Credit Suisse’s autocall contingent income notes tied to Tesla show less appeal than the stock

By Emma Trincal

New York, Feb. 11 – Credit Suisse AG’s contingent income autocallable securities due Feb. 14, 2020 linked to Tesla, Inc. stock subject investors to a disproportionate amount of risk in relation to the coupon paid on a contingency basis, advisers said, adding that buying the stock outright may offer a better risk-adjusted return.

The notes will pay a contingent quarterly coupon at an annualized rate of 17.2% if the stock closes at or above the 50% coupon barrier level on the determination date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if the stock closes at or above its initial level on either Aug. 12 or Nov. 11, 2019.

The payout at maturity will be par plus the coupon unless the stock finishes below its 50% downside threshold, in which case investors will lose 1% for each 1% decline.

Controversial name

“On the surface it seems appealing because of the 50% barrier,” said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

“If you’re a supporter of Tesla and believe in the company, in its CEO Elon Musk and the whole vision, this seems like an attractive deal.”

On the other hand, several research reports are bearish on the electric car manufacturer, he noted. Some of the issues most often mentioned are the company’s limitations on its capacity to increase production capacity.

Research firm Ned Davis Research, Inc. has a sell rating on the stock on the view that its share price is overvalued compared to the consumer discretionary sector on a price-per-book ratio basis.

Other issues include nearly $1 billion in convertible debt coming due next month and concerns over whether the company has sufficient cash flow to meet its repayments obligations. In addition, some of the government’s tax credits for customers are tapering off, which may force the company to lower its prices.

Coincidentally T. Rowe Price, the largest shareholder after Musk, cut its holding in half, according to a 13G filing with the SEC on Monday. The company did not issue any press release commenting on its decision.

The news had little impact on the stock price however.

Tesla bulls are pointing to recent efforts in increasing supply. In its latest earnings call on Jan. 31, the company said its production of vehicles has increased by 8% in the fourth quarter compared to the prior all-time high in the third quarter. Since then, the stock has gained 4%.

High-flyer

“There are supporters of Tesla and those who are skeptical to say the least. Some people believe the company is not worth anything,” he said.

Regardless of anyone’s view, the stock is highly volatile. The implied volatility of the stock is 55 versus 15 for the S&P 500 index.

“The potential for losses is significant. These are risks you have to weigh if you’re looking at those notes,” he added.

Investors may lose principal if after a year the stock price closes down by more than half of its current level.

Such moves are rare, but with a stock like Tesla, not impossible.

The share price fell by that amount in just seven months from July 2015 to February 2016 for instance.

“You’re taking 100% risk on the downside. Once the barrier is breached, you’re long the stock,” he said.

Volatility however works both ways and sometimes plays to the advantage of the bulls. In less than three months for example the stock surged to $377 a share in mid-December from $250 in October, a 51% gain.

“While you’re taking on all that risk you’re limiting your upside,” he added.

“You’re better off trading the stock.”

Upside potential

Jerrod Dawson, director of investment research at Quest Capital Management, reached a similar conclusion.

“I can’t say I like that note,” he said.

He pointed to the autocallable feature, which strikes after six months, and said the likelihood of an automatic call occurring at that time was high.

“Chances are you’re not going to make 17.2% but 8.6%. It’s a good return, don’t get me wrong. But it’s probably all you’ll get,” he said.

“On the other hand, there is such a high magnitude of potential losses. If you breach that barrier, you are guaranteed to lose at least half of your investment. It’s a catastrophic loss.”

Hefty losses

The risk-adjusted return was not satisfying for this adviser due to the potentially harmful losses.

“You’re very likely to make a decent return. But in the event that you don’t, you stand to lose a lot,” he said.

“You’re giving up too much on the upside and you’re keeping too much risk on the down.

“I know that every structured note is a trade-off. But this is not an even trade-off.”

Dawson said he would prefer trading the stock rather than buying the notes.

“You would have a very large downside risk but at the same time, a very large upside potential.

“If you’re not comfortable with the risk you can close your position anytime. With this note, you may have a barrier but your liquidity is very limited. If you’re down more than 50% after one year, which is not impossible, you’ll lose more than 50%. You’ll be wiped out.

“If you have to put 100% of your capital at risk, you might as well get rewarded for it,” he said.

Credit Suisse Securities (USA) LLC is the agent with Morgan Stanley Smith Barney LLC acting as distributor.

The notes will settle on Friday.

The Cusip number is 22549Y727.

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