When FCCB turns ugly: Part I - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

When FCCB turns ugly: Part I

Mar 28, 2012

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.

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.

Company nameFCCB size ($ m)Current
outstanding ($ m)
Redemption
value ($ m)
Conversion
price (Rs/share)
Current priceDebt/Equity
Moser Baer754360408183.56
Jaiprakash Asso400354524165822.74
Subex1803953656262.59
Subex99608580262.59
Gtl Infra30022832153111.99
Hotel leela100426172341.79
3I Infotech1006694166161.77
Rajesh Exports1502435671221.58
Orchid Chemicals1751171683481801.57
Era Infra7540601591411.57
Sterling Biotech250135184163101.45
Suzlon Energy30021130797291.38
Tata Motors4904736241812761.38
Jsw Steel3252743929537781.36
Tata Steel8753824717314721.28
Tulip Telecom15097140227961.26
Prime Focus555579111461.06
Strides Arcolab100801164625961.08
Reliance Com1,0009251,182661930.82
Firstsource Solutions27519126792100.73
Rolta India15097135369960.68
Uflex8522261451230.66
Mascon Global505065130.910.64
Plethico Pharma75751094843450.50
Educomp Solution80791115901930.46
*As on March 21, 2012Source: Bloomberg

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:

  • Repayment through existing cash & cash equivalents

  • Repayment through operating cash flows

  • Refinancing of debt

  • Restructuring of FCCBs

  • Issue of further equity to repay debt

  • Buyback
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.

Equitymaster requests your view! Post a comment on "When FCCB turns ugly: Part I". Click here!

  

More Views on News

APOLLO HOSPITALS Share Price Down by 5%; BSE 500 Index Up 0.2% (Market Updates)

Sep 24, 2021 | Updated on Sep 24, 2021

APOLLO HOSPITALS share price is trading down by 5% and its current market price is Rs 5,183. The BSE 500 is up by 0.2%. The top gainers in the BSE 500 Index are KPR MILL (up 13.1%) and OBEROI REALTY (up 9.3%). The top losers are APOLLO HOSPITALS (down 5.1%) and DHFL (down 10.0%).

Why Zomato Stopped its Grocery and Nutraceutical Businesses (Views On News)

Sep 13, 2021

Zomato believes its investment in Grofers will generate better results rather than its in-house grocery effort.

5 Indian Companies that are Buying Back Shares Big Time (Views On News)

Sep 8, 2021

In fiscal 2021, buybacks jumped to two-year high with 61 companies buying back shares worth Rs 392.9 bn.

Top Performing Sectors in 2021 (Views On News)

Aug 10, 2021

A look at this year's best performing sectors and what has helped them rally.

Nazara Technologies IPO: Should You Apply? (IPO)

Mar 17, 2021

Should you bet on this gaming company backed by ace investor Rakesh Jhunjhunwala?

More Views on News

Most Popular

What is QIP in Stock Market?

Here's a quick guide to QIPs in the stock market.

5 Specialty Chemical Stocks that Turned Multibaggers in One Year (Views On News)

Sep 17, 2021

These specialty chemical stocks have surged 200% or more in the last year. Do you own any?

A Rare Buying Opportunity in an Exciting Stock (Profit Hunter)

Sep 16, 2021

Whether agriculture sector goes through a structural transformation or not, this agrochemical stock has a good chance of winning.

5 Indian Companies with Over 7% in Dividend Yield (Views On News)

Sep 17, 2021

These stocks will give you better yields than bank deposits.

A Great Time to Buy ITC (Profit Hunter)

Sep 17, 2021

Is the worst over for the stock of ITC?

More

Become A Smarter Investor
In Just 5 Minutes

Multibagger Stock Guide 2021
Get our special report Multibagger Stocks Guide (2021 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

MARKET STATS