Monday, May 30, 2011

FCCB - Redemption Pressure.

In the next few days, get set to witness a frenzy in the Foreign Currency Convertible Bonds (FCCBs) markets. It is expected to be making major news in the next couple of days.

The reason is simple. Maturity of FCCBs of around 100 companies is due between now and 2012. Ms Shyamala Gopinath, Deputy Governor, RBI stated that redemption pressures on account of FCCBs would start building up from current fiscal and peak till 2012-13. As per RBI, FCCB redemption profile is $3.622 billion in 2011-12; and $3.757 billion in 2012-13.

Now the problem is that when we say that FCCBs are nearing maturity, it leaves the companies with only two options – either buyback or repay the bond holders. And the problem being that majority of the company’s stock price, whose FCCBs are nearing maturity are trading lower than the price at which these bonds would convert into equity shares.

For eg: Rcom issued FCCBs and its conversion price is set at Rs.661 and today the stock is traded at Rs.85. Then there is Jaiprakash Associates, whose conversion price is at Rs.165 while it is currently traded at Rs.82.

The company can covert when the equation is vice versa from the current scenario – when stock price is more than the conversion price. But converting at such huge discounts makes no sense. Crisil has put out a report stating that only a handful of companies will be able to go for conversion and majority might have to repay the debt on maturity and that means the outgo of a huge amount of money. This repayment can be done with internal accruals of with more borrowings which in todays era will come with a huge interest tab.

Regarding buy back, we could see some serious rush in the coming days, from companies with enough internal accruals. RBI has extended the premature buy back via the approval route till 30th June 2011. Companies are allowed to buy back their FCCBs prematurely, financed by the company's foreign currency resources held in India or abroad. The only conditionality justifying the buy back using foreign currency held in India, including Exchange Earners Foreign Currency Accounts (EEFC) or foreign currency held overseas or raise fresh foreign borrowings, provided there was a minimum discount of 15% on the book value of the FCCB. Companies can also buy back using rupee resources, if there is a minimum discount of 25%, on the book value. The conditionality over ruling all this is that companies will use their internal accruals, which has to be certified by the statutory auditor.

There is one more option which companies might resort to. Making use of the reset clause wherein companies are allowed to reset their conversion price downwards. This in the immediate short term could see a further beating down of their share price, not to mention the fear of equity dilution. Suzlon, Tata Motors, Gitanjali Gem, Subex are some of the companies which reset their conversion price.

Given the current dismal market scenario, one should not be surprised if the RBI steps in and further extends the buy back deadline. The situation is grim, especially for those who have a weak balance sheet and are already leveraged to the hilt. Let us see how this cookie crumbles in the next couple of days.

Food for thought: Indebtedness is no virtue but repayment surely is.


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