Foreign Currency Convertible Bonds: Pros and Cons of financing through FCCB

Hitesh Gupta2011E12

5th of Sep 2012

Flow of Presentation

Introduction to FCCB

Pros and Cons of FCCB and nuances of usage

Regulatory Mechanism

Options post issue

FCCB• Foreign Currency Convertible Bond (FCCB) - Mix

between debt and equity instruments

• Convertible bond issued in a currency different than the issuer's domestic currency

• A quasi-debt instrument attractive to both investors and issuers

• Acts like a bond by making regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock

• Generally available at US$ 1000 each

• Eligible borrowers under approval route include Financial Institutions dealing exclusively with infrastructure or export finance such as IDFC, IL&FS, Power Finance Corporation, Power Trading Corporation, IRCON and EXIM

• Banks are considered on a case by case basis

Anatomy of an FCCB…

Issuer of FCCBs Lender of money

Capital in $

FCCBs

29-Apr-2009 raises money in dollars sets conversion price at premium (say Rs 125) maturity period between 3-5 years

29-Apr-2009 receives FCCBs can trade FCCBs if in liquidity

crunch

Issuer of FCCBs Lender of money

Equity at conversion price

FCCBs returned

29-Apr-2014 no need to pay in cash issues equity at pre decided price (Rs 125) equity dilution

29-Apr-2014 makes windfall profit by selling equity at

prevailing market prices (say Rs 200)

If markets are good…

Issuer of FCCBs Lender of money

Capital in $

FCCBs returned

29-Apr-2014 redeem bonds at par value huge requirement of cash buy back from market before

maturity if traded at discount

29-Apr-2014 redeem FCCBs at par value principal investment comes back with

small returns

If markets are bad…

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ProsPositive impact on the cash flow of the company

Interest rates/Coupon Rates are low compared to debt

Does not dilute the ownership immediately

Normally carry fewer bond covenants

It’s different!

Equity• Immediate equity

dilution• Dividend distribution

Debt• High interest rates in

borrowing• High coupon in Bonds• ECB limited to Capital

goods, capacity augmentation, overseas acquisitions

FCCB• Low coupon/interest

compared to debt• No immediate dilution

of equity• No cash payment in

good market conditions

• All transactions in foreign currency

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Regulatory Mechanism• Permitted End Uses

– For investment (e.g. import of capital goods)– Implementation of new projects– Modernization/expansion of existing production units in:– For Overseas direct investment in Joint Ventures (JV) / Wholly Owned

Subsidiaries (WOS)– For the first stage acquisition of shares in the disinvestment process and also

in the mandatory second stage offer to the public under the Government’s disinvestment program of PSU shares

• Non-Permitted End Uses– On-lending or investment in capital market– Acquiring a company (or a part thereof) in India by a corporate– For working capital– For general corporate purpose– For repayment of existing Rupee loans

Various Options Post Issue• Investors convert their FCCBs into Equity

– When the conversion price is lower than the market price

• If they don’t convert:– Repayment through existing cash, cash equivalents and operating cash

flows: – Refinancing of debt:– Reset the conversion price to bring it closer to the current market price– Buyback or prepayment

For example: Jubilant Life Sciences had raised more than USD $275 m by selling FCCBs overseas. Conversion price for bonds maturing on May 2010 was fixed at Rs 377.9, and for Those maturing on May 2011 was fixed at Rs 588.9.However, stock price tanked to 150. As a result, Jubilant repurchased FCCBs worth

EFFECT ON EPS

Exercise of Conversion option leads to increase in number of outstanding shares.

Basic EPS (Net Income – Preference Dividend)/(Weighted avg. no. of shares outstanding)

Convertible bonds increase the number of shares outstanding and dilute the EPS

INDIAN SCENARIO

INDIAN SCENARIO

Industry Wise..

Points to ponder Increase (from $50M to $100M) in limit of premature buy-back of FCCBs

using Indian currency

- Very less impact because of unavailability of sellers and a scarcity of funds with Indian companies.

Another option is to buy back those bonds using foreign currency reserves or

through fresh borrowing in foreign currency (No limit)

- But raising funds in foreign markets at this moment is a big challenge (Global credit crunch).

So it benefits only those companies who have enough cash in their

internal accruals - But there are not many companies

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Case of HCC

• Hindustan Construction Company has paid $133.03 million to bond holders towards redemption of the entire outstanding FCCBs.

• Repayment funded out of internal resources of the company.• HCC Chairman had earlier said that, if the FCCBs do not get

converted, the company will repay investors with sufficient internal accruals and cash available

• To access cheap foreign currency debt, many mid-cap companies like HCC issued FCCBs in 2005-06 and provided their holders the option to convert the bonds into equity within the pre-determined period and price.

Parting thought …

"Some debts are fun when you are acquiring them, but none are fun when you set about retiring them”

~ Ogden Nash

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