News Analysis date published New: 
Friday, September 28, 2012 - 14:30
New Date created: 
Friday, September 28, 2012 - 15:03
New Date last updated: 
Friday, September 28, 2012 - 14:30

How to Get a 17% Yield from Facebook

Friday, September 28, 2012 - 2:30pm

The hype prior to Facebook's (Nasdaq: FB) IPO on May 18 was unprecedented.

Every media outlet was keenly focused on this revolutionary young company with such massive valuation. Investors competed to be included on the IPO share distribution lists, certain that the world's largest social media company would propel any investment into the stratosphere. For those who didn't have inside IPO distribution connections, an active secondary market took hold, with binary option dealers offering bets on what the company's valuation would be after its first day of trade. Heralded as the savior of the IPO market, Facebook's IPO was, in theory, supposed to make investors wealthy.

Then dreams were shattered.

As many investors cut their losses short, shares went on a downward spiral and now trade at almost half of its $38 IPO price. What was the most expected IPO of the year, quickly became one of the worst-performing IPOs of all time.

Take a look at the chart below:

The market taught a hard lesson that, when it comes to stocks, hubris and hype often lead to disappointment.

But if Facebook is still in your portfolio, then there's a way to mitigate your losses.

I've discovered a little-known method to hedge against Facebook's losing streak. The best part is, even if you are not a Facebook investor, this technique could lead to big gains as an alternative investment.

Here's how it works...

Citigroup (NYSE: CITI) has launched $1.1 million of auto-callable bonds linked to Facebook's stock price. Each bond costs $1,000 and Citigroup pays a 17% coupon, or interest rate, per year that's paid quarterly. If Facebook shares rise above the price of $19.34, then investors get the principle returned plus the coupon payment. If the price drops below that limit, then investors only get the coupon payment.

There is a built-in floor, which means if Facebook shares collapse below $12.57 on one of the quarterly dates, then investors still get the coupon but the bond is swapped for the lowered-value stock or cash.

This investment couldn't have come at a better time for Facebook investors. After all, things are not looking positive for a rebound anytime soon. Here are three reasons why:

1. Lock-up expiration
A large number of Facebook shares are still locked-up, meaning insiders are unable to sell their shares until a specified date. Lockups will expire in stages over the course of eight months, with the final one being in May of next year.

The first lockup was on Aug. 16, bringing 271 million shares to the market. Right after the lockup expiration, the stock fell to $20 a share for the first time since its IPO. Another lockup will expire on Oct. 29, at which point 249 million shares will go to the market, representing 9% of shares outstanding.

Then a bomb drops.

On Nov. 13, 1.332 billion shares, or 49% of outstanding shares, will be released from lockup. It's very likely that investors will want to sell these shares, so downward pressure on price will be substantial.

2. Taxes
Yes, it's just not the working class that pays taxes. Facebook will soon be hit with a multibillion-dollar tax bill. This tax is due to the company's employee stock compensation program. It's a complex issue, but suffice it to say, Facebook will be owing between $2 and $4 billion in taxes during the next few months. Obviously, this will create additional downside pressure on the stock.

3. Keeping employees
Employee retention is critical for all companies. But the highly-specialized workers at Facebook are even more difficult to retain than non-high-tech workers. Each employee who has joined the company in the past 18 months is now underwater on their stock grant, so keeping these employees happy and will be very difficult.

If you consider these three reasons -- not to mention other issues such as competition and user burnout -- then things are not looking positive for a bounce in Facebook stock anytime soon. That's why it's crucial that investors of the social media company look into Citigroup's Facebook note.

Risks to Consider: Keep in mind, these bonds are tailored for each investor. As you can tell, this can be a complicated arrangement, so it's crucial that you research this investment further. Here is the SEC document with full explanation on how these unique tools work. These new auto-callable bonds carry the risk of sticking the investor with greatly devalued Facebook stock or cash equivalent should the share price plummet. Be sure to read the SEC document completely and have a full understanding of these unique tools prior to investing.

Action to Take --> I think the bond's 17% yield is highly enticing. This is particularly true if you are one of the many investors who are sitting on a greatly devalued Facebook stock. This new tool offers an alternative for those seeking to get some of their losses back. The bonds also make sense as an alternative asset to add to a portfolio.

P.S. My colleague Carla Pasternak discovered another high-yield investment that she believes is one of the best of the year. It's an oil and gas stock that couldn't be simpler... or more lucrative. It owns a stake in dozens of oil wells and pays out 90% of its profits to investors. And right now it's yielding 11.5%. Click here to get the name of this stock now.

David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.