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Foreign Woes for India Inc

The hunger for foreign money drove India Inc to ignore some simple warning signs

FCCB! The term has been doing the rounds in the media and among corporates a lot for a few years now. During the bull run it was seen in good light. As the bears started to rule, the light went dim, and by the end of 2008 and early parts of 2009 the concept had all but faded from the top-of-the-mind fad list. However, it was not forgotten, simply because it carried far reaching consequences. And although there is a renewed sense of optimism in the markets now, but only time will tell if it is just a flash in the pan or the heralding of a new dawn.

Foreign Currency Convertible Bonds (FCCBs)
The name says almost everything about the instrument. FCCBs were unveiled in the Indian markets in 1993 to bring much-needed funds to capital-starved Indian shores. FCCBs are bonds issued by an Indian company, and are subscribed by non-residents by making payments in foreign currency. The bond is issued at a discounted price and carries a promise that the instrument would either be converted into the company’s equity at a pre-determined price at any time till maturity or the principal along with the premium would be returned in foreign currency at the pre-determined future date.

Why FCCBs?
Companies preferred FCCBs as they bring debt at lower interest rate since they had the option to convert into equity. And the company gains higher leverage on conversion as debt is reduced and equity is increased. Also, owners stake in the company doesn’t get diluted when FCCBs are turned to equity, as they do not carry holding rights making it all the more attractive for promoters. At the same time it is less strict compared to a syndicated loan or a debenture, hence more convenient to raise funds for mergers & acquisitions especially.

In the face of such advantages companies did not pay too much attention to the negatives.

Hitch in FCCBs
In falling market conditions, investors do not invest in this instrument. Currency fluctuations also affect sentiments since companies will have to pay more when a currency depreciates whereas, if the currency appreciated, the company will have to pay less. India Inc was blind to the possibility of a strong dollar and that the Indian share markets would fall.

Current Crisis
From 2004 to 2007, FCCBs became a fad for raising money to fuel expansion and buyouts by companies. Once the international markets crashed in 2008, FCCBs went out of fashion because of the instrument’s drawback. The problem was that in such a tight credit situation how will companies meet redemption demands, with many FCCBs maturing as early as 2011-2012.

The light at the end of this dark tunnel became visible only after March 2009, when the markets recovered in a remarkable manner. And when the stock market went through the roof on May 18, 2009, it was assumed that this would help companies deal with the FCCBs’ problem as all the companies could comfortably cross the conversion mark in terms of stock prices.

But, so far, the results have been mixed, at best.

Cases like those of Bharti Airtel, which had issued $15 million worth of FCCBs in 2004 upon a conversion price of Rs 233.17, reached the comfort stage. It had foresightedly inserted a clause that this conversion would take place at a fixed rate of exchange of Rs 43.56 per $1; in fact, the company successfully converted FCCBs to equity before the end of maturity (April 2009).

Then the story got twisted, to a small extent, for Ashok Leyland. It had issued FCCBs in 2004 worth $100 million. This was done under a provison that allowed the allotment of 1,422.581 shares for every $1,000 invested, at the rate of Rs 31 per share. After paying dividends in 2007 the company had reset its price to Rs 30 per share. In its annual report for 2007-08 it reported that by March 2008, 99 per cent of its FCCBs were converted to equity. In March 2008 the price peaked at Rs 43 per share, but bottomed out at Rs 12.99 on December 12, 2008. It has recovered most lost ground with the average trading price in the first two weeks of June 2009 jumping up to Rs 30.22. The company in its quarterly results declaration announced that the remaining FCCBs, worth $1 million, too had been redeemed, which matured in April 2009. This loss, though minimal, would be shown in the June quarter.

The problem acquired gigantic proportions for Suzlon though, mainly due to its acquisitive nature. To solve this Suzlon tried to restructure its $500 million FCCBs, but this was rejected by investors. It had issued the zero-coupon bonds, worth $300 million and $200 million respectively, maturing in October 2012, to part finance the acquisition of REpower. Initially holders of one of tranche of the five-year bonds issued in June 2007 agreed to the company's restructuring of debt plans, but investors in bonds issued in October 2007 did not approve the proposal making the company vulnerable to huge losses. But eventually it has managed to restructure the FCCBs, reducing the liability to $389 million. Now how it uses this position of low debt remains to be seen.

The company that was really buffeted by the FCCBs was Ranbaxy. One of the premier pharmaceutical companies in India, it was taken over by Daiichi Sankyo, while the stock markets were on a high. The company had issued FCCBs worth $440 million 2006 at the conversion price of Rs 716.32 with a fixed rate of exchange of Rs 44.15 per $1. The last time the stock was above this conversion price was on July 22, 2005. Since then the stock has never traded around that price tag. Its next peak was on June 13, 2008, when the stock had touched Rs 568.90. In its quarterly results for March 2009 the company’s loss was high due to mark-to-market provisions that were made for the FCCB, it stood at Rs 224.25 crore.

However, there are some success stories too. Among companies that saw successful conversions in the last month, fall under the mid- and small-cap categories.

Among them are Gujarat NRE Coke, which had announced on June 11, 2009 that it has allotted 5,00,224 equity shares at a price of Rs 44.64 per share pursuant to notices received from FCCB holders for conversion of bonds worth $5,00,000. The company had issued FCCBs in two tranches — 2005 and 2006 of $55 million and $60 million.

Here is a list of companies that may yet face FCCB music as their redemption dates are fast approaching. It remains to be seen whether these companies will have to cough up money for bond holders or whether they successfully manage to turn FCCBs into equity.

Deadlines Due
Name of company  Maturity period  Issuing currency  Issue Size (mn)  FCCB Outstanding (mn)  Effective Conversion price (Rs) (A)^^  CMP as on 26-Jun-09 (Rs) (B)  % Diff. (A-B)/B
Wockhardt^ Oct-09 USD 110 109 629.8 142.4 342
Jindal Stainless Dec-09 USD 60 24 155.8 82.85 88
Tata Chemicals Jan-10 USD 150 44 279 227.6 23
Bharat Forge Apr-10 USD 120 104 426.1 152 180
Strides Arcolab^ Apr-10 USD 40 40 490.6 147.35 233
Jubilant Organosys May-10 USD 75 53 377.9 167.7 125
Alok Industries + Jun-10 USD 55 24 71.6 22.3 221
Aurobindo Pharma Aug-10 USD 60 56 730.6 500.95 46
HDFC Sep-10 USD 500 117 1,753.60 2435.5 -28
Hotel Leela Ventures Sep-10 EUR 60 51 59.4 32.7 82
Source: Edelweiss report - “FCCB: Beyond Redemption”
Price adjusted for bonus issue and stock split
^ year ended Dec, 2007
^^ Date for conversion was Nov. 20, 2008
Effective conversion price = Conversion price + redemption premium

The article appeared in the July issue of Wealth Insight magazine