Scotia’s $8.62 million autocalls on Uber seen as too rich based on cost, stock valuation

By Emma Trincal

New York, Oct. 13 – Bank of Nova Scotia’s $8.62 million of contingent income autocallable securities due Oct. 10, 2024 linked to the common stock of Uber Technologies, Inc. present risks due to the high valuation of the underlier and the fee structure of the notes, said Clemens Kownatzki, finance professor at Pepperdine University.

Investors will receive a coupon of 10.75%, payable quarterly if the stock closes at or above its downside threshold, 50% of its initial level, on the related observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The securities will be called automatically starting Jan. 8, 2024 at par and on any subsequent quarterly review date if the stock closes at or above its initial level.

At maturity the payout will be par unless the stock closes below its downside threshold level, in which case investors will be fully exposed to the decline of the stock.

Volatility

“Fifty percent seems like a very deep barrier but when you look at the stock’s volatility it's not that deep,” said Kownatzki.

The price is up about 83% this year, he noted, using the initial price of the stock on the trade date, which was $45.78.

“We’re about 29% off the high of February 2021 but still... The share price has jumped a bit too fast and too much this year.

The Nasdaq in comparison has gained 28% during the period.

“The deep barrier is only the reflection of a high volatility both historical and implied,” he added.

The one-year implied volatility of the stock is above 40%.

The higher coupon is also the result of the greater volatility, which implies a greater risk of losing principal at maturity if the barrier is breached, he noted.

Call risk

In addition, the coupon is not guaranteed.

With the coupon at risk, Kownatzki pointed to two possible scenarios, which both are negative for investors.

“The first one is if you don’t get any or too few coupon payments,” he said.

“The second is the call risk. The probability of being called the first time around in January is pretty high. In fact, it’s about 50%.”

While reinvestment risk is inherent to any callable note, in this case the 2.687% quarterly income may not be sufficient to offset the high fee, which is paid upfront, he said.

The fee is 1.75%, according to the prospectus.

“For a one-year note, it’s quite expensive even if the notes mature. And if you get called especially on the first observation, which is three months from now, the cost of this security is going to be prohibitive. Your return as a result will be minimal.

“This would be my main objection,” he said.

A risk-free alternative

The “job” of any investor is to compare a security with other available alternatives, he added.

“When you see a six-month Treasury yielding 5.57%, it may not seem like an exciting return but there's no risk attached to it,” he said.

“You have to compare that risk-free return with a note, which involves exposure to market risk.”

The debate about risk-adjusted return has evolved since Treasury yields have moved up so strongly, he added.

“Does it make sense to run the risk of losing money while you could get a guaranteed return with no risk attached to your investment?

“The conversation has changed since the zero-interest rate era. People are now making higher allocations to fixed-income in all types of portfolios,” he said.

Fundamentals

Another “problem” with the notes, according to Kownatzki, was associated with the fundamentals of the underlying stock.

“The valuation is pretty rich in relation to Uber’s profitability,” he said.

“Looking back at the earnings since 2016, there has been only one year when Uber actually made money and that was in 2018. Otherwise, it has been nothing but negative earnings every single year.”

This situation is not that unusual with growth stocks, he noted, pointing to Amazon, which showed negative earnings for years.

“But with Uber, you have aggravating factors. The cash flow picture for instance is not great either. It has been bouncing back and forth between positive and negative for a while,” he said.

Uber does not show any price-per-earnings ratio given its negative earnings, he said. But the forward P/E is 47.

“It’s a high forward P/E. Quite frankly, you’re getting exposure to a stock that’s overvalued.

“Your entry point is not great at all. You’re getting in at a very high point,” he said.

The stock price has gained 58% over the past year.

Despite the high price, the early call scenario is the most likely to happen, he said.

“If you’re called in three months, you’ll get 2.69%, which is half of the risk-free rate.”

The yield on the three-month T bill is 5.5%.

“I don’t think the risk-reward of the note is very attractive. The valuation of the stock is stretched. The fee is too high. You’re much better off with a short-term Treasury,” he said.

Scotia Capital is the underwriter. Morgan Stanley Wealth Management is the placement agent.

The notes settled on Oct. 6.

The Cusip number is 06417YVP1.

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