Updates on FCCB Issue

We have seen India Inc. making good overseas acquisitions, as also initiating huge capex plans in the last 2-3 years, mainly based on Foreign Currency Convertible Bonds (FCCB) as a source of funds.

An FCCB holder gets a very low rate of interest, in the form of premium, at the end of maturity period, if it is not converted into equity, at a pre-fixed price, during its tenure. Between 2004- 2008, about 158 Indian companies have issued FCCB of close to US $20 Billion, of which, $3 Billion only have been converted, thus leaving $17 Billion still outstanding. Majority of them are not likely to get converted, due to share now ruling between 20% to 30% of its pre fixed conversion price.

These FCCBs generally have a tenure of 5 years 1 day and hence they will be having maturity between end of 2009 to end of 2012 for redemption. However, many few companies have made provisions for such redemption as they have been presuming it to get converted. Apart from this, the redemption amount increased by about 40% in rupee term, partly due to weakening rupee (20%) and partly due to interest/ redemption premium of about 20%.

A recent case in point is that of Wockhardt, which made an FCCB of $110 million mainly to finance its 3 overseas acquisitions, which is becoming due for redemption on 25/09/2008 with liability of $142.54 million, with interest calculated thereon. These FCCBs will not get converted, as its conversion price is Rs.486 per share, while present price is Rs. 76. Risk of non-conversion of FCCB even persist for those companies, who have reset its conversion price at the lower rate, as per the terms contained in its issue, as current price is still lower than re-set price.

Due to this redemption fear, all the companies having raised FCCBs are taking a beating on the bourses. Many of these companies have not provided for redemption premium while some of them have been providing exchange loss to Profit & Loss (P&L) Account. However Reliance Industries, R-Com and Bajaj Hindustan are not even charging this exchange loss to P&L, relying upon the legal opinion sought by them. However recent relaxation in AS -11, till 31-03-2011, will give a big relief to thsese companies , as now, all this exchange losses and premium can get added to the capital value of assets or charged to P&L Account, as desired by the company.

International Accounting Practices require companies to expend redemption premiums to P&L account, over the FCCB life. But, in India, many companies are charging the FCCB redemption premium to share premium account, while a few companies are even treating it as contingent liability. Contingent liabilities, the other common accounting treatment, may or may not be incurred, as it depends on the outcome of a future event. The reason behind FCCB redemption premium as a contingent liability is an assumption by the company that redemption may or may not occur. This practice is aimed at protecting the P&L of these companies till the maturity of FCCB.

Recently, we have seen about 16 companies buying back its own FCCB, post RBI, initiating liberalised norms of FCCB repayments, since December,08. Some of these companies are Jindal Saw, Firstsource Solutions, Aurobindo Pharma, Financial Technologies, Hotel Leela , Jaiprakash Associates, Moser Baer and Orchid Chemicals. The market has given thums up to these companies, as it was found that these companies are in a position to meet its liabilities and that too at a discount of about 40%, by buying back FCCB at the discounted prices. Due to this, the effective outgo is at its original principal having raised by them in Indian Rupee in the past.

So it is essential to keep an eye on those 158 companies who are able to meet its FCCB redemption and hence those stocks qualify a good and risk free buy as they are ruling at beaten down valuations of about 50% of its net present value.