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Hunting ELKS for a
10%-Plus Yield
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Published:
August 4, 2008
Citigroup (NYSE: C) is the big name behind
ELKS, an acronym for
"Equity-LinKed Securities." ELKS are structure product based
on an underlying common stock. They have a maturity date
(usually a year from the issue date) and offer either cash or
the underlying shares back at maturity. Typically, ELKS pay
quarterly or semi-annual dividends to investors. One of the ELKS
I particularly like is
Citigroup ELKS 11% Linked to Celgene (AMEX: EHC, $10.60).
Snapshot: These ELKS are based on the common stock
of biotech giant Celgene (Nasdaq: CELG). Citigroup issued 2.96
million shares of EHC in March 2008 at $10 a piece, raising
$29.6 million. The security matures in April 2009, at which
point you will either receive your principal back, or shares of
Celgene.
Dividend and principal payments are secured by Citigroup's
investment-grade rating of "A1" from Moody's and "A" from
Standard & Poor's. The ELKS rank as senior unsecured debt,
and debt holders have a claim on Citigroup's assets before
equity holders in case of insolvency. Although the bank has
been under pressure from bad mortgage loans, it has more
than $2 trillion in assets and is generally considered
well-capitalized.
Dividend: EHC
pays a total dividend of $1.1275, divvied up into two payments
-- one on October 6, 2008 and the second on April 6, 2009. At
today's share price, that equates to a yield of 10.6%. To capture the payments, you'll need to own
the shares before they go ex-dividend, usually five business
days before the payment dates.
The payments consist of $0.8226 a share coming from option
premiums (fees from option sales), which are treated as
short-term capital gains and taxed as regular income. The
balance of $0.3049 is paid as interest, which is also taxable at
your ordinary income tax rate. Thus, the shares are suitable for
a tax-deferred account.
Outlook: The "downside threshold price" for shares
of Celgene is $36.17. That means so long as CELG shares stay
above that price during the next nine months, you'll get back
$10 in cash as principal repayment for every equity-linked
security you own. If you'd prefer to receive Celgene stock, you
can use these ELKS like warrants and opt to get the equivalent
value in shares instead.
In the unlikely event the shares fall to the threshold price or
below, you'll get 0.16589 shares of Celgene for each ELKS. If
Celgene's shares were to go down below the threshold price of
$36.17 and stay there, at maturity you would receive less than
your original principal in equivalent CELG shares. Say Celgene
declined to $36.17 a share. At the 0.16589 exchange rate, you
would receive just $6 worth of Celgene shares for each ELKS
($36.17*0.16589).
The risk of that happening appears low at this time. Selling
today at $73.92, the shares have traded above $40 since early
2006. Over the past year they've defied gravity, gaining more
than +20% while the S&P 500 has lost close to -13%.
Looking ahead, Celgene's future appears bright. It has a
blockbuster blood cancer drug Revlimid and a dynamic pipeline of
psoriasis and cancer drugs that should ensure future growth.
With the
shares trading near their $10 par value, we see little downside
and good upside in EHC.
Since only 2,200 shares change hands daily, interested investors
may want to consider buying small lots over several days, so as
not to move the price.
Good Investing!
Carla Pasternak
Editor
High-Yield
Investing
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