Morgan Stanley’s $1.5 million 12.3% RevCons on three stocks show good risk return profile

By Emma Trincal

New York, July 6 – Morgan Stanley Finance LLC’s $1.5 million of 12.3% worst-of fixed coupon RevCons due June 29, 2023 linked to the worst performing of the stocks of McDonald’s Corp., Lyft, Inc. and Pinterest, Inc. bring back the old reverse convertible structure with a decent risk-adjusted return, advisers said.

If each stock finishes at or above the 60% downside threshold level, the payout at maturity will be par plus the final coupon, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will be fully exposed to the decline of the least performing stock.

Interest is payable monthly.

Yield, barrier

“It’s a nice coupon. When you compare 12.3% with the 10-year yielding 1.35% it’s very appealing. Of course, the risk is not comparable, but you’re definitely getting a juicy yield,” said Tom Balcom, founder of 1650 Wealth Management.

“The 60% barrier is very strong. Even if we have a pullback, this note should do well in two years.”

Investors even have the additional protection of two years’ worth of a 12.3% annual guaranteed income, which is the equivalent of a 24.6% buffer, he said.

“You may be taking risk with the three stocks and the worst-of, but you still have good downside protection through the barrier and the income.”

High-yield substitute

The risk associated with a worst of three stocks was not suitable to everyone.

“It would be more of a high-yield play, a high-yield replacement type of investment because of the equity underlying. I wouldn’t use it as a cash replacement or bond replacement,” he said.

Balcom did not think the companies themselves presented a particularly significant risk.

“They picked three companies that are pretty healthy. McDonald’s is not going anywhere. Pinterest is not as common as McDonald’s but it’s a popular name. And Lyft is an established franchise,” he said.

“I can’t see any of those dropping more than 40% in two years.”

These views on the individual stocks reflected Balcom’s upbeat outlook on the market in general.

“I’m not bearish at all. Not with the Fed being very accommodative. Does it mean we won’t have a pullback? Of course not. We will have a pullback. But the note offers enough downside protection in my view,” he said.

Correlations

Donald McCoy, financial adviser at Planners Financial Services, assessed the risks and reward associated with the notes. His conclusion was somewhat positive even if the product may not be a match for risk-averse investors.

One of the obvious risks was the worst-of payout, he noted.

Such risk is increased when correlations between the assets are low or negative.

“I don’t know if there is any rhyme or reason in those three picks. One company is a food company, the other, Pinterest, is a social media type of business and Lyft is a ride-hailing service,” he said.

“If your goal was to pick three stocks that don’t have a lot of correlation with each other, you did a good job.”

McDonald’s and Pinterest as well as Lyft and Pinterest have negative coefficient of correlation.

McDonald’s and Lyft have a 0.13 coefficient of correlation.

Due diligence

Investors would have to do their research on the three names not only to examine correlations but also volatility levels.

“McDonald’s is probably the most stable of the three in terms of share price. The two others I’m sure are pretty volatile,” he said.

Indeed, the implied volatilities of Pinterest and Lyft are 58.37% and 50.85%, respectively. McDonald’s has an implied volatility of 20.31% only.

“You have to feel comfortable with the three stocks. Even though you receive the income payment, these, especially Pinterest and Lyft, which are recent IPOs, can move up or down quite a lot,” he said.

Both Pinterest and Lyft went public in 2019.

“If you lose, if one is down 41%, you’re still going to lose 17%.”

He was referring to the 41% loss induced by the barrier breach partially offset by the 24.6% collected in income at the end of the two years.

“At the same time, you’re getting 12.3% in return for the risk. What’s the likelihood you would make 12.3% by picking one of those three stocks?

“For investors with an aggressive profile, it would be a solid return,” he said.

Fair value

He examined the stocks, noting that all three were fairly valued or close to fair value, according to Morningstar.

“At least, from a valuation standpoint, the three stocks seem to be in a healthy place,” he said.

The companies had a niche in their industry giving them some additional value.

“Lyft definitely has its position. It’s not Uber but it’s the second one people use after Uber. It seems unlikely it would drop a huge amount unless we have another global issue,” he said.

Pinterest’s outlook is a little bit more uncertain given the competition in the social media space, he added.

“Barring another catastrophic event, I don’t see any of those two falling 40% and McDonald’s even less.

Not bad

“You’re investing in the worst of the three, but you’re getting a strong return while doing it.

“You’re just hoping none of them will fall apart.

“Perhaps for some people used to investing in equity-linked income notes, this is a little bit different.

“You don’t have the call features built into it. You’re in for the two years.

“For those autocall investors you may want to take a second look.

“But you have a conservative barrier of 60% and a fixed income.

“For many people it should be sufficient,” he said.

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes settled on July 1.

The Cusip number is 61773FCH4.

The fee is 0.4%.

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