Mar 28, 2012|
When FCCB turns ugly: Part I
This is a first of a two article series on Foreign Currency Convertible Bonds (FCCBs). Many Indian companies issued FCCBs in 2007 which are due to redeem in 2012, and this has challenging implications.
*As on March 21, 2012
FCCBs have been in the limelight in India for some time now as an option for raising capital for meeting capital expenditure requirements. Initially it was in the news as a great tool for raising funds for meeting company's capex requirement. The advantage it offers relative to other debt instruments like straight bond is that being a foreign currency instrument, it carries lower interest rates. And it is better than pure equity which immediately dilutes equity base. With FCCBs, conversion to equity is only possible if certain conditions are met.
However FCCBs, originally considered a boon, turned out to be a millstone around India Inc.'s neck. Since the Indian stock market is in bad shape, most of the bonds are up for redemption this year (2012). As a result, there will likely be a negative impact on the capital structure of the issuer companies.
This article explains FCCBs and these developments. And, it also looks at the alternatives available to corporate India.
A convertible bond is a mix between a debt and an equity instrument. It has the features of a bond, with regular interest payments to be made, and at maturity, the principal to be repaid. A convertible bond also has the attractive characteristic that, at or before maturity, the bondholder can convert the bonds into equitable equity shares in the company. The conversion price at which the bond will be changed into shares is decided beforehand. If the shares of the company never reach the predetermined conversion price, and the bond reaches its maturity, then the principal is repaid to the bondholder along with a redemption premium which ranges from 20% to 40%.
A Foreign Currency Convertible Bond (FCCB) is a special type of convertible bond which is issued in a currency different from the issuer's domestic currency. Companies prefer issuing FCCBs as the interest rate on them is much lower than that on a regular "domestic" bond. For example, a company in India issues a bond in dollars with an interest rate of approximately 3%, which is much lower than an Indian currency bond rate of 9%.
From the investors' perspective, they get the advantage of an instrument which offers debt, as well as, the additional value of an option to convert the bond to equity. It gives the investor upside potential by being able to convert to equity, and the debt element protects the downside. They are also assured return in form of fixed coupon rate payments.
The biggest problem with FCCBs for bond issuers occurs when the share prices of the companies start heading south. During market crashes and bear periods, the conversion price of the FCCBs becomes many times higher than the current share price. This combined with a depreciating domestic currency can lead to devastating consequences.
Current Scenario - Indian companies in a FCCB bind
Between 2005 and 2010, Indian companies issued three and five year FCCBs worth USD $23bn of which USD $7.8bn (at redemption value) will mature in 2012. With stock prices in many cases significantly below conversion prices, conversion is unlikely. And so, redemption is the option for a vast majority of these issues.
The following table lists Indian companies whose FCCBs are maturing in 2012.
What options do these companies facing redemptions in 2012 have?
In the most likely scenario of "mass" redemptions of FCCBs in 2012, these companies will choose to exercise one or a mix of the options mentioned below:
In our next and last article of this FCCB series, we examine each of these options available to issuer companies who are in this FCCB redemption "bind". And, we will also look at the implications for bondholders.
- Repayment through existing cash & cash equivalents
- Repayment through operating cash flows
- Refinancing of debt
- Restructuring of FCCBs
- Issue of further equity to repay debt
More Views on News
Jun 14, 2017
Should you subscribe to the IPO of Tejas Networks Ltd?
May 26, 2017
Don't be surprised to come across some Super Investors there!
May 19, 2017
Not all small-cap investors see themselves as traders. Some see themselves as business owners.
Jul 31, 2017
Should you subscribe to the IPO of Securities & Intelligence Services Ltd?
Jul 8, 2017
If Super Investors can wait for the right pitch, so can you.
More Views on News
Aug 7, 2017
The data tells us quite a different story from the one the government is trying to project.
Aug 10, 2017
Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.
Aug 8, 2017
Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...
Aug 12, 2017
The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.
Aug 7, 2017
Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...
Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement. LEGAL DISCLAIMER:
Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here
. The performance data quoted represents past performance and does not guarantee future results.SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.
Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: firstname.lastname@example.org. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407