Debt-fuelled growth can have unintended consequences if the business environment does not pan out as expected. An estimated $5.3 billion worth of foreign currency convertible bonds (FCCBs) are expected to mature next year. According to IIFL, the bonds are estimated to have a redemption value of $7.2 billion.
In a normal business environment, when conversion rates are lower than the market prices, FCCB holders would convert the securities into shares. But with equity markets in a bear grip and stock prices of most companies’ way below the conversion rates, FCCB holders would prefer to redeem the bonds. According to IIFL 90% of the FCCBs maturing in 2012 could lead to redemptions.
Prasad Koparkar, Head-Industry & Customised Research at CRISIL Research says “The risk in terms of conversion not happening is very high.” A study by CRISIL Research in May this year found that close to two-thirds of the FCCBs maturing by March 2013 are unlikely to get converted into equity shares due to the huge gap between market and conversion rates.
Companies will have the option to either redeem FCCBs or reset their conversion price downwards. Resetting the conversion price to lower levels could significantly dilute the promoter holding.
Redemptions, on the other hand, can have adverse financial implications for firms with high debt and poor credit rating. Interest rates in the domestic economy are close to double digits. With risk aversion high in global markets, companies with weak balance-sheets will find it hard to raise money at competitive rates. Even if they manage to raise fresh debt, converting them into dollar or euro denominated currencies will cost them dearly due to huge rupee depreciation.
Overall, companies with sound finances could raise money at competitive rates. But they cannot avoid the pain of high refinancing costs. Ashutosh Datar and Ravi Saraogi of IIFL said in a note “With stock prices depressed, a large majority of the issues would need to be redeemed, and refinanced by domestic ‘expensive’ debt in most cases, creating refinancing risk as well as impacting profitability.”
Reliance Communications, Tata Steel, Tata Motors, Jaiprakash Associates, JSW Steel, GTL Infrastructure and Suzlon Energy are some of the notable companies whose FCCBs will mature in 2012. While the gap between the conversion rate and market price is the lowest for Tata Motors it is very large for Reliance Communications, according to IIFL.