Killer Debts

Both these may be one-off cases of manipulations by Indian companies but are very unique in nature concerning foreign currency convertible bonds (FCCBs). However, considering the phase in which the Indian market presently is in and the situation in the financial markets, it will not be a surprise if more of such stories hit the deck in the near future. This is particularly so because many FCCB issues of companies are coming up for maturity. During the four years preceding 2008, Indian companies have raised money through the FCCB route as if they would not have to return that money ever. The ‘FCCB moment’ peaked in 2006-07. The Indian companies have raised over USD 20 billion via this route during these four years and which had a maturity of five years.

Since 2005-06 there was formed this presumption by the companies that this was easy money and given the robust forecast about the Indian economy, they could exploit as much of this money as they wanted to for the next one or two decades. In fact the mathematics of these companies proved right for the next three to four years as their share prices appreciated by leaps and bounds in that period. But as every rise has its fall, the global financial meltdown hit India too in 2008 and after a very big boom, gloom finally arrived. Share prices crashed badly. It was such a rude shock that even after three years the share prices of a very big chunk of companies are still reeling under that shock.

This situation has literally upset the apple-cart of these companies as they have raised huge amounts of money from foreign investors in their hey-days and now after four to five years those investors are coming to take back their money. Even the thought of returning this ‘debt’ sends shivers down the spine of many companies as the liquidity situation is not very good and what disturbs them more is the level at which their share price stands. Barring Gitanjali Gems, Monet Ispat, Strides Arcolab, Sadbhav Engineering and Tata Motors (see table), the share prices of almost all the companies are way down the conversion prices at which the FCCBs were issued.

FCCBs have an option attached to them which gives the lender a right to convert the bonds into equity shares at a predetermined price (conversion price) at any point before the date of redemption. At the same time if the lender doesn’t opt for a conversion then at the time of maturity he will be given a fixed return on the money lent just like a creditor as there is always a coupon value attached to it, though it is always less than the existing lending rate. This condition is the most disturbing element for companies as they have to pay a fixed amount on maturity and this would be huge.[PAGE BREAK]

According to an investment banker, many of these companies don’t have that kind of cash to satisfy this liability. In fact companies like Cranes Software, JCT, KLG Systel, Prithvi Information Solutions, Pyramid Saimira (see table of outstanding FCCBs) have a market cap which is less than the FCCB liability. Considering that, investors in these companies should be very conscious about their investment as this FCCB liability will put some of the mediocre companies in a very strained position. A genuine threat of default is also looming large over them as has happened in the case of Wokhardt that defaulted in the payment of its FCCBs in 2009.

On the whole, for a company there are very few options for the financing of this debt. First, it can raise money from the market to finance the FCCBs coming for redemption. Now in such a case, since these are companies that haven’t performed well in the past, borrowing huge money is certainly a big problem given the liquidity crunch and high interest rates. If at all any-body is ready to finance them, the rate of interest is likely to be a strangle-hold. The second option would be to finance through internal accruals, but for a company that is not performing well this option is not quite possible. The third option for the companies would be to raise equity from the market to finance the FCCB liability. But here again many companies are not in a position to further dilute their holdings.

The last option available to these companies would be to restructure their debt with FCCB holders. “This option seems to be the most sensible one for various companies as well as the bond holder as given the state of Indian legal system, if any company does default in the payment of FCCBs then it is almost impossible to get back that money via a legal tussle. So it is always better for FCCB holders to restructure their debt and give the company time to return the money,” Jagannadham opines. Another interesting thing that is going through the minds of various small to mid-sized company managements is that they are even thinking of taking shelter behind the not-so-stringent legal process and planning a deliberate default.[PAGE BREAK]

Companies intending to do this are those who don’t want to tap the foreign markets again. Experts are of the opinion that in the next two to three years we will certainly see many companies resorting to such a hostile practice as the redemption term for FCCBs are coming near. At the same time companies who seriously want to redeem their FCCB debt would face a tough challenge. First of all the rate of interest is at an all-time high that would put extreme pressure on their profit and loss account if they resort to the debt option to finance the FCCB redemption. On the other hand, the equity option for the company is also not very encouraging as at present the market is moving in a narrow range so that these companies cannot command a good premium for their equity from the markets. Considering this, the payout of FCCBs would be a real problem for these companies.