Citi’s digital plus notes on Netflix offer alternative to long position, contrarian says

By Emma Trincal

New York, May 20 – Citigroup Global Markets Holdings Inc.’s 0% enhanced barrier digital plus securities due Nov. 29, 2023 linked to the common stock of Netflix, Inc. allows investors to get exposure to a volatile stock while mitigating the downside risk, a portfolio manager said.

If the final share price is greater than or equal to the final barrier value, 54% of the initial share price, the payout at maturity will be par plus the greater of 10% and the underlying return subject to a maximum return of 35%, according to a 424B2 filing with the Securities and Exchange Commission.

If the final share price is less than the final barrier value, investors will receive a number of shares equal to the final value of the underlying shares or, at the issuer’s option, an amount in cash equal to the value of those shares.

Losers

“The notes offer value if you want exposure to the stock,” said Steven Jon Kaplan, founder and portfolio manager at True Contrarian Investments.

The contrarian investor buys stocks at deep discounts. Yet Netflix would not be in his buy list despite the plummeting stock price. The notes however would make for a viable alternative to a long-only position.

“Netflix has suffered a big decline this year. It’s down close to 70%,” he said.

“It’s not nearly as overvalued as the other high-flying growth stocks like Apple and Microsoft that have barely dropped.”

The shares of Apple and Microsoft have fallen by 22.5% and 25%, respectively, for the year.

But Netflix is not yet a bargain, he said.

“Trendy stocks like Netflix, Zoom have been hit very hard. These companies were so popular with investors, their stock prices skyrocketed to huge levels, which never reflected their profit growth,” he said.

Last month, Netflix dropped 35% in one day after the company reported it lost 200,000 subscribers in the first quarter.

Value first

Price moves for a value investor are important but not sufficient, he noted.

“It’s not enough to find a stock in free fall. In bear markets, people tend to buy just because the stock dropped a lot. That’s a mistake. The price drop in itself doesn’t necessarily mean that the stock went from overvalued to suddenly undervalued,” he said.

In his approach, Kaplan always compares price to value.

“I look for value in companies where the average annual profit growth exceeds the P/E preferably by several multiples.

“It’s not the case with Netflix.

“The fact that the share price declined is certainly an improvement. The company is closer to fair value but not anywhere near,” he said.

No insiders

Kaplan pointed to another missing signal.

“A lot of insiders were selling the stock last year around September. But no buyers right now. Before buying the shares, I want to see more insiders buying. We’re just starting to see some, but it’s limited so I wouldn’t just jump on it right now,” he said.

The most recent insiders’ buying was from the co-chief executive officer in January.

Barrier

“That said, the note is very attractively priced,” he added.

“The terms reflect the fear associated with buying the stock because it has dropped so much.

“The option premiums are much higher both for calls and puts, which means that people are not that bearish. The implied volatility on September contracts is at about 60%, roughly the same for calls and puts, so the skew is fairly flat.

“Issuers can sell those options and get higher premiums, which provide more generous terms.”

The stock has rebounded in the last couple of weeks, he noted, but remains depressed.

Kaplan said that the 54% barrier was an attractive part of the structure.

“This is a deep barrier and it’s a good thing. It’s unlikely that the stock could be down as much as 46% at maturity,” he said.

“You want a big barrier when a stock is as volatile as Netflix even if the price has already dropped a lot.”

Payoff

Kaplan said he also liked the 10% minimum return if the final price is above the barrier.

“It’s great because you don’t need the stock to be up...you just need the stock not to post a huge loss. Any price drop of 48% or less will give you that 10%,” he said.

The 10% digital return over 18 months will generate a “reasonable gain” if the stock finishes higher. If the final price is negative, the note will significantly outperform, he said.

“They had to cap it at 35% to be able to price those terms. But even 35% is a reasonable return especially if the price is negative. From -46% to +10% you’ll outperform.

“For investors not used to selling puts and calls, this is a very well-structured product.

“While I wouldn’t buy the stock just yet, I would consider buying the notes. It’s a good alternative to buying the stock. It’s a more conservative play.”

The notes are guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes will price on May 23 and settle on May 26.

The Cusip number is 17330DED4.

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