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Telecom Structured Notes Undervalued, Says Salomon

08 Jul 2001

Schroder Salomon Smith Barney believes structured notes issued by France Telecom to investors in telecom company Equant are trading below fair value and is recommending investors sit on long positions or snap up the instruments. France Telecom last month acquired a 54% stake in Equant and last week issued the notes, known as contingent value rights (CVR), to investors. The three-year CVRs consist of a long and short put on Equant's stock, giving protection against a sell off in the stock price following the acquisition, according to Dharmendra Patel, equity derivatives strategist in London.

Investors holding the CVRs are short a three-year European-style Equant put struck at EUR45 (USD38) and long a put struck at EUR60 with an identical maturity. The options can only be exercised if they are in the money for a majority of the final 30 days of the note's life.

Equant was trading at EUR21.36 on Friday. The CVR is in the money because Equant's share price has plummeted from a high of EUR128.9 on Feb. 10, Patel said. If the share price does not recover to EUR45 the holder of the CVR stands to make EUR15 per note.

The CVRs were trading at EUR10.6 on Tuesday and Salomon estimates the value of the note is above EUR12, according to Patel. Because the CVR is so far out of the money it can also be viewed as a synthetic bond in which investors might receive EUR15 at maturity in three years, which translates to a 12.3% yield per year.

France Telecom issued 138.5 million CVRs, worth approximately EUR1.4 billion, at an average price of EUR10. One CVR was given to minority shareholders for each Equant share they held.

08 Jul 2001