There has been a revival in demand for foreign currency convertible bonds (FCCBs) in the past few weeks. This is partly due to the fatigue in the equities rally since mid-September and partly because merchant bankers have discovered that convertibles help circumvent pricing restrictions imposed by the Indian markets regulator on direct equity issuances.
The markets have traded in a narrow range ever since the Nifty hit the 5,000 mark on 17 September, and the consensus view is that a correction is due. In such an environment, taking a direct equity exposure through either a qualified institutional placement (QIP) or global depository receipts (GDR) issue is fraught with risk. A convertible bond, however, promises to keep investors’ capital intact and even generate a reasonable yield if an investor chooses not to convert the bonds into equity.
Additionally, the Securities and Exchange Board of India (Sebi) mandates the minimum price at which a direct equity issue can be made. Often, an issue may generate demand only at a price that is lower than this minimum prescribed price, and hence would have to be scuttled. To circumvent this, issuers such as Larsen and Toubro Ltd (L&T) and Tata Motors Ltd have discovered that issuing a combination of direct equity and convertible bonds works well with investors.
Both these companies split their fund-raising programme by partly issuing direct equity and partly issuing convertibles.
In the case of L&T, it was done in a 2:1 ratio, with $400 million being raised through a QIP issue and $200 million through FCCBs. For Tata Motors, a total of $750 million was raised, evenly split between a QIP and an FCCB issue.
The terms of the FCCBs were rather generous. For Tata Motors’ bond holders, the conversion premium was set at just 7.5% over the price at which the equity was issued, and the bonds carried a healthy yield till maturity of 5.5%. This was done to compensate investors for tight pricing of the equity shares, points out an investment banker who did not want to be identified because of company policy.
The equity was priced at a discount of just 1.5% to prevailing prices because of Sebi’s pricing norms. Genuine demand would have come in only at a lower price, which is also evident from the fact that Tata Motors’ shares have fallen by 7% soon after the issue closed. But the convertibles have proved to be decent compensation, trading at a premium of about 4% in the secondary market.
In L&T’s case, the bonds are trading at a premium topping 7% currently.
In the September quarter, direct equity issuances were still the norm, just as they were in the preceding April-June quarter. According to data collated by Bloomberg, Indian companies raised Rs16,100 crore through QIPs in the September quarter and Rs12,672 crore ($2.64 billion converted at Rs48 a dollar) by issuing depository receipts. In comparison, the amount raised through FCCB issues was just Rs4,128 crore ($860 million).
This is likely to change in the December quarter if the current trend continues. Apart from the combination offers, there have been pure FCCB issues as well by Sesa Goa Ltd, Welspun Gujarat Stahl Rohren Ltd and Amtek Auto Ltd in recent weeks. What has also helped revive interest in convertibles is the fact that credit spreads have dropped across the board, resulting in relatively lower interest costs. At the same time, the investment banker points out that Indian companies have also begun to realize that they can’t expect the same pricing terms as in 2007. For instance, they have to settle for a much lower conversion premium on the bonds.
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