Mumbai: Rural Electrification Corp. Ltd (REC), the state-owned lender to power utilities, has firmed up plans to raise $500-600 million (Rs 2,650-3,180 crore) overseas.

H.D. Khunteta, director (finance), REC.

REC approached the department of disinvestment in May with a proposal to raise $1 billion through foreign currency convertible bonds (FCCBs). But that would have meant reducing the government’s stake in REC—currently 66.8%—by about 10%.

“It was then decided that a smaller amount be raised resulting in lesser dilution of stake by the government," H.D. Khunteta, director (finance) at REC, said by phone.

The stake dilution will be capped at 5-6%, he said.

“We have sent a proposal to the cabinet and are waiting for approval. The plan is to raise money by the first quarter of next year," an official in the finance ministry’s department of disinvestment said about REC’s FCCB plan.

The department is looking at innovative ways of raising capital for state-run companies, the official added, declining to be identified.

FCCBs are bonds with an equity element. They remain debt instruments as long as investors hold on to them. Investors convert their holdings into equity when the share price touches a conversion price promised by the issuer. If this does not happen, the issuer needs to treat the bonds as debt and redeem them.

REC’s overseas bonds will have a tenure of at least three years and offer a coupon of 2% payable annually with no redemption premium at maturity. “The idea is to ensure the bonds get compulsorily converted and, hence, there is no redemption premium," Khunteta said. “Besides, the stock price of the company has already corrected significantly this year, offering a huge discount to the investors."

REC has lost about half of its value on the Bombay Stock Exchange this year, dropping faster than the Sensex’s 23% fall. On Friday, REC shares fell 4% to 147.85 apiece.

REC’s bonds will offer as conversion price a 30-35% premium to the stock price on the day the bonds are sold. This means that when the stock appreciates 30-35%, the bondholders can convert the bonds into equity shares of the company.

It is difficult to price the bonds at a time when the markets are at their lows, said the head of investment banking at a foreign lender. “Also, there is a fear of having sold it cheap and a probable loss to the exchequer," said this person, who didn’t want to be named.

According to him, finding investors in such a market will be difficult for REC. The fear stems from the fact that the shares of most Indian companies that have sold FCCBs in the past have failed to perform, with their stocks trading at huge discounts to the promised conversion price.

With most of the bonds carrying no interest (zero coupon), bondholders now want to redeem the bonds. “This has resulted in the bonds sitting as debt on companies’ books, something which the companies never envisaged and provided for," the banker said.

Khunteta is optimistic.

“Most of the bonds that were sold in 2005-07 were sold in a bull market, and with the fall in the market, the bonds failed to perform. But with the market having corrected already, there would be great demand for the bonds and we are confident of raising the money," he said.

Another state-owned lender to power utilities, Power Finance Corp. of India Ltd (PFC), may also be looking to borrow abroad, according to government officials, but its chairman and managing director Satnam Singh denied such a plan.

“We will tap the market time-to-time to meet our requirements. But nothing has been finalized as yet," he said.

REC and PFC lend to power utilities and, hence, access the capital and debt markets regularly. In a 22 November report on REC and PFC, Antique Stock Broking Ltd wrote, “REC and PFC have seen multiple rounds of de-rating because of issues related to distribution losses and unavailability of coal, etc. However, with the slew of measures and accommodative policy stance by government/regulators, power lenders address the concerns relating to the sector, thereby improving the visibility for REC/PFC."