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India Inc.: FCCB hungry - Views on News from Equitymaster
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  • Nov 17, 2006

    India Inc.: FCCB hungry

    With inorganic options in the overseas markets and capital expansion plans in the domestic market beckoning, Indian corporates are putting their best foot forward when it comes to arranging for the finances. While there are a plethora of options available for the same today including ADR / GDR issues, Qualified Institutional Placements, Private Equity placement, public issue and the plain vanilla bank funding, the option that seems to have been the cynosure of India Inc. is Foreign Currency Convertible Bond better known as FCCB*. As per the data released by the Reserve Bank of India (RBI), the cumulative FCCBs issued by Indian companies until 1QFY07 are to the tune of Rs 542 bn.

    The relatively attractive return on investments offered by emerging markets like India, increased international recognition of strong economic fundamentals of the Indian economy and demand for funds from Indian companies to finance the ambitious capex plans fuelled the spurt in FCCB issues over the last couple of years. It is also worth noting that while most of the issues carried zero coupon rates, conversion price of FCCBs issued by Indian companies were fairly attractive (at a considerable premium to the market price as on the date of issuance).

    What makes them popular amongst India Inc?

    • Being a hybrid instrument, the coupon rates on FCCBs are typically lower than pure debt or zero, thereby reducing the debt-financing costs.
    • FCCBs are book value accretive on conversion.
    • Save the risk of immediate equity dilution as in the case of public issues.

    What makes them popular amongst investors?

    • Guaranteed returns on the bond in the form of coupon rates
    • Ability to take advantage of the price appreciation in the stock by means of warrants attached to the bonds, which are activated when the price of the stock reaches a certain point.
    • Substantial yield-to-maturity (YTM) is guaranteed at maturity.
    • Lower tax liability as compared to pure debt instruments due to the lower coupon rates.

    The flipsides ignored...
    Despite the all the positives linked to the instrument, what gets ostensibly ignored are some of the risks that are attached to it. For one, FCCBs do not portray the real extent of leveraging and do not divulge the exact date of conversion, as there is a reasonable time period available to investors to exercise he option. Usually, the company's ability to meet the repayment obligations if the issue does not get converted into equity - is not looked into. Also, the zero coupon FCCBs fail to factor in the cost of servicing the debt (the promised yield to maturity) in case of non-conversion.

    While India Inc.'s ambitious capex plans surely make a good reading and project the economy with a superlative bias against its peers, the fact that the same may build up palpable risks for the future is a concern that needs to be looked into with disdain.

    • FCCBs are defined as a type of convertible bond issued in a currency different than the issuer's domestic currency. In other words, the money being raised by the issuing company is in the form of a foreign currency. A convertible bond is a mix between a debt and equity instrument. It acts like a bond by making regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock. (Source: Investopedia)



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