A PROJECT ON FCCB'S UTILITY , RELEVANCE, FOREX RISK MANAGEMENT AND SUITABILITY FOR CORPORATES

Submitted By : CA Ankit Bhansali

ALL ABOUT FCCBS

Flow of Presentation
Introduction to FCCB Pros and Cons of FCCB and its Utility and Flexibility Company Suitability and Analysis

Conclusion

FCCB-Foreign Currency Convertible Bonds- Features

Convertible bond issued in a currency different than the issuer's domestic currency Combination of Debt and Equity Function as a bond by giving regular coupon and principal payments alongside providing the option of conversion into stock A quasi-debt instrument which is attractive to both investors and issuers. The investors receive the safety of guaranteed payments on the bond and are also able to take advantage of any large price appreciation in the company's stock. Generally available at US$ 1000 each

PARTICIPANTS IN ISSUE

Issuer Company Local legal advisor

e.g. Law firms e.g. Companys auditors

Local accountants

Local custodian

Typically Banks
e.g. Investment Banks e.g. Bank of New York / State Street / Global e.g. UK Law firms Typically Overseas Banks

Lead Manager

Depository bank

Overseas legal advisor

Escrow bank

How does FCCB work?

Capital in $ Issuer of FCCBs FCCBs Lender of money

05-OCT-2012 raises money in dollars sets conversion price at premium (say Rs 90) maturity period between 3-5 years

05-OCT-2012 receives FCCBs can trade FCCBs if in liquidity crunch

CASE I : If markets are BULLISH

Equity at conversion price Issuer of FCCBs FCCBs returned 05-OCT-2017 05-OCT-2017 no need to pay in cash makes windfall profit by selling equity at prevailing market prices (say Rs 100) issues equity at pre decided price (Rs 90) equity dilution Lender of money

CASE II : If markets are BEARISH

Capital in $ Issuer of FCCBs FCCBs returned 05-OCT-2017 redeem bonds at par value huge requirement of cash buy back from market before maturity if traded at discount 05-OCT-2017 redeem FCCBs at par value principal investment comes back with small returns Lender of money

Pros
Positive impact on the cash flow of the company

Cons
Difficult to get the subscription for FCCBs in a bear market

Interest rates/Coupon Rates are low compared to debt

EPS goes down when the FCCBs are converted; dilute the ownership

Does not dilute the ownership immediately

When interest rates seem to be going down , FCCBs are not preferred as equity is costlier than debt

Normally carry fewer bond covenants

Exchange rate risk

Benefits to Issuer and Investor

Benefits for Investor
To bring down the exposure of a country by diversifying their portfolio Investment opportunities in emerging markets

Benefits for Issuing Company

Low overseas interest rates Relatively strong rupee against the greenback

Gives much of the upside of investment in equity

If share prices go up benefits from capital appreciation Debt elements protect the downside Assured of a fixed return and capital protection Investors buy FCCBs not as instruments of debt but for the lure of equity

FCCB does not require any rating nor any covenants like securities, cover etc
Can be raised within a month while pure debt takes longer to raise Low cost means of financing Cost of withholding tax is lower compared to other ECB instruments No need to shell out large sums of money to redeem the debt

Relevance and Flexiblity

FCCB carries fewer covenants as compared to a syndicated loan or a debenture, hence these are more relevant to raise funds. The chief benefit of FCCBs for investors is flexibility, especially considering that stocks usually do well when the bond market suffers. Investors have the guarantee of interest rate payments and return of the principal (the amount originally paid in exchange for the bond) at the maturity date if the FCCB is not converted into stock beforehand. FCCBs combine stocks and bonds by allowing FCCB holders to convert the bond into stock at any time. Hence, FCCBs provide more flexibility to investors than most other financial products. Flexibility also decreases the potential risk of investing because investors have the ability to take advantage of stock appreciation or

Regulatory Mechanism

Permitted End Uses/Flexibility

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 Governments disinvestment programme of PSU shares

Non-Permitted End Uses/Rigidity

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

Ministry of Finance Guideline for Listed Companies

Eligibility of Issuer Only Companies who are allowed to raise capital from Indian market Eligibility of Subscriber Overseas Corporate Bodies (OCBs) who are eligible to invest in India through the portfolio route and entities allowed to buy, sell or deal in securities by SEBI

Pricing of FCCB

The pricing should be made at a price not less than the higher of the following two averages: (i) The average of the weekly high and low of the closing prices of the related shares quoted on the stock exchange during the six months preceding the relevant date; (ii) The average of the weekly high and low of the closing prices of the related shares quoted on a stock exchange during the two weeks preceding the relevant date.

Various Options Post Issue

Investors convert their FCCBs into Equity

When the conversion price is lower than the market price

Repay bondholders at maturity

If they dont convert:

Raising domestic debt through banks Restructuring these i.e replacing with new set of FCCBs having lower conversion price Internal Accruals or Sale of Assets

Reset the conversion price to bring it closer to the current market price Altering the terms of the issue Buyback or prepayment

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 Diluted EPS

Other instruments that contribute to dilution of EPS:

Convertible Preference shares, Warrants, Options

BUYBACK

RBI Regulations:

The amount of the buyback is limited to US $50 mn of the redemption value per company The companies have to use either internal accruals, cash reserves or raise fresh funds overseas. The FCCBs such bought back must be cancelled

Three factors that can hold back a company from buyback of FCCBs:

The price The sellers realizing the downside of buyback The lack of liquidity

INDIAN SCENARIO FCCBs Issued

INDIAN SCENARIO

Exchange Rate

Industry Wise..

The highest year of redemption is the current year of 2012. Since the exchange rate (as shown in the previous figure) is continuously rising upward we can estimate the amount of pain the corporates will have to face this year.

Some Case Studies of Corporates who have issued FCCB

FACTS

Reliance Communications is Indias one of the largest mobile phone service provider. It raised a total of $1,500 million through two FCCB issues one in 2007 and the other in 2006
2007 $1 Billion $1000 5 years and one day (Feb 2012) Zero Rs 661 Singapore stock exchange Refinance the old loans and for expansion 2006 $500 million $1000 5 years and one day(May 2011) Zero Rs 480.68 Singapore stock exchange Expansion of telecom network

Parameters Total Amount Raised Price of each bond Maturity Coupon Conversion Price Listed on Purpose for Issue

Contd.

The book runners : JP Morgan, Deutsche and HSBC

Issue was sold across Asia, Europe and the US and was oversubscribed by 3-4 times. It was trading at a premium in the aftermarket, which illustrates strong demand

For the 2006 issue, conversion price was 50% more than the previous
days closing price. The bonds on conversion would lead to issue of 4.62 crore equity shares with a face value of Rs 5 each

Buyback

The company bought back FCCBs worth at the very right time

US $25 Million on Dec 29, 2008(250 FCCBs)

US $10 million on Jan 10, 2009 (100 FCCBs)

Reasons:

At the time of buyback, the gap between the share price of RComm and its conversion price was less and bonds were trading at 35% discount to the issue price.

It also had Rs 10,000 Crore in cash reserves.

Results:

The worth of the bonds has come down to US $650 Million from $1 Billion.

Thus, it reduced its liability, forex exposure and thereby forex risk.
The amount of FCCBs repurchased by the company will determine not only the gains to the size of the discount, but also the extent of reduction of debt from its balance sheet.

EPS ,DEPS, INTEREST COVERAGE RATIO

35 0.9 30 0.8 0.7 0.6 25 0.5 0.4 0.3 20 0.2 0.1 15 0 2007 0.47 7.20 6.3 2008 0.77 0.88 3.99 2009 0.67 1.68 2.49 16 14 12 10 8 6 4 2 0

EPS & Dil EPS

10 EPS Fully DEPS

2007 17.56 16.71

2008 26.32 24.97

2009 29.29 28.05

D/E Cash Flow in '000 Crs Int Coverage Ratio

The dilution of Earnings per share have a variety of reasons such as warrants and bonds including FCC Bonds

Rcomm Effect on Share Price

Facts

Ranbaxy in 2006 issued 5-year Zero Coupon Foreign Currency Convertible Bonds (FCCBs) priced at par value , raised $ 400 million with a Greenshoe option (OverAllotment option) of $ 40 million.

These FCCBs were listed on Singapore Stock Exchange. The yield to maturity of the bonds is set at 4.8 per cent per annum

The Bond holders had the option to convert these into Common Shares or Global Depository Receipts/Shares (GDRs), at a price of Rs 716.32 per share (@ 60%

premium to the previous days issue price) with a fixed exchange rate of ` 44.15 per US
$ 1, at any time on or after April 27, 2006 and but before March 9, 2011

Utilize the capital raised through FCCBs to fund acquisitions and had set aggressive

revenue targets of $2 billion by 2007 and $5 billion by 2012 at the time of the issue.

Developments after the Issue

Ranbaxy missed the revenue target of $2 billion for 2007

Ranbaxy acquired the entire share capital of Mundogen Farma SA, generic
business of GlaxoSmithKline (GSK), in Spain for a total cash consideration of $ 5.73 million funded by FCCB proceeds FCCB proceeds were also utilized for acquisition of Romanias Terapia SA, and other acquisitions in Italy, Belgium and South Africa

Ranbaxy was not able to buyback FCCBs since the cash received from Daiichi Sankyo could not be used as per the RBI guidelines

Conversion Price was revised to Rs 555 per share after the acquisition by Daiichi Sankyo.

EPS and DEPS

D/E and Interest Coverage ratio

Debt Position: The D/E ratio increased from 0.43 to 1.35 in 2006 because of the FCCB issue but it is still not very high and should not be an issue in case Ranbaxy wants to raise more debt from the market. D/E ratio further reduced to 1.05 in 2008 after Ranbaxy retired debt amounting to approx `3,400 crore after the stake sale to Daiichi Sankyo. Interest coverage ratios are also very high ranging 6.6-9.29 from 2005 to 2009 Interest

Variation of the stock over the last many years

FCCB issues by TATA Motors

July 2008 April 2004 raised $490 million tranche I: $300-million conversion price INR 960.96 conversion price INR 780.40 maturity comes on June 12, 2012 maturity on March 28, 2011 repurchased 170 Zero Coupon tranche II: $100 million Convertible Securities at avg. price of conversion price of INR 573.10 50.375%. maturity on March 28, 2009 outstanding bonds reduced from $490 million to $473 million. March 2006 $100 million raised in Japanese Yen (JPY 11760 million) convertible at INR 1,001.39 maturity on February 19, 2011 repurchased 30 Zero Coupon Convertible Notes at an average price of 54.27% 34 outstanding bonds reduced from JPY 11760 Mn to

Impact on EPS

Debt position

Stock Price Movement wrt Sensex

on March 23 2009 the company had offered to convert bonds worth $431 million into shares about a year before they mature. The companys share price fell 3 per cent because the conversion would dilute the companys share capital by 4.3 per cent.

Developments since the Issue and future

On January 1, 2008, Tata Motors share price was at Rs 741.45, while it fell to Rs 159.05 on December 31, 2008. The prices were being reviewed and all these adjustments are being made because of reset clauses attached to the convertible bonds

On 15-Apr09, Tata Motors share prices jumped 12.41% to INR 283.50 on BSE after the company repurchased and extinguished its US and Japan listed foreign currency convertible bonds at 50% discount

But in the current scenario considering the large capex program planned by the company and the downturn in automobile industry, shut down of production facilities, likely increase in borrowings to fund JLR, it could face difficulties in terms of cash flow management in near term future and is unlikely to opt for pre-payment option for FCCBs.

FINAL CONCLUSION

Two to three years back Indian markets were on high growth and FCCBs became popular for raising funds from overseas market. With the fall in the market, many FCCBs has gone down, which means no money and more problem in the market. Issuing companies will now have to search for resources to restructure or repay the debt along with redemption period whenever it matures. For this companies will seek resort to fresh borrowings, with high interest rates, which in turn would impact their profitability or may have to reset the conversion clause, to bring it closer to reality or may even have to sale their divisions (like in case of JP Cement) to repay the debt and sustain in the business.