By Tanuj Khosla
Act in haste, repent at leisure. India's well-functioning and globally popular capital market almost always manages to take the attention off its debt market. Consequently, a lot of people are completely unaware of the crisis of sorts being faced by Indian companies which have issued Foreign Currency Convertible Bonds (FCCBs) and are scouring the horizon for funds. Some, as we shall see later, are also getting ready to unleash dirty tricks to get out of a tight situation.
FCCBs are bonds issued in foreign currency and sold offshore with an embedded option to convert to equity at pre-determined conversion prices.
FCCBs became the favoured instrument to raise capital for Indian companies during the bull run from 2004-05 to 2007-08. Most companies that issued them were on a high growth trajectory and assumed that increased earnings in future would induce investors to convert their bonds to equity in the future.
Investors, which mainly consisted of hedge funds, on the other hand, were more than happy to be able to access the superior returns promised by an exponentially growing Indian equity market while continuing to benefit from the cash flows of the bond. It was a match made in heaven.
However, there is trouble in paradise. The Indian equity is market is nowhere near the levels it was during 2007. As a result the conversion price for most of the outstanding FCCBs is way below the company's current stock price.
Consequently, the majority of the outstanding bonds haven't been converted to equity. In investment parlance, these convertible bonds are known as 'busted converts'. The redemption premium for most is also quite high and companies are bracing themselves to give the money back to the bondholders.
According to some estimates, about 100 companies have FCCBs maturing over the next 12-24 months with a combined potential payout of close to US$ 8 billion (about Rs 36,000 crore). According to Prime Database, more than 200 companies raised close to Rs 72,000 crore through the FCCB route during 2006-08.
The big question is: are Indian companies ready for this kind of payout? How are they addressing this challenge?
The answer: some are resorting to unfair means to get out of their obligations. Here's an instance.
A packaging company with around $10 million of FCCBs due for redemption in April covertly bought its bonds back from the secondary market through various nominees. These nominees then voted against the other minority bondholders to change the terms of the FCCBs unfavourably. The RBI was not amused, but has asked the minority bondholders to approach Sebi for a solution.
A new trend that I am seeing these days is a few companies driving down the prices of their FCCBs in the secondary market by spreading 'bad news' about themselves. They then go ahead and conveniently buy back those bonds at cheap prices. This is nothing but unethical manipulation of the market by such shady enterprises.
In the worst-case scenario, some companies are also preparing to default. Their rationale is simple - they don't expect to tap the offshore market ever again and hence don't care about the company's international reputation.
The lack of strong bankruptcy laws in India combined with their ineffective implementation doesn't leave the holders of the FCCBs, which are classified as unsecured debt anyway, with much recourse to get their money back. The corporates use this fact to their advantage.
Different companies are following different tactics based on their financial position, connections and level of corporate governance. Here are the major ones:
1. Internal accruals: This is an ideal case scenario. However most of them don't have enough cash on the books to redeem their FCCBs in entirety.
2. Company buyback: The Reserve Bank of India (RBI) opened a one-year window in 2009 under the automatic route for Indian firms to raise foreign currency loans to buy back their bonds at a discount to the conversion price from bondholders. This window has now been extended till March 31, 2012. While some companies were successful in repurchasing their FCCBs, many faced stiff resistance from bondholders, especially hedge funds, who were unwilling to exit their position at a haircut - discount to the price mentioned in the FCCB.
3. Promoter buyback: There have been a few cases in which the FCCBs were trading at a discount in the secondary market and have been bought back by the promoter under his personal account and/or in the name of some 'friendly' parties. The promoter then does one of two things:
Roll over the bonds: Since the promoter owns a super majority (either directly or indirectly), he alters the terms and conditions of the bonds and extends the date of maturity, sometimes by as much as 10 years. This way the company doesn't have to service the debt in the short to medium term.
Redeem the bonds: This enables the promoter to take cash out of the company and put it in his pocket as effectively he is just paying himself. Moreover, since the bonds were bought at a discount from the secondary market but redeemed at the redemption premium, the promoter realises a neat profit.
4. Refinancing: This is the preferred way of repaying the bonds by most Indian companies. However, with banks tightening their credit, a lot of companies won't be able to secure bank loans. A few large companies like Bajaj Hindustan and Bharti Shipyard have managed to raise funds domestically to meet their obligations. At the same time many mid-cap companies have been knocking at the doors of various foreign hedge funds to obtain private debt which won't come cheap. Bigwigs like Reliance Communications Ltd, which has secured a US$ 1.33 billion loan from China Development Bank, are also looking at foreign banks, especially Chinese ones for refinancing.
5. Issuing new FCCBs: Many companies like Assam Company have tapped/are tapping the international markets to place a new issue of FCCBs. While some of them have chalked out large capital expenditure plans and claim that only a part of the proceeds shall be used to service outstanding FCCBs, others are quite open about their intent regarding the funds raised.
6. Raising equity: Not only is raising equity in this market difficult but it would also lead to substantial dilution of the promoter's stake in the company. However, many companies don't have a choice as they are highly leveraged and can't take on any additional debt. While some of them are issuing global depository receipts, many others are rumoured to be in talks with private equity (PE) players to get funding.
7. Negotiations with bondholders: A few corporates have entered into talks with their bondholders to either roll over the existing bonds with a lower conversion rate or a higher redemption premium. Unfortunately for them, not many hedge funds are willing to take a haircut on their investment and are examining their legal options.
In conclusion, the experience of Indian companies and bondholders alike has not been good with FCCBs and if there are a large number of defaults over the next 12-15 months that might well be the last nail in the coffin for this debt instrument. This would be very bad news for smaller companies which aspire to be a Tata or an Infosys but won't find an audience next time they come to the international markets to raise funds. Things might start looking up though if one or more of the following happens:
- RBI accelerates the growth of credit default swaps, a form of insurance cover purchased by lenders against the risk of default by borrowers. This shall allow foreign institutional investors (FIIs) to hedge their credit risk in India and shall give them some comfort.
- The Indian equity market improves drastically in the same period and most bond holders convert to equity.
If not then a large crisis looms over this former love of international investors for sure. Watch this space.
(Tanuj Khosla is currently working as a Research Analyst at a hedge fund in Singapore. He is a die-hard cricket fan and can be followed on Twitter @Tanuj_Khosla. Alternatively he can be reached at email@example.com. Views expressed are personal.)
Updated Date: Dec 20, 2014 03:59:00 IST