Morgan Stanley’s fixed-coupon autocall on Biogen raises volatility, American barrier concerns

By Emma Trincal

New York, Jan. 16 – Advisors raised objections to the risk-adjusted return of an innovative short-term autocallable note offering a double-digit, guaranteed coupon in exchange for the added risk of a daily observation barrier. The underlying and its volatility was an additional concern, they said.

Morgan Stanley Finance LLC plans to price 14.1% fixed-coupon autocallable securities due Jan. 26, 2021 linked to the shares of Biogen Inc., according to a 424B2 filing with the Securities and Exchange Commission.

Interest will be payable quarterly.

The notes will be called at par if the stock closes at or above the 100% redemption threshold level on any quarterly determination date.

If the stock closes at or above 70% of its initial level on every trading day during the life of the notes, the payout at maturity will be par.

Otherwise, investors will be fully exposed to the decline.

Guaranteed coupon

Last week, this issuer priced $1.2 million of another fixed-coupon autocallable issue. The 18-month security carried a fixed, quarterly payable coupon with an annual rate of 7.76%. The 70% barrier had the same amount but unlike this product’s downside threshold set, which can be breached any day (American barrier) it was observed at maturity as a standard European barrier. The downside exposure was not based on one stock as this note is but on the worst of three uncorrelated stocks – Chevron Corp., Walt Disney Co. and Newmont Mining Corp.

The coupon was nearly twice lower for a longer maturity and a worst-of payout. But sources said that this issuer may have extracted a lot more premium with biotech company Biogen.

Roller coaster trials

The biopharmaceutical company specializes in therapies for neurological and neurodegenerative diseases.

When it comes to Biogen, uncertainty and wide price moves either way are the norm.

One important factor of uncertainty is the company’s upcoming launch of its experimental Alzheimer’s drug, aducanumab. Terence Flynn, analyst at Goldman Sachs, said in a research note published Wednesday that “patient diagnosis would be the most important bottleneck” and that the company is working with partners to have testing available.

The regulatory filing process however “is going well,” the analyst said, adding that the company is in the initial stages of a launch.

As with any new drug, the launch will be a catalyst for price moves.

Patent challenged

A more pressing overhang on the stock is a patent battle with generic drugmaker Mylan, which filed a petition last summer with the U.S. Patent and Trade Office to challenge the company’s blockbuster multiple sclerosis drug Tecfidera. A decision about the patent is expected on Feb. 7.

If Biogen loses, it will appeal, which could take between 12 and 18 months, the Goldman Sachs analyst said, adding that “generics could [still] elect to launch at risk,” in the interim. If so, the issue would remain in limbo and the price of the stock could suffer.

Another wildcard, this time, over the very short-term: Biogen will report its fourth-quarter earnings on Jan. 28. The upcoming event is also adding more volatility.

The implied volatility of the stock is at 48.76% versus 18% for the iShares Nasdaq Biotechnology index, the benchmark for this sector.

Call risk

Steve Doucette, financial adviser at Proctor Financial, was uneasy about the reinvestment risk and market risk associated with the notes.

“It’s 14% for one year. But in the next quarter, you might only get 3.5%,” he said.

“14% is a pretty nice coupon obviously and it’s nice that it’s not contingent. But your upside is capped at 14% a year while your downside is unlimited.

“I guess you do keep your 14% coupon, but in theory, you could lose all of your initial investment.”

Volatility

Investors could also be easily penalized on the upside.

In just the last three months, the share price has gained 26.8%.

“It’s a volatile stock. It could have a lot of upside. If the stock is up just a little bit, you get called. Volatility will have dropped if you’re called, which means the terms you would get wouldn’t be as good,” he said.

And because of the volatility, the stock price could drop 30% anytime, which would cancel the downside protection, subjecting investors to the full downside risk, he added.

In March, the stock plunged 26% in one day after the company announced that it would end its trials on its aducanumab Alzheimer’s drug. In October, the stock price jumped 28% on the day the company announced that it was resuming its trials in light of new test results.

“If you bring the elections in your outlook, you could have even more volatility in the overall market,” said Doucette.

“As I step back and look at it, I’m not comfortable with the downside risk even with a 14% coupon.

“A lot of people would take that risk thinking this thing is going to get called. But if the price bursts through the barrier, you’ve got no downside protection. The stock is down in one year; you take all the losses.”

Protective put

Matt Medeiros, president and chief executive of the Institute for Wealth Management, did not see how he would benefit from buying the note compared to being long the shares.

“I’m not a fan of this note. I would be curious about the cost,” he said.

The prospectus did not disclose the fee amount.

“Based upon the terms of this product, I’d rather own the stock outright as opposed to buying this note.

“If I had concerns about the downside, I would buy a put option to protection myself.

“The coupon is not advantageous enough to warrant such level of risk.”

Another issue was the reinvestment risk.

“There’s a high probability this note would be called in the short term,” he said.

“If you like the stock why not buy it along with a put? That way you’re not limiting your upside and you get a much more reliable protection.”

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes will price on Jan. 21.

The Cusip number is 61770FDD5.

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