Mumbai: Indian companies that raised money through foreign currency convertible bonds (FCCBs), a quasi-equity instrument, could well be staring a huge debt burden in the face because their stocks have fallen well below the level at which this debt would have been converted into equity.
A Mint analysis of Bloomberg data reveals that the outstanding amount on all Indian FCCB issues—bonds that haven’t already been convert-ed into equity—is to the tune of $17.7 billion (Rs71,685 crore). Of this, $4.7 billion worth of bonds have a conversion price that is at least 40% higher than the current traded price of the stock.
If these bonds actually end up as debt, it would come as a rude shock for the firms. They have to pay interest on the bonds and may even have to resort to fresh borrowings in order to repay bond holders. It will also affect their debt-equity ratio and leveraging power.
However, it is too early to gauge the extent of impact on Indian firms’ balance sheets as in most cases the bonds mature beyond 2011 and the market conditions can change in this period.
The meltdown in the Indian stock market this year, induced by global bearishness following the subprime crisis in the US, has resulted in pulling down the current market price of the shares of some Indian FCCB issuers way below the bonds’ conversion price.
FCCBs are debt instruments, issued normally in dollars, with an option to convert them to equity at a pre-determined price. The convertible bonds, which help companies raise foreign currency funds at attractive rates, have largely been zero-coupon bonds, where the interest payment is due on the maturity of the bonds. As a result, there is no cash outflow from the issuing company either towards interest payments or for repayment of principal.
FCCBs are usually priced at a premium of 30-70% over the prevailing market price of the share and the option holder converts the bonds to equity if the stock price exceeds the conversion price. If the market price of the stock does not exceed the option price, the holders will not opt for equity conversion and the issuer will have to redeem the debt.
Although these instruments are treated as debt on the balance sheet, the assumption at the time of issue is clearly that the bonds will get converted into equity and no payments need be made by the issuer towards redemption. In fact, corporations usually do not even show the pro-rata interest charge on account of FCCBs in their profit and loss statement.
FCCB holders normally convert their holdings when a company’s shares are trading at a hefty premium to the conversion price. Else, they prefer to hold on to the bonds till maturity and earn interest income, which would be about 35% of the original investment for a bond with a 6% yield and a five-year tenure. It’s only when they are assured that the return on the shares will be much higher than the interest earned on the bonds, that they convert FCCBs into equity.
According to Anil Advani, head of research at SBI Capital Markets Ltd, the investment banking arm of India’s largest lender State Bank of India, some of these issuers could be in a difficult situation as they may not be capable of raising additional debt to repay FCCB holders (if the bonds are not converted). Some companies, then, could even collapse under the weight of their outstanding debt.
A case in point is Subex Ltd, the Indian IT firm which has grown rapidly through mergers and acquisitions in the past few years.
Subex has FCCBs worth $180 million outstanding. The company’s 2006-07 cash flow was Rs25 crore, while the interest payment on the FCCB works out to roughly Rs58 crore.
Since the FCCBs were issued, the firm’s stock has slid 65% from Rs577.45 per share to Rs199. The FCCBs will mature in 2012. If its stock does not rise substantially, Subex will have to redeem the debt.
Similarly, for Sakthi Sugars Ltd, the outstanding debt on two FCCB issuances is $60 million. The market capitalization of Shakti is down 62% since 30 May 2006, the date of issue, to $57 million.
The date of maturity of one tranche of FCCBs worth $20 million is 30 May 2009. The company’s stock is now trading at Rs73.80 and the conversion price is above Rs270. It’s quite likely that its first tranche of FCCBs will end up as debt.
“Many companies, when they issue FCCBs, do not expect outflow at a later time,” said the head of equity research at a foreign brokerage in India who did not wish to be identified.
R. Ravimohan, region head and managing director, Standard and Poor’s, South Asia, said: “FCCBs were floated during an exuberant time. Now the market realities have changed and some of the firms will have to honour their debt obligation.”
Reliance Communications Ltd is the biggest issuer of FCCBs. In two different issues, the company issued FCCBs worth $1.5 billion; the first tranche matures in May 2011.
Two Tata group companies follow in the list of big issuers. Tata Steel Ltd has issued $875 million worth of FCCBs and Tata Motors Ltd, $490 million. Other big issuers include Ranbaxy Laboratories Ltd, J aiprakash Associates Ltd, Sun Pharmaceuticals Industries Ltd and JSW Steel Ltd.
The companies for whom the gap between the current stock price and the conversion price is huge include sugar companies Simbhaoli Sugar Mills Ltd and Sakthi Sugars apart from Shah Alloys Ltd, Vardhman Textiles Ltd and Subex.