RBC’s digital plus barrier notes tied to Alibaba to outperform in range-bound market

By Emma Trincal

New York, Nov. 16 – Royal Bank of Canada’s 0% digital plus barrier notes due Dec. 10, 2021 linked to the American Depositary Receipts of Alibaba Group Holding Ltd. allow investors to outperform the stock in a range comprised between 80% and 108%, according to an FWP filing with the Securities and Exchange Commission.

If the final level is greater than or equal to the barrier level, 80% of the initial level, but less than or equal to 120% of the initial level, the payout will be the greater of par plus the return and par plus 8%.

If the final level is greater than 120% of the initial level, the payout will be par plus 20%.

If the final level is less than 80% of the initial level, investors will receive a number of shares equal to $1,000 divided by the initial share price or, at the issuer’s option, the cash equivalent.

A different story

Carl Kunhardt, wealth adviser at Quest Capital Management, said he liked the offering even though he usually avoids single-stock exposure.

“This note is a little bit different. I like it, and I probably would do it,” he said, adding that he is familiar with Alibaba.

“Having a client who likes it, I’ve been researching it. It’s the Chinese Amazon. A mix of Amazon and eBay.

“They haven’t done so well during the trade war, but the stock has rallied this year just like Amazon and for the same reasons. People have been buying online during the pandemic. It just dropped recently because the Chinese government wants to keep an eye on big internet platforms.”

Red flag

Chinese regulators announced “anti-monopolistic” regulations last week, which could negatively impact e-commerce platforms like Alibaba. The market immediately reacted, and the stock lost 15% in the past week.

However, Alibaba’s share price is still up 22% for the year due to an exceptional recovery from the March sell-off as did most “stay-at-home” stocks including Amazon.

Kunhardt downplayed the regulatory risk.

“One thing the Chinese have really kind of figured out is to implement their socialist policies with a healthy dose of capitalism. They may enforce social and political control...that’s what they want. But they still keep the stock market running.”

Barrier

Kunhardt was satisfied with the 20% contingent protection.

The recent regulatory tightening and its impact on the stock generated a buying opportunity and a margin of safety in his view.

“The 80% barrier is pretty healthy despite the volatility of the stock,” he said.

“Could we see a retracement? Sure, but given the recent drop, I don’t expect the stock to be 20% lower a year from now.

“If it were an American barrier, I wouldn’t be so sure, but not point to point.”

American barriers, which are observed during the life of the notes, are more likely to be breached than so-called “European” barriers, which are observed at maturity.

Not too bullish

The least attractive aspect of the note was the cap.

“Perhaps my main concern would be the upside. This 20% cap is going to limit some of your potential,” he said.

Several geopolitical factors may contribute to push the stock higher than 20%.

“The relationship between the U.S. and China is going to improve with the new Administration.

“Even if the tariffs are maintained – and they may be maintained – the rhetoric between the two countries is going to change. The Chinese will accommodate us. Overall, the bottom line will improve for Chinese companies because the key headwinds for them were the tariffs.”

Since its initial public offering six years ago, Alibaba has experienced strong growth, making it the world’s largest retailer and e-commerce company, and one of the largest internet companies in the world.

“This is a company with a strong potential for growth. I’m pretty sure the stock will do more than 20% next year,” he said.

Buy the stock

Jerry Verseput, president of Veripax Wealth Management, expressed similar concerns about the limitation in the upside.

“I see this note as more complicated than it’s worth,” he said.

“If you want exposure to Alibaba, you buy the stock outright. It has a big upside potential. Why would you want to sacrifice it?”

Investors in the note, he said, are betting that the stock can drop but not more than 20%.

“I’d rather take a small position, put a stop at minus 20% and get my unlimited upside.

“Your risk is the same and you can maximize the return.”

The payout of the note with its digital return of 8% allowing investors to outperform the stock from a 20% decline to an 8% gain, did not seem attractive enough to him to warrant a 20% cap.

“It just looks like they try to make this fit into a structure. But it doesn’t really work.

“I can take the same risk on the downside and get unlimited gains,” he said.

Chinese opportunities

Investors with a range-bound view on the stock would benefit from the structure. Part of his reasoning came from a bullish outlook on Alibaba.

“We have no idea what the stock is going to do. But if it’s up, it will be up more than 20%.

“Biden will be more friendly with China than Trump was.

“I’d rather own Alibaba, or better, own stocks of U.S. companies doing business in China.”

He mentioned Apple Inc, Cummins Inc., a diesel engine manufacturer which has formed joint ventures in China as well as industrial equipment maker Caterpillar Inc., which is a large exporter in China.

“As trade restrictions are lifted, these stocks will do very well,” he said.

RBC Capital Markets, LLC is the underwriter.

The notes will price on Nov. 30 and settle on Dec. 3.

The Cusip number is 78013GYW9.

© 2015 Prospect News.
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