|»5 Minute Wrap Up by Equitymaster|
On This Day - 13 MARCH 2012
Beware of companies with these bonds on their books
In this issue:
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.
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!
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.
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.
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