes linked to the name, according to data compiled by Prospect News, which tracks publicly listed offerings.

The first one was announced in May by UBS AG, London Branch, a 13% to 14.35% reverse convertible. It ended up not pricing, according to the SEC website.

In late August, Citigroup Funding Inc. issued $1.1 million of 17% autocallable equity-linked securities due Sept. 3, 2013 linked to the share price of the social networking company, with quarterly observation dates and a downside threshold price of 65% of the initial price, according to Prospect News data.

The following month, Credit Suisse AG, Nassau Branch sold $720,000 of 10% callable yield notes due March 27, 2014, a callable reverse convertible with a 50% knock-in price.

Too rich

More traditional equity investors and analysts remain skeptical about Facebook for reasons other than the stock's volatility.

For Tim Travis, chief executive of T&T Capital Management, a registered investment advisory firm specializing in value investing, the stock remains overpriced and a lot could go wrong for the company.

"I wouldn't recommend doing this, personally," Travis said.

"It's still a pretty expensive stock from a valuation standpoint. It's not dramatically overvalued, but there is no margin of safety, so ... things can end quite badly due to the implied expectations.

"If I was interested in making that bet, I would sell a put. I would pay less in transaction costs and get similar results with better liquidity."

As a value investor, Travis said that the stock remains expensive from a price-to-earnings standpoint.

"I know Facebook has a lot of momentum. Several hedge funds have been buying it. But I also know a lot of hedge funds who were buying Apple when it was expensive. And Facebook is expensive from a P/E standpoint.

"The company, a lot of times, releases its adjusted earnings, which take out stock options expenses. It's a bit misleading. They're not really profitable because the shareholders are getting diluted. It's very common. Other companies do that. But it doesn't really reflect the company's performance."

Travis said he would not be long the stock because he does not believe in its fundamentals.

"They're not extremely profitable. They are doing a lot better. But still, they're trading at very high multiples. I'm not comfortable that they will be around forever. I don't know what the company would look like five years from now," he said.

Competition and monetization of ad revenues were the company's main headwinds on the path to growth, he said.

"This note would make sense to me if it was a stock I thought was undervalued and if they paid a coupon that would be more than what I would get from selling a put. Then maybe I would be interested."

Buy and hold

Rick Summer, a senior equity analyst at Morningstar, said that he advises investor to hold the stock for the long haul but with a "caveat," he said.

"My view is that Facebook is worth about $32.00. We are bullish on the stock. But we're telling our institutional investors or equity fund managers that they should not be long the stock unless they're willing to encounter a great deal of volatility," he said.

He explained that his fair-value estimate was different from other valuation methods.

"We don't price on P/E or on an adjusted P/E basis. For investors looking for multiples, yes, Facebook has still a rich valuation," he said.

"Our estimate is for the long term. We're looking for a 10- to 15-year trend.

"I'm an equity investor. We don't worry so much about pricing volatility. This [note] is obviously a volatility trade.

"It's for some investors. It's not for others. It's definitely not a low-risk trade.

"Despite the fact that we think the stock is trading less than what the company is worth, our view is long term. For now and a few more quarters, we know that the stock will be extremely volatile."

The notes (Cusip: 173095886) are expected to price March 15 and settle three business days later.

Citigroup Global Markets Inc. is the underwriter.

The fees are 1.5%.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.