FCCB’s

arvatha Vardhini C
Foreign Currency Convertible Bonds (FCCBs) have been
in the news for most part of this year, thanks to the global
financial turmoil. First, FCCBs were a problem due to the
mounting forex losses of Indian companies.
In addition to the marked to market losses on derivatives,
companies also had to provision for interest costs on
FCCBs, following the sharp depreciation of the Indian
rupee.
Later, the problem of high conversion prices for
outstanding FCCBs made its presence felt amid falling
stock prices, underscoring the possibility of their non-
conversion. It again made headlines recently, when the
RBI allowed the buyback of FCCBs. But before we begin
to track these developments, let’s get the basics right.
Brass Tacks
FCCB is an instrument that has the features of both equity
and debt. Issued as interest bearing or zero coupon
bonds, FCCBs are convertible during their tenure into
equity. They are a popular source of raising money as it
benefits both the investors and issuers.
For investors, it brings the advantage of capital protection
(like an investment in any other debt instrument), as well
as the chance to capitalise on an appreciation in the price
of the company’s shares through conversion. For the
company, it is a source of low-cost debt as coupon rates
on the bond are lower than the average lending rates.
Tough times
In the past few years of strong economic growth, rising
share prices and lower interest rates, Indian companies
resorted to funding their growth plans through FCCBs in
large numbers. But the current liquidity crunch and the
market meltdown have taken the wind out of their sails.
Companies with FCCBs maturing in the next one or two
years are now in a tight spot, especially so for companies
whose stock prices have fallen way below the conversion
prices originally fixed. Take the case of Tata Motors. For
11,760 million yen worth FCCBs maturing in March 2011,
the conversion price has been set at Rs 1,001. But the
stock currently trades at Rs 179.
Several other companies such as Subex Azure, Suzlon
Energy, Tata Steel, Wockhardt, Ranbaxy and Reliance
Communications are also faced with a similar problem.
Double-edged sword
In these troubled times, FCCBs have turned out to be a
double whammy. That is because if bondholders do not
convert, these companies will be forced to pay up their
liabilities. For example, FCCB holders of Coimbatore-
based Shanthi Gears exercised the redemption option in
November, following which the company had to redeem
outstanding FCCBs worth $5.3 million (Rs 25 crore)
In the current cash crunch scenario, small and medium-
sized companies may find it challenging to raise funds to
meet this additional liability. Besides, a higher debt
obligation at a time when the economy is already
witnessing a slowdown may be a further drag on their
profits.
That said, even if companies choose to lower the
conversion price instead of taking on this burden, their
woes may continue as it will then imply a higher equity
dilution than planned.
This notwithstanding, some companies such as Simbhaoli
Sugars, Pioneer Embroideries and Spice Jet have lowered
their conversion prices in the past few months.
Time running out
While companies whose FCCBs mature two-three years
down the line can expect the markets to rebound, others
such as Wockhardt, whose FCCBs worth $110 million (Rs
517 crore) mature in October 2009 do not have the luxury
of time.
Its shares now trade at Rs 104 as against its FCCB
conversion price of Rs 486, virtually ruling out the
possibility of conversion.
Any additional borrowing too might not be a very good
option as its debt-equity ratio, currently at about 2.3:1, is
already on the high side. The company is reportedly
looking to sell off some of its non-operational assets to
meet its liability.
RBI moves
Realising the catch 22 situation that some of the Indian
companies were in, the RBI had permitted the buyback of
FCCBs, (on satisfying certain conditions) last month
through new ECBs (External commercial borrowings).
It recently allowed buyback through rupee resources as
well. Reliance Communications, which had issued zero-
coupon FCCBs in February 2007 for $1 billion (Rs 4,700
crore), at a conversion price of Rs 661 is the first company
to avail of this. GTL Infrastructure too has followed suit.

Buyback of FCCBs
M. R. Rajaram
Of late there have news reports on various developments
relating to Foreign Currency Convertible Bonds (FCCBs).
It was only in the late 1990s various corporations started
leveraging FCCBs to fund their growth plans.
It is an efficient method of funding, as an FCCB enjoys the
general advantage of any convertible instrument. It has
the right smoothing effect on the EPS when used for
funding a new project or an expansion. Generally the
conversion to equity takes p lace after completion of the
project for which the funds are raised through the FCCB
route. The servicing cost of an FCCB till its conversion is
capitalised and hence does not affect the EPS. Post
conversion, the earning from the project should more than
offset the dilution in EPS due to the expansion of the
equity base. Also FCCBs, till they are converted to equity,
have the advantage of lower servicing cost applicable for
foreign currency loan.
Equilibrium upset
At the same time it also provides an opportunity to
leverage the higher PE multiple in the overseas market,
which we had seen till the recent meltdown of the global
economy. Hence FCCB was a very attractive method of
financing.
But the steep fall in share prices together with tight
liquidity in the global market has upset the equilibrium,
placing both investors and companies in difficulty. The
conversion prices for most of the FCCBs were agreed
upon years back when the market was experiencing a
bull-run. As a result of the steep fall in share prices, the
rates are not attractive enough for investors to exercise
the conversion. Hence the issuing companies have to find
ways to finance the repayment of these bonds.
In this scenario, it makes economic sense for companies
to buy back the FCCBs. Such action will not only benefit
the companies but also their shareholders. Realising the
need and the advantage, the RBI has relaxed its
guidelines to enable an issuing company to buy back
FCCBs from the market.
RBI eases norms
The earlier relaxation permitted buyback only when the
issuing company funded this requirement through new
ECBs. This has very little benefit as in today’s global
financial market it is almost impossible for companies to
raise fresh ECBs to fund the buyback of FCCB.
The new set of guidelines issued by the RBI on December
6, 2008, addresses this difficulty to a certain extent. Now
the requirement can be funded using rupees. The foreign
currency required to purchase the FCCB can be obtained
from the RBI. However this facility is available only when
the company is able to buy the FCCB at a discount equal
to or more than 25 per cent. One could argue that though
the threshold level of 25 per cent discount is arbitrary it is
a right step in terms of effective use of the forex reserves.
Internal accruals
However the RBI should seriously reconsider the other
condition, namely, that the buyback has to be funded from
internal accruals only. This is a stringent condition to meet,
as internal accrual will not include share capital or
premium on issue of shares. Thus to meet this condition,
the total borrowings, including the money required for
buyback, should be less than the retained earnings of the
company.
This effectively means a debt-equity ratio of less than one.
By any standard such a low gearing as a precondition is
not justified. Even under the Companies Act, for permitting
the buyback of shares the maximum debt-equity ratio
allowed is 2:1.
The RBI should reconsider this requirement and bring this
precondition in line with Companies Act regulation for
buyback of shares. Else, many companies will not be able
utilise this opportunity.
(The author is Director, ICI India
Ltd. blfeedback@thehindu.co.in)

Foreign convertible bonds buyback with rupee

resources allowed
New guidelines announced; prepayment window open till
March 2009.
Our Bureau
New Delhi, Dec. 6 Indian companies can now pre-pay
their existing foreign currency convertible bonds (FCCBs)
from their rupee resources in addition to their foreign
currency accruals.
The guidelines for pre-payment/buyback of FCCBs by
Indian companies, issued by the Finance Ministry here on
Saturday, coincided with the Reserve Bank of India
Governor, Dr D. Subbarao’s announcement in Mumbai of
growth stimulus measures.
Dr Subbarao said the RBI would now consider
applications for buyback of FCCBs out of rupee resources
of companies. The central bank had in mid-November
invited proposals for premature buyback of FCCBs under
the approval route so long as it was financed out of foreign
currency resources held in India or abroad and/or out of
fresh external commercial borrowings (ECBs).
This is the first time ever a buyback scheme had been
framed by the Government for FCCBs, say experts in
financial services industry, who see this move as another
effort of the Government to placate the Indian corporate
sector that had been badly hit by the global financial
meltdown.
The Finance Ministry has in its guidelines specified that
the provision of pre-payment (premature purchase) of
existing FCCBs would be available up to March 31, 2009.
Also, the existing condition of minimum maturity period for
redemption of bonds has been put on hold till March 31,
2009.
It has also been specified that the initiation power/right of
pre-payment was vested with the issuer of bonds and not
with the holder of bonds. However, the actual pre-payment
would be subject to the consent of the bondholder. Also,
the bonds purchased from the holders must be cancelled
and should not be re-issued or re-sold.
For buyback allowed under the automatic route out of
foreign currency funds raised through fresh ECBs, it has
been stipulated that the all-in-cost ceiling should not
exceed 6 months LIBOR plus 200 basis points, if the fresh
ECBs are co-terminus with the residual maturity of the
original FCCBs but is less than three years. Also, there
should be a minimum discount of 15 per cent on the book
value.
In the case of approval route, Indian companies can
buyback out of rupee resources, representing internal
accruals, so long as the amount does not exceed $ 50
million of the redemption value of the FCCB per company
and a minimum discount of 25 per cent on the book value.
“This is too little, too late and more of a signal to corporate
sector, with an eye on the elections. The challenge is to
get bigger volumes and more transactions under this
prepayment window. I don’t see very many institutional
players relinquishing their rights under the bonds at a
discount”, Mr Apurva Mehta, Director (Financial Services),
KPMG, told Business Line.
The redemption millstone
S. Murlidharan
Foreign currency convertible bonds (FCCBs) have
been hugely popular with Indian corporates as a
source of capital mobilisation. And they have been
lapped up by foreign investors wanting to test the
waters first before committing themselves to the
uncertain, yet hugely rewarding, world of equity.
Cheap funds
An FCCB has all the trappings of a convertible
debenture; only it is denominated in a foreign
currency. Till conversion, which is entirely optional,
companies get to enjoy some cheap funds given
the fact that the interest rates in the US and
European markets have always been low vis-À-
vis the Indian rates of interest.
What beckons the foreign investors is the promise
of acquiring shares at a discount vis-À-vis the
ruling market price. But unfortunately for many
Indian companies, the inexorable decline in their
fortunes in the Indian bourses has spelt non-
exercise of the conversion option by the foreign
investors resulting in a huge redemption liability
staring at them in the near future for which they
were not obviously prepared punch drunk as they
were with confidence that such an eventuality
would never arise.
Markets however have the ability to humble
anyone, including the high and mighty as well as
those who are blasé.
In a bind
These companies are now at their wits’ end. First,
how to pay back the foreign investors when the
redemption time arrives? Second, Section 117C of
the Companies Act mandates them to create
reserve out of profits so as to be able to redeem
the debentures out of such accumulated profits.
And, third, user charges for these funds have not
been provided for in the accounts, thus giving a
bloated and exaggerated figure of profits.
The first predicament of these companies is not the
subject of this article. The second and the third
are. The reason trotted out as to why these
companies did not provide for user charges and did
not create a redemption reserve is simple — never
in their wildest dreams did they foresee the
possibility of investors not exercising their
conversion option.
The Ministry of Company Affairs (MCA) stand is
that reserve under Section 117C is to be created
only on the non-convertible portion of the bonds or
debentures. In fact, this has come handy for
companies which say that they did not know how
much is redeemable so as to be in a position to
create a reserve, anticipating as they did 100 per
cent exercise of conversion option.
And the same we-lived-in-fools-paradise theory
has been extended for not providing for user
charges that has had the effect all these years of
considerably overstating their profits.
Foreign investors have often complained of lax
regulatory framework as an inhibiting factor. The
FCCB accounting fiasco is a telling example of this.
Unfortunately, AS-31 is some distant away, taking
as it does mandatory effect only from the year
2011.
Notify standard
But it does throw some valuable light on the issue
to the benighted corporates: “The company’s
contractual liability to make future payments
remain outstanding until it is extinguished through
conversion ….”
Simply put, what the standard says is a company
has no business or need to second-guess the
minds of the investors — till they exercise their
conversion option, the FCCB very much remains a
debt instrument.
The ICAI has, in fact, hit the nail on the head. But
its standard, sound as it is, has had no applicability
to accounts prepared all these years. Shouldn’t the
MCA try to steal a march over the ICAI for a noble
cause and notify this standard under the
Companies Act with immediate effect?
(The author is a Delhi-based chartered
accountant.)
FCCB redemptions put India Inc in a Catch 22
situation
Arun Kumar / New Delhi October 3, 2008, 0:55 IST
Indian companies that raised large sums of foreign funds
to finance growth and acquisition plans during the bull run
in the stock markets are in a Catch 22 situation. The
conversion price of their foreign currency convertible
bonds is several times higher than their current market
prices.
This leaves them with two options. One is to reset the
price at current market price, a move that could dilute
promoter holdings (since it would entail issuing more
equity shares). The other is to redeem the bonds, which
could increase debt obligations that are already
substantial in some cases.

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The maturity of many of the FCCBs is expected to start in
October 2009 and peak in 2010-11. Most analysts say the
market is unlikely to recover so significantly over the next
two years that market prices will match the conversion
prices.
In some cases, the outstanding amount on account of
FCCBs is higher than or around the current market
capitalisation of the companies concerned (see table). For
instance, Hyderabad-based Subex Auzure raised $180
million (Rs 846 crore) in 2007 to finance the acquisition of
Azure. The company’s market capitalisation as of
September 30 was Rs 298 crore.
Should the management decide to re-set the conversion
price and link it to the current market price, the company’s
equity would be diluted. If it decides to repay these bonds,
the redemption amount with interest would be around Rs
1,150 crore. The company has already raised debt of
around Rs 1,050 crore.
The $110 million FCCB raised by pharmaceutical major
Wockhardt is slated for conversion in October 2009 at Rs
629.80 against a current price of around Rs 155. If the
company chooses to redeem the bonds, it will have to pay
$140 million or Rs 658 crore. The company already has a
debt obligation of around Rs 3,000 crore.
Firstsource, which is being put on the block by its
promoters ICICI Bank, had mopped up $275 million
through FCCBs, for which the conversion rate is Rs
128.60 against its current share price of around Rs 28.