Morgan Stanley’s contingent income autocalls on Boeing, FedEx offer tactical bet, high yield

By Emma Trincal

New York, March 25 – For investors confident that the worst is over for Boeing Co.’s share price, Morgan Stanley Finance LLC’s contingent coupon deal offer an above-average yield courtesy of the recent surge in volatility of the stock as well as the worst-of payout.

The autocallable securities due March 31, 2022 linked to the worst performing of the common stocks of Boeing and FedEx Corp. will pay a contingent coupon of 12.04% a year if each stock closes at or above its 65% coupon threshold on a quarterly determination date, according to an FWP filing with the Securities and Exchange Commission.

After six months, the notes will be automatically called at par plus the contingent coupon if each stock closes at or above its initial share price on any quarterly determination date.

The payout at maturity will be par unless any stock finishes below its 65% downside threshold, in which case investors will be fully exposed to the losses of the worst performing stock.

On March 10, an Ethiopian Airlines Boeing 737 MAX 8 crashed, leading several countries including China to ground the aircraft. The U.S. followed suit and grounded the aircraft.

This tragedy, which cost human lives and followed a similar accident in October, pushed down the stock price immediately. From $400 a share prior to the crash, the stock closed at $369 on Monday.

The stock recovered some of its losses but is still notably down. The share price is trading sideways as the ongoing audit and investigation make the situation difficult to predict.

News-driven return

“You’re getting paid an unusually high coupon because of the unusually high volatility of Boeing,” said Michael Iver, chief executive officer of iVerit Consultancy.

“They’re offering you a high return because of Boeing idiosyncratic risk. That’s the source of this yield.”

The use of a second underlying stock to construct a worst-of payout is also a return enhancement factor.

“Because Boeing is in the news and because this is a very specific situation, the correlation of the two is probably disengaged. There is probably some dispersion risk at the moment, which adds more premium and therefore allows for a higher coupon. But it doesn’t mean the dispersion will continue to be high,” he said.

Assessing the value of the 65% barrier, a level applied to the coupon and the principal repayment at maturity, is not something that can be determined without pricing the deal, he added.

“I couldn’t say whether or not the coupon is fair or whether the barrier is providing enough protection. There are the same criteria – credit risk, the fact that you’re locked in for three years, the same pricing factors that are common to all structured products.

“And you also have something very specific here, which is the news.”

First worst-of seen

This deal will not be the first Boeing-related trade since the tragic accident. A total of 14 deals tied to the stock of Boeing have been priced since the March 10 tragedy for a total of $12 million, or 2.66% of the total issuance volume, according to data compiled by Prospect News.

In comparison, the first two-and-a-half months that preceded the crash saw the pricing of only four offerings amounting to $5 million, or 0.07% of total notional.

What is new with the notes since March 10 is the use of a worst-of. According to Prospect News, it is the first Boeing deal that is not solely tied to the stock of the aircraft company in the past two weeks.

It’s all about one stock

Carl Kunhardt, wealth adviser at Quest Capital Management, who usually avoids single-stock deals and especially worst-of deals, saw this one in a different light.

“Boeing would be the worst-of and it’s already down. I’m not worried about FedEx. As long as the USPS continues to be not as reliable as it should be, those guys...FedEx, UPS will be in business. Everybody needs to send packages. FedEx will do fine.

“So the outcome at the end is going to depend on what’s going to happen with the 737 issue.

Bargain price

“Right now, the company is working with investigators. It looks like it’s a software issue. It’s the software that has created the two crashes, and Boeing is working on an update that should be delivered soon.

“I believe that Boeing is a company that offers the safest plane in the airlines. But you can’t convince people because of the buzz. People have lost trust in the aircraft. But the trust will be restored. Right now, you can’t convince investors or consumers because the media is very negative about it and people believe the media.”

In his view, the stock price is down only temporarily. Investors in the notes are buying the stock at a deep discount.

If one risk can be outlined, it would be to receive a coupon below the potential upside of the stock in a three-year timeframe.

Autocallable

The autocallable feature, which debuts six months after the trade date, is likely to shorten the duration of the product though.

For Iver, it was a positive element in the structure.

“You’re always more likely to be called around the first call dates than later. If you get called right away, that’s 6% for six months. That’s great,” Iver said.

“The no-call for six months is a good feature.”

As long as the stock price does not drop another 35% investors will either continue to get their coupon or will be called, said Kunhardt.

Tactical play

“I don’t see Boeing down 35% from where it is now. It has already dropped quite a lot,” he said.

“This note is more exciting than the typical leveraged buffered on the S&P, which you see every day.

“This is much more tactical and interesting because it’s news-related.

“People perceive risk because the media talk about it every day. So you get a 12% coupon. That’s an equity return.

“But you have a nice margin of safety with the barrier and more importantly the big drop in the share price two weeks ago.

“It’s pretty attractive.”

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes will price on Tuesday.

The Cusip number is 61768D3T0.

© 2015 Prospect News.
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