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INTERNATIONAL FINANCIAL MANAGEMENT

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Group 8: Arpit Agrawal

Sheena Renu, Marina Kurian Jeby Stephen, Ashutosh Gupta Yogesh Ellani, Kumar Narayan

FCCBs have now proved to be undoing of a large number of corporate. We should simply have INR only financing for domestic operation of corporate
Foreign Currency Convertible Bond (FCCB) Mix between debt and equity instruments A quasi-debt instrument attractive to both investors and issuers

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 Investors receive the safety of guaranteed payments on the bond and are also able to take advantage of any large price appreciation in the company's stock THE DIFFERNECE Equity Debt High interest rates in borrowing High coupon in Bonds ECB limited to Capital goods, capacity augmentation, and overseas acquisitions Immediate equity dilution Dividend distribution

FCCB Low coupon/interest compared to debt No immediate dilution of equity

No cash payment in good market conditions All transactions in foreign currency

Withholding tax is payable at the rate of 25 per cent of the coupon. It is like TDS and is payable by the issuer on income remitted to a party overseas.

Arguments Against the Topic i.e. FCCB financing should still be issued by corporates. Why FCCB??- Some basic qualities that support FCCB Issues and make it beneficial. It makes sense to raise money through the FCCB route as companies are still able to save two to three percentage points in borrowing costs even after hedging and with tight liquidity conditions. It is a lucrative option. Indian companies usually raise between $30 million and $100 million in FCCBs, and banks and financial institutions readily subscribe to such offerings. The reason: Banks and FIs negotiate with issuers for the hedging business and make a killing by selling the converted equity at bourses. It helps in enlarging companys equity base through FCCB conversion without significant difference in their financial ratios such as EPS and P/E Governments, companies and banks issue bonds in foreign currencies because they are apparently more stable and predictable than their respective domestic currencies It provides issuers the opportunity to access investment capital that is available in markets overseas Companies can use the bonds to foray into foreign markets. FCCB is a low-cost debt and the interest rates charged are usually 30-50% lower than the market rate An FCCB is redeemable at maturity if not converted and is easily marketable because it offers the option of converting it into equity that would lead to an appreciation in capital. It also takes advantage of any significant price appreciation in the companys stock FCCBs can also play a key role in a well-diversified investment portfolio for both conservative and aggressive investors The impact on cash flow is positive as most companies issue FCCB with a redemption premium, which is payable on maturity, only if the stock price is less than the conversion price.

The conversion premium is also adds to the capital reserve of the company making raising capital through FCCB yet more attractive. The issue of FCCBs does not receive credit rating and hence companies find it easier and convenient to float such bonds.

RBI supported & pushed FCCB issues:


In December 2008, RBI relaxed guidelines of FCCBs to companies by allowing premature buy-back of FCCBs through rupee resources. On March 13, 2009, RBI further liberalised the norms by extending the deadline for companies to complete the buyback by nine months from March 31, 2009 to December 31, 2009. In April 2009, Under approval route, RBI relaxed amount of buy back from $50 Mn of the redemption value per company to $100 Mn

RBI;s policy decisions also tend to tell us that as an instrument for financing FCCB is beneficial for both investors and issuers and even regulators believe that FCCB issues are not entirely disastrous, it is rather the use of the instrument that can make it dangerous for corporates. How FCCBs can go either way:

The anatomy of FCCB thus clarifies that if the markets tend to hold up then FCCB issues can prove highly beneficial for all parties. The problem that corporates are facing right now with unexpected debt repayment knocking on their door is because of the sudden spur of issues that every major co. in India did without realising the possible downsides of such issues. The data below shows us the sudden rise in FCCB issues in 2009 that are all now heading towards maturity.

In spite of some notable drawbacks, the upsides tip the balance in favour of FCCBs and India has been using them as a major tool for raising finance to meet its capital expenditure requirements at competitive rates. The countrys regulatory regime has completely endorsed the industrys efforts to meet its financing needs. The quality of Indian bonds has also gained widespread International acceptability and is expected to gain further momentum in the future.

Arguments in Support of Topic: Corporates should no more issue FCCB.

Why no FCCB.?? Some basic problems with FCCBs. FCCB when converted into equity brings down the earnings per share, and will also dilute the ownership. In a falling stock market, there will be no demand for FCCB. FCCB may remain as debt and not get converted at all. FCCB is shown as debt on balance sheet until conversion.

In case of redemption, cash outflow is heavy in one financial year, unlike traditional debt which has regular repayment. Any depreciation in rupee against the designated foreign currency may make the interest and principal repayment costly. The end use of proceeds is restricted. The issuer does not control conversion. The book value of converted shares depends on prevailing exchange rates. The cost ultimately dependent on share price development.

FCCBs The Real Deal: FCCBs, originally considered a boon, turned out to be a millstone around India Inc.'s neck. Since the Indian stock market is in bad shape, most of the bonds are up for redemption this year (2012). As a result, there will likely be a negative impact on the capital structure of the issuer companies. "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," 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.

Since early 2012, sundry analysts have pointed out the looming problem. Roughly $3.8 billion in FCCBs was due for redemption in 2012-13. Most FCCBs are issued with a five-year timeline. So, these were issued in 2007-08. By 2008-09, the global situation turned sour. Hence, few FCCBs were taken that year and the redemption pressure drops in 2013-14, when only about $0.6 billion is due for redemption. So, if 2012-13 can be weathered, there will be respite. Most corporates, which opted for FCCBs, never expected to have to pay back the loans in cash. It was assumed that, at redemption, lenders would convert holdings to equity at the agreed prices. It was also assumed the currency situation would remain more or less stable. But earnings growth slowed dramatically, as did GDP growth. The subprime crash torpedoed global markets. The rupee hit new lows. By 2012, there was no question of lenders converting debt to equity. Corporates with rupee earnings and overseas debt to service were hit hard. India Ratings says that of the USD1.5bn worth of foreign currency convertible bonds (FCCBs) due for redemption for the rest of FY13, around 67% are expected to either default or restructure.

Most of the companies refinanced their FCCBs either through foreign or domestic debt or through issuance of fresh FCCBs. Only five companies have used any internal accruals to redeem FCCBs. India Ratings expects the interest coverage ratios of the companies who used debt to refinance FCCBs to deteriorate by 15%-25% from the current levels.

Of the 26 companies who had defaulted on FCCBs on due date, three companies redeemed FCCBs post due date through cash while investors in four companies converted FCCB into equity at a conversion price much lower than the original conversion price. Redemption still is due for 19 companies which had defaulted on FCCBs. Such obligations are around 21.4% of the total redemption value between 1 March 2012 and 15 October 2012.

For these 19 defaulted/restructured FCCB cases, India Ratings has estimated recovery rates and potential time to recovery considering contractual and structural subordination, expected liquidation value, economic motivation of sponsor and operational viability of the underlying business. FCCB holders in 12 companies may expect below-average recoveries in the range of 0%-30% with an average recovery span of at least five years. Of these 12 companies, six companies or their subsidiaries went under corporate debt restructuring and six defaulted on their local currency obligations. For the remaining seven companies, India Ratings expects aboveaverage recovery of 30%-70% with an average recovery span of three to five years. When the FCCBs were taken, the rupee value was RS 40-44. Today, the rupee is at Rs 52 to a dollar. This means to buy the same number of dollars and pay back, companies need to pay 20% more and this is apart from the compound interest and given that if they try to pay back the FCCBs, they will end up floading the market with buy orders, the rupee will fall even more. This rupee fall hurts conversion as well. Consider an FCCBs issue with the dollar at 44, and a conversion price of Rs 440. That means one share= $ 10 worth. Today even if the stock stays at Rs 440 it will be worth just $8.46, a loss of 15%. This hurts more when the companies borrowed to deploy money in India- if they used the funds abroad, the return of those funds would also be in dollar so the impact is lesser.

Some example of companies who defaulted: Suzlon seeks extension for FCCB payment, stock down. ICICI de-rates Tulip Telecom on FCCB issue. Zenith Infotech defaulted on $33 million worth of FCCB repayment in October. Tata steel offered to increase coupon rate from 1% to 4.5% if bondholders increase the tenure fron 2012 to 2014, which it could do because of its size.

Weve already seen the problems faced by erstwhile blue-chips, such as Reliance Communications, Educomp, Suzlon, JP Associates, Moser Baer, Hotel Leela, etc in managing FCCB redemption pressure. Other corporates like Tata Motors, JSW Steel and Tata Steel have managed better but it has definitely been a cause for worry for everyone.

Quite a few more companies are due to come up for redemption in the remaining months of calendar 2012. The list includes Pidilite, Everest Kanto, Websol Energy, Firstsource, Great Offshore, Indowind, Ankur Drugs and GV Films.

The Final Word: The current situation of FCCB issues done by all corporates in India is not rosy and yes corporates have their backs against the wall considering the amount of debt that is getting due for repayment. With all major Indian companies suffering from these issues FCCBs would surely become one of the major reasons that is pushing back India Inc.s growth story. All that been said , we also cant deny the fact that FCCB offer immense benefits to issue and investors both and they serve as a very efficient source of financing for all and that cant be taken away even after recognizing the grave situation they have put corporates in today. The problem here lies not in FCCBs as an instrument but in the rash and irrational way that the corporates used them and so we believe that FCCBs should still be issued but with utmost caution and the job of regulators we believe is primary here to ensure that caps are put on the amount of FCCBs that can be issued and the whole issue is well regulated and the regulators are able to control the issues whenever corporates go berserk with these issues.

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