Around 60 Indian companies are facing redemption of $7-billion foreign currency convertible bonds (FCCB) this year. This means investors need to be cautious about investing in these companies, especially the ones that are not in a position to refinance and might default. Investors who have purchased shares of companies with high FCCBs don?t have any direct exposure to them. But, historically, stock prices of such companies tend to be more volatile and could erode investor wealth.
A recent report by Fitch Ratings shows that out of 59 companies that face FCCB redemption this year, only five are in a position to choose their refinancing method. Around 26 companies have weaker financial profiles, but would be in a position to access low-cost funding with external commercial borrowings or high-cost domestic debt funding.
Another eight companies are stretched for liquidity and their FCCB repayments are likely to be driven by the sale of identifiable, non-encumbered assets. Given the current market conditions, a timely sale of assets to redeem the bonds looks challenging. Already eight companies have defaulted and the rest have weak cash flows and unsustainable debt. Investors have to keep in mind that companies with high FCCBs exposure can either default or go for higher equity dilution.
A report by CLSA says Indian companies, over the last five years, have issued FCCBs worth $20 billion, at an exchange rate of R45 per dollar. Most of these FCCBs will start maturing in the next two years and, with most companies trading way below the conversion price because of the fall in stock price last year and the sharp depreciation of the rupee, experts say redemption seems to be unlikely unless prices of these stocks recover.
Companies, in order to fund their growth drive, took the FCCB route to raise funds. FCCB is a convertible bond issued in a currency different than the issuer?s domestic currency and is a hybrid between bonds and stocks as the bond acts like both a debt and equity instrument.
It is a low-cost debt as the interest rates given to FCCBs are normally 30-50% lower than the market rate because of its equity component. FCCBs also give the bondholder an option to convert the bonds into stocks at a premium to the market price. If FCCBs are converted into shares, it will not lead to any capital gains tax. For an investor, FCCBs offer guaranteed returns with further gains from price appreciation by way of equity participation above the effective conversion price.
The Fitch Ratings report says one of the key reasons for most companies accessing the FCCB market was low interest expenses as around 42 companies have zero coupons. The report says that when redeeming the existing FCCB, the companies would prefer to access sources of funds that would keep the interest expenses low.
Earlier, the government opened a window for the buyback of FCCBs issued by corporates trading at steep discounts, thereby, providing a lucrative exit opportunity to corporate India till March 31, 2010 (recently extended till March 2012). Only a few corporates were able to capitalise on the opportunity on account of low liquidity in FCCBs and difficulties in complying with the requisite requirement.
Company-wise, the Fitch Ratings report says Reliance Communications has already tied-up funding sources for redeeming its FCCBs. Others like Strides Acrolab, Educomp Solutions and Tulip Telecom have some internal accruals that are expected to significantly facilitate their redemption.
However, companies like Sterling Biotech, Pyramid Saimira Theatre, Zenith Infotech and Ankur Drugs and Pharma are in the imminent default list.
While Reliance Communications has already accessed yuan-denominated loans to redeem their outstanding FCCB, only a few companies can access this low-cost source of funding. The report underlines that companies that have access to yuan-denominated loans are likely to be large corporates in the telecom, power and infrastructure sectors.
While internal accruals are an option, given the market conditions, this may be available to a few companies only. Also, a lot of promoters have already pledged a significant portion of available shares and this is expected to adversely affect their ability to inject fresh capital.
For companies looking to refinance FCCBs through domestic sources, the interest cost would be high. Investors of these companies will have to keep in mind that the interest outgo would be much higher and would make the equity of these companies volatile in the near and medium-term.
