Beware of companies with these bonds on their books

In this issue:
» Indian Railways facing tough times
» Why small caps have risen so sharply
» Is China's manufacturing prowess on the wane?
» Job growth in the US not fast enough
» ...and more!

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00:00

Foreign currency convertible bonds or FCCBs as they are called were the toast of the town way back in 2005 when stock markets were rising and there was a general sense of well being all around in the financial world. So much so that raising money through this route became a fad with many companies joining the bandwagon. So what made these bonds so attractive to Indian companies?

FCCBs had a mix of debt and equity in the sense that it gave the bond holder the option to convert bonds into equity shares at a predetermined price. If the shares of the company never reach the predetermined price and the bond reaches its maturity, then the principal is repaid to the bondholder just like in the case of regular debt. And therein lay the catch.

Most companies set a very high conversion price assuming that stock markets would continue to head upwards. But there were a series of corrections since, the largest being the meltdown witnessed post the financial crisis. Suddenly, converting bonds into equity shares did not seem so attractive. Thus, companies were saddled with debt on their books on which regular interest payments had to be made. Because the bonds were priced in another currency, whenever the rupee depreciated sharply, it resulted in large quantum of forex losses. This dented profitability in the bond holders' books. Plus, many of them had to ensure that they had sufficient cash on their books to ensure redemption of these bonds. Those not having ample cash resorted to either raising fresh loans or selling assets to be able to redeem these bonds. This proved to be the undoing of many companies, Wockhardt being one of them.

After all this time, the FCCB pain has not completely diminished. According to Firstpost, 2012 seems to be the year of reckoning for FCCBs. This is because almost US$ 7 bn worth of bonds are set to mature this year. Further, 59 companies are expected to face redemptions, of which 20% are likely to default.

What this means is that investors have to keep a watchful eye on debt being raised by companies and in what form. Too much of it is bound to impact the company one way or the other if it is not able to bring it down in the longer term. In case of FCCBs too, investors will need to read the terms and accompanying conditions to understand what kind of impact it can have on the company's financial health before they decide to invest in such companies.

Do you think one should invest in companies having a large amount of FCCBs on their books? Let us know your comments or post them on our Facebook page / Google+ page.

01:26		Chart of the day

Today's chart of the day shows that Wall Street bonuses once again fell in CY11 as weak economic conditions in both the US and Europe took toll. Not just that, firms are also increasingly offerign higher base salaries and deferred compensation and this has also contributed to the fall in bonuses doled out. But a new standard has been set and it may be a really long while before bonuses match those that were seen in the heady days of 2006 and 2007.

Data Source: The Economist

02:01

The Indian Railways has been facing tough times. On one side operational costs have been going up with fuel prices spiraling upwards. On the other hand, the Railways have not hiked its passenger fares for nearly a decade. And the worst part is that there are high chances that they would not be able to hike rates this year either. Why? Because it would make the government look bad. But at the same time, the Indian Railways needs cash. Cash to modernize its systems. Cash to improve the safety standards.

So who will give this cash? Obviously the government. And who will give the cash to the government. Obviously the common man. This is nothing but another Air India in the making. Just like Air India, Indian Railways too has adopted a bad business model based more on populist votes rather than on common business sense. And the government is happily bailing it out. All with the tax payers' money. Are they justified in doing this? If you feel the same way as we do, then raise your voice to Ban Bailouts. Remember, every vote counts!

02:36

It is extremely undesirable for an economy to be vulnerable to external factors it has no control over. But what can an economy like India do when it depends on more than 70% of imports of crude oil? Moreover, crude oil is a basic commodity that propels the engine of an economy. We cannot do without it. So we have no choice but to bear the brunt of volatile crude prices. In fact, this month crude oil prices touched a historic high of Rs 6186.8 per barrel. And there is no indication that oil prices are going to cool down anytime soon. What has added further to our woes is a weak rupee. These factors are going to weigh heavily not only on the government's finances, but will also hamper growth and profitability of India Inc. In fact, smaller companies tend to be hurt even more than their larger counterparts.

So what will be the impact on small cap stocks? You may have noticed that in the last couple of months, the Indian stock markets have registered a brisk rally. In fact, small cap stocks have appreciated even faster than their larger counterparts. Why have small cap stocks risen so sharply? Well, small cap stocks tend to have low liquidity. So they tend to swing to extremes depending on the direction of the overall markets. When market sentiment is upbeat, they tend to be the best performers. And vice-versa.

03:11

China surpassed America's manufacturing capacity in 2010. The dragon economy now produces one out of every five goods manufactured globally. China has not just produced in large quantities but also managed to sell it dirt cheap. So much so that has curbed inflation in many of its trading partners. But as data suggests the era of cheap Chinese manufactured goods may be drawing to a close. As per an article in economist, China, like India, is not unaffected by increases in land prices, environmental norms and higher taxes. But what has affected its manufacturing cost the most is rise in labour cost. For instance, the overall wages rose by 10% in 2011. However, Foxconn, a Taiwanese contract manufacturer that makes Apple's iPads in Shenzhen, revised salaries higher by 16-25%. Labour costs are currently 30% lower in countries such as Vietnam than in China. But lack of efficiency has so far dissuaded producers from quitting China in search of cheap labour. China's supple supply chain is also a key reason for producers to stay put. Hence higher labour costs may not hurt China's manufacturing prowess. At least not as long as other countries catch up with it on efficiency and other infrastructure.

03:45

It is hard to believe that just six months ago, many were forecasting a double-dip recession for the United States. At that time, the economy had been growing slowly, but there were reasons for believing that growth would pick up. For instance, the economy created 227,000 jobs in the month of February, the best job growth since the recovery began two years ago. Unemployment rate has fallen to 8.3%. But still the growth in jobs is not fast enough. This is because the economy is still down by close to 10 m jobs from its pre-recession level. Output is roughly 6% below potential. Even if the economy creates 250,000 jobs a month and grows at a 3.0% annual rate, it will be close to the end of the decade until the US is back to its trend path.

04:15

The euro came into existence with great pomp and splendor in 1999. But, now things have completely fallen to pieces. The crippling nature of excess debt has all but sunk the periphery nations. Greece recently restructured its debts with some private creditors. The European Union (EU) and the International Monetary Fund (IMF) also recently set aside US$ 172 bn in rescue funding. While this deal gives the country a temporary lifeline, it doesn't solve the fundamental issues. Greece is still struggling with rising unemployment and shrinking output.

Now, according to New York University economist, Nouriel Roubini, Portugal will be the next country to restructure its debts. He believes that these two countries will soon exit the Eurozone. This will help their exports to become more competitive, in turn helping growth. But, if the current recession continues with the same intensity for much longer we may see other nations also abandoning the Euro ship.

04:47

In the meanwhile, the Indian stock markets built on their opening gains and traded very positively throughout. At the time of writing, the BSE Sensex was up by 205 points (1.2%). All sectoral indices were trading higher led by metal stocks (up by 3%). Barring China, all Asian stock markets too were performing well.

04:56

Today's Investing Mantra

"As an investor with small capital, one should prefer businesses that have high returns on capital and that require little incremental investment to grow." - Warren Buffett

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