FCCB: luring those who eye cheap money from abroad

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: Sumit Binani, VP, SREI Capital Markets gives you a perspective on the cues you must draw when a company goes for FCCB. He interacted with Rajesh Naidu of The Financial Express.

What are the factors investors must consider when subscribing to an FCCB issue?

A foreign currency convertible bond (FCCB), issued as a bond by an Indian company, is expressed in foreign currency, and the principal and the interest too are payable in foreign currency. The maximum tenure of the bond is five years. A convertible bond is, in fact, a quasi-debt instrument, which can be converted into equity shares at the choice of investors either immediately after issue, or upon maturity, or during a set period, at a predetermined strike rate or a conversion price. It acts like a bond by making regular interest and principal payments, but these bonds also give the bondholder an option to convert the bond into shares. The investor benefits if the conversion price is higher than the traded price and suffers a loss if the traded price is higher than the conversion price. The investor has the discretion to hold the bond till maturity, receive regular interest payments and principal on maturity, without exercising the option of converting the debt instruments into equity.

This future switching option allows the bond-holder to judge the performance of the company down the line, and then decide whether to substitute the debt for equity in her portfolio. This naturally reduces the capital risk of investment. FCCBs are usually priced at a premium over the prevailing market price. If the market price of the share does not exceed the conversion price, the holders do not opt for equity conversion and the issuer has to redeem the debt after the expiry of the stipulated period of five years. Clearly, the debt servicing rack record of the issuer company, its solvency, its business fundamentals and growth, the interest rate and other macro economic indicators influence the decision of an investor to invest in such an instrument.

Could give us your take on qualified institutional placement and an FCCB issue? Which one would you prefer?

Capital market regulator Sebi introduced the option for listed companies to raise funds through qualified institutional placement (QIP) as it was concerned over the growing number of Indian listed companies tapping funds through the GDR/FCCB route. In comparison with FCCB/GDR, QIP is a cheaper option to raise funds as the issue costs are lower. It is a less time-consuming option due to lower regulatory approvals which need to be procured. For example, there is no requirement of prior approval of the preliminary placement document before the issue of specified securities. Also, no pre-issue filing with Sebi is to be done. FCCB also has restrictions as far as end-use of money raised is concerned. Therefore, QIP may prove to be a more viable option for medium-sized companies to raise capital as they do not have global presence.

However, there is a cap on the funds that can be raised through QIP in a financial year and is linked to the net worth of the issuer company. There is no such restriction in case of FCCB subject to approvals. Hence, FCCB/GDR remains a viable option for raising funds on a large scale. The option of FCCB also depends upon factors like issuer company’s overseas branding and capex plans, YTM, forex risk, liquidity in the overseas market etc.

What are the cues domestic investors must take when a company issues an FCCB?

Companies go for FCCB issues with an intent of raising cheap money abroad. The interest payments on FCCB is much lower than that is prevailing in domestic market or on other loans or bonds. The need of companies to have a global presence or a capex plan abroad also lure them to this option. If the conversion happens, the company gains higher leverage as debt gets reduced and equity is enhanced upon conversion. However, this might be totally opposite if the share prices are not favourable and conversion does not happen. Such a situation could jeopardize the debt equity ratio of the company as the company might have to raise further debt to redeem the bonds and make interest payments. The dilution of ownership happens once the shares are converted. This reduces the earning per share (EPS).

Studies say that FCCBs work good in a bullish market, but not in a bear one? What is your opinion?

The viability of FCCBs depends upon the market trend--whether it is bullish or bearish. When the equity rises, the sensitivity is higher and when equities fall, this sensitivity comes down. In terms of the prescribed scheme, the issue of FCCB and GDR/ADR has to be priced at the higher of the average six-monthly prices of the related shares or the average price thereof in the last fortnight before the ‘relevant date’ which is a month before the general meeting approving the overseas issue. Such a provision makes it easy to raise capital in a situation when stock prices are generally on the rise. In a bearish market run, the stock prices fall and it becomes difficult to raise capital. However, the situation could be different, if in spite of a bearish domestic market, the international market where the money is proposed to be raised is vibrant.

What factors must the investors take into account while exercising a) the call option in an FCCB, b) the put option (equity) in an FCCB?

FCCB issues have a ‘call’ and a ‘put’ option to suit the structure of the bond. It all depends upon the structure of the instrument as to which party has a call or a put option. An investor having call option would exercise the option if the interest rate rises. This would enable him to recall his low interest yielding funds and invests it afresh for better returns.