Citigroup's 7.5% ELKS issue tied to Schlumberger is second largest reverse convertible in 2011

By Emma Trincal

New York, June 1 - Citigroup Funding Inc. caught the market's attention with the pricing last week of $87.63 million of 7.5% Equity LinKed Securities due Nov. 23, 2011 linked to Schlumberger NV shares. The issue was the top reverse convertible deal for the month of May.

"That's a massive trade. I can't recall the last time I saw a reverse convertible of that size," said a sellsider. "Obviously it's going to an institutional investor."

The deal is the second largest convertible offering of the year to date, according to data compiled by Prospect News.

The biggest one in 2011 so far - also issued by Citigroup - hit the market in March. It was a $111.37 million offering of 12% ELKS due Sept. 21, 2011 linked to the common stock of United States Steel Corp.

With its Schlumberger deal, Citigroup will pay par in cash at maturity unless Schlumberger shares fall below the protection price, 80% of the initial price, during the life of the notes and finish below the initial price, in which case the payout will be 0.12008 shares of Schlumberger stock.

The notes offer an "above-market" fixed-rate coupon "in return for the risk" that the notes will pay out a number of shares of stock worth less than the initial value, according to the prospectus.

Investors are betting that the closing price will not decline by more than 20% from its original value.

On the upside, investors will not participate in any appreciation of the stock. As a result, they need to be only moderately bullish on the stock.

Downside

"This is for somebody who has a bullish view on Schlumberger but who doesn't think the stock will rise beyond the cap," the sellsider said.

"It works if you think the underlying is not going anywhere. If you see the stock trading flat or maybe down a bit but not down by more than 20%, that's a good play."

"A 20% decline is a stock trading at $66.63. Is it possible for the stock to go down to that level in six months? Anything is possible with stocks, but it's highly unlikely unless you have a significant slowdown in the overall global economy," said an oil services analyst who is bullish on the stock.

The last time the share price of Schlumberger hit the $67.00 threshold was in October, the analyst noted.

Upside

With a 7.5% maximum return per year, or 3.75% for the six-month term, the analyst said that investors in the notes should not expect the stock to exceed the cap, which is a share price of $86.40.

"We're fairly bullish on the stock. We have a 12-month price target of $112.00, and I would expect a higher return than this in the next six months," the analyst said.

"But if you're more skittish or bearish on energy, if you think we've had a fairly robust first half in oil, if you're taking the view that what's been in favor will be out of favor, then it makes perfect sense.

"I'm not in that bucket, but if you're a little bit nervous about the near term and want to figure out a way to generate 7.5% annually for something that may be flat or even a little bit down, then it's perfectly logical."

Citigroup has a buy rating on the stock. It raised its target price in April to $115.00 from $110.00.

Citigroup Global Markets Inc. is the agent.

Fees were 1.5%.

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