Mumbai: Many Indian firms might buy back foreign currency convertible bonds (FCCBs) to take advantage of the huge discounts at which these instruments currently trade on foreign bourses.
The Indian banking regulator’s decision to extend the deadline for buy-back of such bonds by nine months to 31 December will encourage them further, said analysts and executives of consulting firms that have been advising Indian corporations on such deals.
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FCCBs are debt instruments issued typically in dollars that have an option to convert them into equity at a pre-determined price. As many as 156 companies have raised $17.7 billion through this route. On average, most FCCBs carry a conversion price of 40% higher than the current traded price of these firms’ stocks.
At least nine companies have so far initiated exercises to buy back FCCBs. Investment bankers expect more companies to follow. Companies buying back FCCBs include Reliance Communications Ltd, Jubilant Organosys Ltd and Aurobindo Pharma Ltd. (The promoters of HT Media Ltd, which publishes Mint, and promoters of Jubilant Organosys are closely related. The companies have no promoter cross-holdings.) At least two analysts said quite a few others have been buying FCCBs from the market but they have not yet informed the stock exchanges. Both spoke on condition of anonymity.
Reliance Communications, part of the Reliance-Anil Dhirubhai Ambani Group, started the process in December. It has so far bought FCCBs worth Rs170 crore in two lots at a 52.5% discount to their price, indicating a major saving for the company.
“At a time when financial crisis is deepening globally and inflation is dropping, it’s a great opportunity for Indian companies to buy back FCCBs,” said Girish Vanvari, executive director at consultancy firm KPMG India Pvt. Ltd. They can do so by taking loans, “available at far more attractive rates.”
A number of firm, however, said funds are not available in the domestic banking system to buy back FCCBs.
The central bank has brought down its policy rate to a historic low of 3.5% through a series of rate cuts since October but commercial banks do not seem to be excited about giving loans to corporations.
In fact, the year-on-year bank credit has dropped to about 19.5% from around 30% or more in the past few years. Banks are not aggressively giving loans for fear of rising defaults in repayment.
Most companies will not be able to buy back FCCBs if the banks do not lend. If FCCBs are not converted, they could end up as debt in the books of the companies. If that happens, the firms will have to pay interest on such debt.
In addition, the debt to equity ratios of these companies will be affected, which will have on impact on their leveraging power. Simply put, higher debt will restrict firms’ capacity to borrow more.
Hiresh Wadhwani, a partner at consulting firm Ernst and Young, argued that despite RBI move, “few Indian companies have thus far exercised the option to buy back (the FCCBs).” According to him, “liquidity is still an issue.” However, “things could change dramatically if liquidity improves in the coming months.”
Vanvari of KPMG expects interest rates to fall further in tandem with a steady drop in inflation and hopes that liquidity will change favourably after the general election that ends on 13 May. KPMG is advising several companies on FCCB buybacks, but Vanvari declined to name them on client confidentiality.
At the height of the bull market, many Indian companies raised money through FCCBs. They were aggressively priced at a premium of 30-70% over prevailing market prices. The FCCB holder converts the bonds into 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 company that issued to FCCBs will have to redeem the debt. The market prices of all these stocks are trading much below their conversion price and, in some of the cases, the gap is as much as 90%. India’s bellwether equity index Sensex lost 52% in 2008 after posting at least 45% gain in previous two years. So far in 2009, it has lost 8.12%.
Reliance Communications made two FCCB issues, of $1 billion and $500 billion, respectively. Its shares are quoting at a discount of 67% and 76%, respectively, against the conversion price of FCCBs.
Tata Steel Ltd share prices are traded in the domestic stock bourses at 77% discount to the conversion price of Rs757.99. Tata Steel’s outstanding FCCBs is $875 million (about Rs4,500 crore) but the redemption date is 5 September 2012.
Most of the large companies have two-three years’ time to convert FCCBs to equities. They won’t need to buy back the bonds if their stock prices rise by that time and the bonds get converted into equities.
Graphics by Paras Jain / Mint