Not the Best Bond

Sowmya Kamath        Print Edition: February 2012

Foreign currency convertible bonds, or FCCBs, have been in news for some time. The stock market, already worried over India's current account deficit, depreciating rupee and high interest rates, is now feeling the tremors of FCCBs Indian companies issued more than three years ago.

FCCBs are bonds issued by a company to raise money in a foreign currency. They have a coupon rate, that is, an interest rate. Buyers have the option of redeeming their investment or converting the bonds into equity at maturity. The payment of the principal is usually in the currency in which the money is raised.

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"Largely, the money raised through FCCBs was used for inorganic growth or expansion. In most cases, these bonds were issued when the stock market was bullish and companies were able to get premium valuations," says Vikram Hosangady, partner, KPMG.

Here lies the rub. When the markets were at their peak in 2006-2008, FCCBs were the flavour of the season as many companies found it a cheaper way to raise money compared to rates they were getting in the domestic market. The companies believed that since their shares would only rise, the bonds would be converted into equity instead of being redeemed.

However, things did not turn out this way. Economic conditions weakened and their expansion plans did not play out the way they were expected to.

"Many of these acquisitions or growth plans haven't played out to plan. Hence, these companies have weak balance sheets. This, coupled with depressed capital markets, makes the FCCB conversion a complex affair," says Hosangady.

The cash flow from growth plans has been below expectation and these companies now have huge debts. A fall in stock prices means investors will not convert their bonds into equity as shares of most companies are trading well below the agreed conversion price. The result is that the companies will have to redeem the bonds by raising money at the high interest rates prevalent today.

In addition, the rupee has started falling against the dollar, making the debt more expensive, as companies will have to pay more rupees to buy dollars. In 2012, FCCBs worth $6 billion, or Rs 30,000 crore, are coming up for redemption by April 2013.

DEFAULTS THAT MAY BE
In October 2011, Zenith Infotech said it had defaulted on $33 million worth of FCCBs due for redemption in September 2011, but was in negotiations with the bondholders to extend the repayment time. The stock fell 79% between September and December.

A classic case is Wockhardt, which defaulted on FCCB payments in 2009, following which the bondholders filed a winding-up plea in a court. The case on Wockhardt is still pending. In a recent development, Wockhardt agreed to pay in five instalments ending August 2012.

How fund-raising became a problem
With most FCCBs maturing in 2012-13, the number of defaults may rise. Subex, Moser Baer, Aksh Optifibre, GTL Infrastructure and Plethico Pharma might have a high probability of default due to high yields, Kotak Institutional Equities said in a recent note. Rising yield on a bond means its market price is falling.

What happens if there is a default? "There is a huge risk for retail investors. The bondholders have the option of take the company to court and request that it be wound up," says Daljeet Kohli, head of research, IndiaNivesh Securities.

"I would recommend investors to stay away from stocks of companies with foreign currency exposure, both FCCBs as well as external commercial borrowings, or ECBs" he says.

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However, some experts believe that companies will be able to refinance their FCCB obligations. "FCCBs could burden some companies, but that will depend on the company, its rating and the industry it belongs to," says Ramanathan K, chief investment officer, ING Investment Management (India).

"If a company has AA(AA) kind of rating, I am sure it will be able to refinance its debt without many issues," says Ramanathan.

However, a lot will depend on the company's position. "While companies like Tata Steel and Tata Motors have exposure to foreign debt, they have the ability to refinance too. Investors should, however, stay away from such stocks too," says Kohli.

RUPEE IMPACT
FCCB redemption may not have a significant impact on the rupee, say experts.

"The issue has been blown out of proportion. It's just that the rupee has depreciated and the market has come off. Some companies have, in fact, hedged their FCCBs," says Ramanathan.

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The investors would want their money back and so would be open to negotiations over extending the repayment tenure. "Companies faced with FCCB redemptions are attempting to sell non-core assets and are in certain situations open to equity injection as well," says Hosangudy.

While FCCB redemptions may not impact the rupee much, the recent rupee depreciation will impact companies big time by increasing the amount they have to pay in rupee terms. Several companies have also started negotiations for refinancing FCCBs expiring in 2012, which means the pressure of dollar outflows will be low.

TACKLING THE FCCB TIDE
A few companies have already initiated steps to tackle the issue. Subex is raising $135 million to redeem FCCBs maturing in March. Orchid Chemicals has raised $100 million through ECBs. Zenith Infotech is negotiating new terms with the bondholders. Welspun Corp announced a buyback, but investors were not willing to sell at a discount.

Companies under pressure
"Quite a few companies have issued FCCBs, which will convince bondholders to roll over the debt. Bondholders will take a call after a review of the recent financial performance of the companies in question," says Hosangudy.

Companies can tackle the issue in several ways such as buying back the bonds before maturity at a discount, selling assets, raising fresh debt or equity and restructuring the bonds.

PROFIT MAY TAKE A HIT
While companies may fulfill their FCCB obligations, their profitability may be hit as the funds they will raise now will cost more due to high interest rates prevalent in the market today.

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"Corporate profitability will fall. The market has already discounted this," says Ramanathan of ING. In addition, there are companies which will see FCCB redemptions in the second half of the year. The situation may change for the better by then.

However, FCCB redemptions will drop sharply in 2013 and 2014 as a majority of FCCBs issued at the market peak of 2007 are due for redemption this year, according to IIFL Institutional Equities.

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