Study and analyze the trends in FCCB by Indian CompaniesDiscuss the pros and cons of issuing FCCBs with

special reference to companies in India

 FCCB is a quasi-debt instrument that is issued in a currency different than the issuers domestic currency with options to either redeem it at maturity or convert it into issuing companys stock. It gives two options. One is, to get the regular interest and principal and the other is to convert the bond in to equities. It is a hybrid between bond and stock.

1) It is a low cost debt as the interest rates given to FCC Bonds are normally 30-50 percent lower than the market rate because of its equity component. 2) Conversion of bonds into stocks takes place at a premium price to market price. Conversion price is fixed when the bond is issued. So, lower dilution of the company stocks. 3) Simple regulatory process 4) Investors are mostly nonresidents or hedge fund arbitrators. 5) Mostly FCCBs are issued to suit the company needs

1) Like any other debt instrument, capital protection by guaranteed payments to the bond. 2) Greater return potential if the stock price appreciates more than the previously fixed conversion price. 3) Redeemable at maturity if not converted

Limitations
1) FCC Bonds are ideal for the bull market scenario as the conversion occurs at a premium price lowering the dilution. But if the stock price plummet like what we are witnessing right now due to the economic downturn, then investors will not go for conversion and they go for redemption at maturity value. So, companies have to refinance to fulfill the redemption promise and refinancing is not that easy particularly in times like this with lot of credit crunch. Earnings will get hit because of the redemptions. 2) If the investors do not go for conversion, then companies will be forced to lower the conversion price (Previously Fixed) to entice the investors to go for conversion which will lead to higher dilution. 3) It will remain as debt in the balance sheet until conversion. 4) If the exchange rate goes up, then the issuer has to pay more to the investors. So, foreign exchange plays a role too. 5) If the stock price goes below the conversion price, then the issuer loses an opportunity to dilute at a higher price.

Why companies bought FCCBs

Foreign currency convertible bonds provide for low-cost debt In an ideal market, conversion occurs at a premium They lead to lower dilution

KPMG, says: "Three years ago, premiums were higher than domestic prices and FCCBs were hot. With the euro crisis, and the market correction deeper than anticipated, companies are exploring other ways to raise funds. Nobody I know is looking at FCCBs now - companies are looking at raising funds through QIPs and selling stake."

 FCCBs were popular instruments during the bull run in the equity markets between 2005 and 2008 Rising stock prices allowed companies, including many midcaps, to raise hybrid capital using convertible instruments. In those three years, 201 overseas convertible issues raised close to Rs 72,000 crore, according to Prime Data Base. The conversion price on such bonds was 25-150 per cent higher than the prevailing stock price at the time of issuance and they carried zero or very low coupons RBI expected about 45 per cent or Rs 32,000 crore of these bonds to be up for redemption during financial year 2012-13. Two-thirds of this may not get converted into equity shares, as the current stock prices of issuing companies are significantly below their conversion prices

The Nifty is now only about 10 per cent below its highs in January 2008. But many of these companies, accounting for more than half of the outstanding FCCBs, are trading at a discount of more than 50 per cent to their January 2008 prices, quoting a Crisil estimate

According to a Crisil report, bonds worth Rs 31,500 crore are coming up for redemption within the next 24 months

Accounting treatment
AS 29 in conjunction with Companies Act, 1956 Either charged to securities premium a/c or contingent liabilities, no company has charged it to the P&L a/c, thus, by-passed from the actual cost/burden of interest on FCCB, under reporting the true indebtedness & inflating profitability 2 most widely accepted are IFRS and US GAAP, under which proportional redemption premium charged through P&L account

Translational losses
Risk of non-conversion, keep aside money for eventuality of debt not converting into equity lead to forex losses Jaiprakash Associates and Reliance Communications did not provide for such loss On the other hand, Aurobindo Pharma at the time of FCCB issue, fixed rate of exchange on conversion of Rs. 45.15/$

Alternatives in case conversion not taking place

Raising additional debt, equity Internal accruals or sale of assets Amtek Auto Ltd disposed off assets upto Rs. 3000 crores Reset conversion clause to bring it closer to reality Altering terms of issue Suzlon restructured through swaps, prematue redemption Buy-back of FCCB Auto Route Approval Route

Wockhardt

group of three FCCB holders, led by QVT, had filed a winding-up petition against Wockhardt. Wockhardt had to pay an outstanding of $110 million worth of FCCBs by October last year. It managed to settle with several creditors, but was still left with disputed FCCBs worth about $75 million, sending investors to court. FCCB buyback window extended

Hotel Leela Ventures

market capitalisation of Hotel Leela Venture has nosedived from around Rs 2,555 crore in 2007 to about Rs 1,600 crore today. conversion price of Rs 72 a share. Shares of Leela Venture are currently trading at around Rs 40 each D/E=1.85, trading at half the conversion price, $42 million worth of FCCBs will have to be redeemed by April next year group is hoping to raise around Rs 1,000 crore through a qualified institutional placement, or QIP, and fresh FCCBs. The money, says Deshika, will be used for debt reduction and redemption

Reliance Communications
raised $1.27 billion through FCCBs in 2007, which come up for maturity in March 2012. At a conversion price of Rs 661, and the stock currently trading at Rs 93, RCOM will have to go for redemption 52-week high of Rs 204 in June 2010, but that too is not even half of the conversion price

Venus Remedies
In 2009, US-based hedge funds DE Shaw and Citadel Investment Group filed a winding-up petition against the Chandigarh-based Venus Remedies after the company defaulted on an FCCB issue. A winding-up petition is filed to initiate liquidation proceedings against a company. DE Shaw and Citadel had subscribed to a $12 million FCCB issue of the company in May 2006. The share price fell below the conversion price, and the company failed to pay the investors when it came up for redemption tardy Indian legal system will work as deterrent for investors who would want to consider filing a winding-up petition

UFlex
Uflex Industries, a flexible packaging company, raised $85 million through FCCBs in 2007 at a conversion price of Rs 164. With the maturity date less than a year away, the company has started buying back the bonds. It redeemed $50 million worth of bonds in 2009 and another $2 million worth in 2010. redeemed the bonds at a 45 per cent discount of the face value

Adani Group

decided to go for a conversion of $250 million of FCCBs in the second quarter of 2010/11, more than a year before the maturity date

Suzlon
Suzlon raised $300 million through FCCBs in 2007, at a conversion price of Rs 359 - later restructured to Rs 97. The bonds are set to mature in June 2012 and October 2012.

Tata Motors

Orchid Chemicals & Pharmaceuticals

raised Rs 1,500 crore through external commercial borrowings, or ECBs, to redeem FCCBs ECB norms liberalised. But it is postponement of the problem, not the solution

Aurobindo Pharma

Moser Baer
Raised $150 m through issue of Zero Coupon FCCBs ( face value $100000 each) with tenure of five years from allotment Issued in two tranches
Tranche A: US$ 75 m, YTM of 6.10% & conversion premium of 25% over closing price of Rs. 436.75 on BSE on June 4, 2007 (Rs 545.94 per share) Tranche B: US$ 75 m, YTM of 6.75% & conversion premium of 40% over closing price of Rs. 436.75 on BSE on June 4, 2007 (Rs. 611. 45 per share)

The Bonds are convertible on or after 31 July 2007 and up to close of business on 11 June 2012 by the Bondholders into newly issued equity shares with full voting rights with par value of Rs 10 with a fixed rate of exchange on conversion of Rs 40.27=US$1 Unless previously redeemed, converted or purchased or cancelled, the bonds will be redeemed in US$ on June 21, 2012 at 135.07 % of their principal amount for tranche A and at 139.39 % of the principal amount for tranche B The issue received overwhelming response from investor community and was oversubscribed by 2.25 times the issue size The bonds are listed on the Singapore Exchange Securities Trading Limited and for tranche

Buyback
During 2008-09 the Company bought back and cancelled 260 Zero Coupon Tranche A Convertible Bonds(Face value $26m) and 250 Zero Coupon Tranche B Convertible Bonds(Face value $25m), the purchase being made with the approval of the Reserve Bank of India, at a discount to the face value During 2009-10 the company bought back $3.5 m of face value of Tranche A bonds & $7 m of face value of Tranche B bonds at a discount to face value

Proceeds from FCCB used for investment in overseas subsidiary and for the purchase of capital equipment and also for FCCB buyback

Current Share Price Rs 29 on Aug 10, 2011, well below the conversion price of FCCBs