Markets surge, but few takers for FCCBs

Markets surge, but few takers for FCCBs

Mumbai: Once a popular instrument among companies that wanted to raise debt without paying any interest, foreign currency convertible bonds (FCCBs) are finding few takers despite the recent run-up in share prices. Indian companies are now ready to issue FCCBs with a coupon rate at cheaper conversion prices and even secure the debt, but so far this year there have been only five floats which have raised $315 million (around Rs1,395 crore), according to Bloomberg data.

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This compares with the $7.5 billion that 80 issues mopped up in 2007, when the markets were in the final phase of the last bull run. FCCBs are typically popular in a bull run since investors are sure of getting good returns because share prices are rising. However, despite markets gaining 17% in the past year, the response from investors has been mild, said investment bankers.

“Given the past experience in FCCBs, firms are a bit sceptical about the product," said Sanjay Sharma, head of equity capital markets at Deutsche Equities India Pvt. Ltd. “Hence, while there is investor interest, and deals are happening in Asia, Indian firms have more or less been staying away."

Investors burnt their fingers with FCCB issues during the previous bull run, said bankers. A case in point is Wockhardt Ltd. At the time of conversion in October 2009, the firm’s shares touched a high of Rs193.35, way below the conversion price of Rs486. Rather than convert their bonds into equity, investors wanted to redeem them, forcing the company to restructure the issue with a new redemption date.

While the instrument can be viewed as either “cheap debt" or “equity at a premium", in the previous round of FCCBs, most companies looked at it as “equity with a premium", which may not have necessarily been the case, given the downturn in the markets in 2008-09, said Sharma.

In other words, these were zero-coupon or non-interest-bearing bonds, and investors, too, were glad to buy them because prices were increasing. In the downturn that followed, however, stock prices crashed, and the FCCBs remained as debt. There are no zero-coupon bonds now, as nobody is willing to buy due to the change in market sentiment, said Sharma.

Jaiprakash Power Ventures Ltd’s $200 million bond issued in January had a coupon rate of 5%. The $76 million bond issued in April by Core Projects and Technologies Ltd paid interest at 7% a year. Of the five FCCBs issued in fiscal 2011, only IOL Chemicals and Pharmaceuticals Ltd has issued bonds with a zero coupon. The Reserve Bank of India provides data on two more zero-coupon FCCB issuances in this fiscal—$300 million raised by Essar Oil Ltd and $280 million by Essar Shipping Ports and Logistics Ltd. In the last fiscal too, every issue with the exception of Suzlon Energy Ltd was interest-bearing.

The nature of the FCCB market is changing, said Madhabi Puri Buch, managing director and chief executive officer, ICICI Securities Ltd, pointing to the coupon rates and lower conversion premiums in the new issues.

“The emphasis is more on credit ratings and it’s large-cap companies that are coming out with issuances," she said.

Companies are also getting wiser and charging smaller conversion premiums to attract investors.

Conversion premium is the amount by which the price of a convertible bond exceeds the market price of the underlying stock.

Current premiums are in the 15-20% range, lower than earlier, where conversion premiums were as high as even 50%, said Nishikant Das, head, capital markets solutions, India, Standard Chartered Bank. The bank was involved in the FCCBs of Jaiprakash Power and Core Projects. Bankers also said firms are not trying to secure the FCCBs or back the debt with collateral to reduce the risk for investors.

While some say investors and the corporate base may shrink, there would still be a class of investors such as private equity companies that would want to use this instrument.

FCCBs “will come back as a kind of structuring option in the context of private and semi-private deals, where large investors may want to put money as convertible bonds rather than put in money as equity", said Sanjay Bhandarkar, managing director at NM Rothschild and Sons (India) Pvt. Ltd.

Secured debt means that even in the case of the company folding up, the private equity investor can sell off the collateral and regain part of its money.

Graphic by Ahmed Raza Khan/Mint