Too soon to buy UBS’ $100,000 trigger phoenix autocalls on Freeport-McMoRan, contrarian says

By Emma Trincal

New York, April 29 – UBS AG, London Branch’s $100,000 of trigger phoenix autocallable optimization securities due May 2, 2024 linked to the common stock of Freeport-McMoRan Copper & Gold Inc. present too much risk to the downside given the volatility of the stock and its current valuation, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

If Freeport-McMoRan’s stock closes at or above the trigger price – 60% of the initial share price – on a quarterly observation date, the issuer will pay a contingent coupon at the rate of 15.67% per year. Otherwise, no coupon will be paid that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

If the shares close at or above the initial price on a quarterly observation date, the notes will be called at par plus the contingent coupon.

If the notes are not called and the shares finish at or above the trigger price, the payout at maturity will be par plus the contingent coupon. Otherwise, investors will be exposed to the share price decline from the initial price.

Follow the smart money

For Kaplan, who has been following the stock for years, the entry point for the trade was too high.

“The stock is down but it’s still many times higher than its March 2020 levels,” he said.

Insiders in this company have a “very good track record,” he said.

“Whenever the shares are worth buying, they’re buying aggressively and right now, they’re not,” he said.

One of Kaplan’s investment tools consists of following the trading patterns of insiders, which in his view point to opportune entry and exit points. When insiders are buying the shares of their own company in large notional amounts, especially when the trades originate from higher-ranked officers, such as chief executives or chief financial officers for instance, a buying signal may be emerging, he said.

Without such signals and when the stock still trades at higher levels than former lows, his approach is to wait, in line with the discipline adopted by most value investors.

“Tracking purchases and sales from insiders is a very efficient way to time a trade,” he said.

“Many of the companies I’ve been tracking on the NYSE since the 1990s show a consistent record of buying when the price is low and selling when it’s high.”

Valuation still high

The initial level of the underlying was at $41.69 when the notes priced on Wednesday.

Kaplan compared this entry price with the most significant buying pattern from top executives of the company.

“Insiders started buying in January 2020 at much, much lower prices,” he said.

Around March 2020, insiders became heavier buyers of the stock.

“We saw early on that month huge size purchases,” he said citing data from J3 Information Services Group website.

For instance, on March 2020, CEO Richard Adkerson purchased $2,505,725 at a price of $10.02 a share while on the same day Kathleen Quirk, president of the company, bought $852,601 at $10.03 per share.

“As you can see, both of these prices are substantially lower than the barrier of $25,” he said.

Last year, the cycle reverted itself with insiders becoming sellers of the shares.

On Feb. 4 Quirk sold $1.5 million at $38.55, close to four times the price she bought the stock at, he noted.

On Dec. 6, Adkerson sold $7.5 million worth of shares at $36.71, a price, or 3.6 times more than his purchase price.

In some instances, insiders sold at even higher prices than the current price, he said, pointing to vice-president and controller Donald Whitmire, who sold a position in March at $49.96.

Freeport-McMoRan’s shares closed at $40.55 on Friday.

“Before I get exposure to the stock for a three-year holding period, I want to see top executives buying more aggressively,” the portfolio manager said.

Not enough protection

One of the main problems with the structure was the 60% barrier, set at $25.

“Insiders have been buying the stock for less. There is a risk to see the share price go down below that barrier especially for a three-year note,” he said.

Aside from the risk of principal loss, investors may also be losing some of their return.

“I wouldn’t mind getting called even after three months. But there is a real risk to see the stock stay below the 60% [coupon] barrier for a year and a half. You could be missing a lot of your income,” he said.

The downside risk was substantial given the volatility of the stock and current market conditions.

“Even though a 40% protection seems generous, it really isn’t that much given the volatility of the stock. It’s not like having a 60% barrier on the S&P,” he said.

The implied volatility of Freeport-McMoRan is 56.87%.

Bears are out

Market conditions may indeed add more pressure on the stock, said Kaplan, who said that a bear market in the U.S. stock market began on Jan. 4.

The S&P 500 index hit an all-time high on that day at 4,818.62 after the Nasdaq-100 index peaked in November.

On Friday, the Nasdaq closed nearly 24% off its high while the S&P 500 index was in solid correction mode, down 14.25% from its peak.

Kaplan said there is no hard and fast definition of a bear market such as a more than 20% loss from a high point. Instead, he looks at a variety of signs.

“You can tell by the way the market is behaving. We are making lower highs, the VIX is extremely volatile. There are a number of metrics that indicate the bear market has already started.”

Another sign: some of the most crowded trades are beginning to crumble.

Netflix Inc. for instance lost a third of its value overnight a couple of weeks ago. On Friday, Amazon.com Inc. dropped 15% intraday after reporting its first quarterly loss in seven years.

“We are in what will become one of the most severe bear markets in world history,” Kaplan predicted.

Macroeconomic factors

Materials stocks like Freeport-McMoRan may hold up better than shares of overvalued tech stocks. Still the company is vulnerable to an economic downturn given that its main mining operations are in copper, not gold, he noted.

“They’re a base metals producer, an activity that doesn’t do so well when the economy is slowing.”

“When those companies are hit by a recession, their stocks don’t typically rebound quickly,” he said.

Volatility, high valuations, exposure to a coming recession, all those factors make the notes relatively unattractive at this time, he said.

“I would want to wait for insiders to buy the shares again,” he said. “They are likely to be patient. That’s their style. Wouldn’t you be willing to wait a year or two to quadruple your gains?”

Trading for a living

Freeport-McMoRan is among the best companies for investors relying on insider transactions to spot entry and exit points, he said.

“From all the companies that I track, Freeport-McMoRan has one of the best track records. They buy when the price is low and sell when it’s high. You can never time your trades perfectly, but they tend to be much more accurate than most,” he said.

Such result may have to do with compensation.

“The top executives at Apple and Microsoft get paid millions a year in compensation packages. They don’t typically make money trading the stock,” he said.

“But for lower-paid CEOs, trading is much more important. They tend to be much more alert because trading revenues is where their net worth comes from.”

While the issuer picked an interesting name for the underlier, the timing of the trade and the size of the barrier were sticking points.

“There is too much downside risk. I would have wanted to see a memory coupon in there. But mostly the problem is the barrier and the risk of losing money at maturity,” he said.

“The notes are coming too soon. There is no reason to buy ahead of the smart money at a time when the share price is still relatively high,” he said.

UBS Financial Services Inc. and UBS Investment Bank are the underwriters.

The notes settled on Friday.

The Cusip number is 90303K753.

The fee is 1.5%.

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