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FCCB: Is it beneficial for shareholders?

Oct 4, 2005

In the last two years, almost all the top corporate houses have raised debt (FCCB issue i.e. foreign currency convertible bonds). This has been for the obvious reason of savings in interest costs (by way of lower interest rates). To give a perspective, while the LIBOR rate (rate based on which the interest component is determined in overseas market) is around 3.5%, the prime-lending rate (rate at which the domestic banks lend money) is at about 10%. Indian companies, which raise funds in overseas markets, provide a 'sweetener' of converting the loans into equity share capital to the lenders. In this article, we try to look whether these 'sweeteners' are in favour of the existing shareholders.For the purpose of this article, we have considered the financials of Tata Motors for the year FY05. Further, we have also altered the interest cost and the paid up share capital keeping other factors constant for the sensitivity analysis.

About the FCCB issue: Tata Motors had raised funds to the tune of US$ 400 m (Rs 17.5 bn) in April 2004. The primary purpose of the borrowing was to fund the Rs 60 bn capex plans of the company spread over next five years. This FCCB issue was amongst the largest borrowings by any Indian corporate house in a single deal.

The financial impact...
FY05* FY05**
Operating profit 21,261 21,261
Other income 2,108 2,108
Less: Depreciation 4,502 4,502
Interest 3,244 2,208
Extraordinary item (139) (139)
PBT 15,762 16,798
Tax @ 25% 3,894 4,150
Net Profit 11,590 12,370
Share capital 362 386
EPS 32 32
CFPS 44 44

*In FY05, the debt of the company has almost doubled to Rs 24.9 bn as compared to FY04. The interest, net profit and share capital figures are based on the assumption that the company would have borrowed from the domestic market at average interest rates, which is better than FY04 average interest rates by about 200 basis points

**The interest, net profit figures are the reported numbers for FY05. Share capital figure is derived based on assumed conversion of the entire US$ 400 m into share capital.

As can be seen from above table, the management (in this case) was prudent to keep the interest of the existing equity shareholders in mind while determining the terms of conversion, as there is no dilution in the EPS and Cash flow per share (CFS) figure, assuming other things being constant. Going forward, as the conversion of FCCB takes place, the interest liability of the company will reduce further. To that extent, there is a potential upside in the EPS number.

However, this may not be the case in every FCCB issue, and hence the investor should keep in mind that though an FCCB issue can be beneficial for the financial health of the company, it may not necessarily add to the EPS. Further, with FCCB, the company is exposed to vulnerable global economic situation like rising interest rates or currency fluctuations, which can adversely impact the earnings of the company.


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