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

    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 name FCCB size ($ m) Current
    outstanding ($ m)
    Redemption
    value ($ m)
    Conversion
    price (Rs/share)
    Current price Debt/Equity
    Moser Baer 75 43 60 408 18 3.56
    Jaiprakash Asso 400 354 524 165 82 2.74
    Subex 180 39 53 656 26 2.59
    Subex 99 60 85 80 26 2.59
    Gtl Infra 300 228 321 53 11 1.99
    Hotel leela 100 42 61 72 34 1.79
    3I Infotech 100 66 94 166 16 1.77
    Rajesh Exports 150 24 35 67 122 1.58
    Orchid Chemicals 175 117 168 348 180 1.57
    Era Infra 75 40 60 159 141 1.57
    Sterling Biotech 250 135 184 163 10 1.45
    Suzlon Energy 300 211 307 97 29 1.38
    Tata Motors 490 473 624 181 276 1.38
    Jsw Steel 325 274 392 953 778 1.36
    Tata Steel 875 382 471 731 472 1.28
    Tulip Telecom 150 97 140 227 96 1.26
    Prime Focus 55 55 79 111 46 1.06
    Strides Arcolab 100 80 116 462 596 1.08
    Reliance Com 1,000 925 1,182 661 93 0.82
    Firstsource Solutions 275 191 267 92 10 0.73
    Rolta India 150 97 135 369 96 0.68
    Uflex 85 22 26 145 123 0.66
    Mascon Global 50 50 65 13 0.91 0.64
    Plethico Pharma 75 75 109 484 345 0.50
    Educomp Solution 80 79 111 590 193 0.46

    *As on March 21, 2012 Source: 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.

     

     

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