This is a first of a two article series on Foreign Currency Convertible Bonds (FCCBs). Many Indian company issued FCCBs in 2007 which are due to redeem in 2012, and this has challenging implications.

FCCBs have been in the limelight in India for some time now as an option for raising capital for meeting capital expenditure requirements. Initially it was in the news as a great tool for raising funds for meeting company’s capex requirement. The advantage it offers relative to other debt instruments like straight bond is that being a foreign currency instrument, it carries lower interest rates. And it is better than pure equity which immediately dilutes equity base. With FCCBs, conversion to equity is only possible if certain conditions are met.

However 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.

This article explains FCCBs and these developments. And, it also looks at the alternatives available to corporate India.

A convertible bond is a mix between a debt and an equity instrument. It has the features of a bond, with regular interest payments to be made, and at maturity, the principal to be repaid. A convertible bond also has the attractive characteristic that, at or before maturity, the bondholder can convert the bonds into equitable equity shares in the company. The conversion price at which the bond will be changed into shares is decided beforehand. If the shares of the company never reach the predetermined conversion price, and the bond reaches its maturity, then the principal is repaid to the bondholder along with a redemption premium which ranges from 20% to 40%.

A Foreign Currency Convertible Bond (FCCB) is a special type of convertible bond which is issued in a currency different from the issuer's domestic currency. Companies prefer issuing FCCBs as the interest rate on them is much lower than that on a regular “domestic” bond. For example, a company in India issues a bond in dollars with an interest rate of approximately 3%, which is much lower than an Indian currency bond rate of 9%.

From the investors’ perspective, they get the advantage of an instrument which offers debt, as well as, the additional value of an option to convert the bond to equity. It gives the investor upside potential by being able to convert to equity, and the debt element protects the downside. They are also assured return in form of fixed coupon rate payments.

The biggest problem with FCCBs for bond issuers occurs when the share prices of the companies start heading south. During market crashes and bear periods, the conversion price of the FCCBs becomes many times higher than the current share price. This combined with a depreciating domestic currency can lead to devastating consequences.

Current Scenario - Indian companies in an FCCB bind

Between 2005 and 2010, Indian companies issued three and five year FCCBs worth USD $23bn of which USD $7.8bn (at redemption value) will mature in 2012. With stock prices in many cases significantly below conversion prices, conversion is unlikely. And so, redemption is the option for a vast majority of these issues.

The following table lists Indian companies whose FCCBs are maturing in 2012.

Company name	FCCB size ($ m)	Current outstanding ($ m)	Redemption value ($ m)	Conversion price (Rs/share)	Current price	Debt/Equity
Moser Baer	75	43	60	408	18	3.56
Jaiprakash Asso	400	354	524	165	82	2.74
Subex	180	39	53	656	26	2.59
Subex	99	60	85	80	26	2.59
Gtl Infra	300	228	321	53	11	1.99
Hotel leela	100	42	61	72	34	1.79
3I Infotech	100	66	94	166	16	1.77
Rajesh Exports	150	24	35	67	122	1.58
Orchid Chemicals	175	117	168	348	180	1.57
Era Infra	75	40	60	159	141	1.57
Sterling Biotech	250	135	184	163	10	1.45
Suzlon Energy	300	211	307	97	29	1.38
Tata Motors	490	473	624	181	276	1.38
Jsw Steel	325	274	392	953	778	1.36
Tata Steel	875	382	471	731	472	1.28
Tulip Telecom	150	97	140	227	96	1.26
Prime Focus	55	55	79	111	46	1.06
Strides Arcolab	100	80	116	462	596	1.08
Reliance Com	1,000	925	1,182	661	93	0.82
Firstsource Solutions	275	191	267	92	10	0.73
Rolta India	150	97	135	369	96	0.68
Uflex	85	22	26	145	123	0.66
Mascon Global	50	50	65	13	0.91	0.64
Plethico Pharma	75	75	109	484	345	0.50
Educomp Solution	80	79	111	590	193	0.46

*As on March 21, 2012 Source: Bloomberg, company data

What options do these companies facing redemptions in 2012 have?

In the most likely scenario of “mass” redemptions of FCCBs in 2012, these companies will choose to exercise one or a mix of the options mentioned below:

• Repayment through existing cash & cash equivalents
• Repayment through operating cash flows
• Refinancing of debt
• Restructuring of FCCBs
• Issue of further equity to repay debt
• Buyback
  
  

In our next and last article of this FCCB series, we examine each of these options available to issuer companies who are in this FCCB redemption “bind”. And, we will also look at the implications for bondholders.

By Equitymaster – India’s leading share market research initiative. Our research coverage includes both large and small companies, including the BSE Sensex stocks.

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