FCCB: A saga of Fancy Companies Crazy Borrowing

The year 2010 saw the Indian currency get its very own symbol and in 2011, the rupee was the symbol of the countries ailing condition. The Indian rupee holds the dubious distinction of being Asia’s worst performing currency, depreciating close to 20% in last five months. Reactive rather than pro-active RBI policies have left people in dilemma with ample rate hikes and little intervention in the forex market.



The current scenario of high interest rate, thanks to RBI, was a repetition of the 2006-2008 situation wherein companies shifted focus to raising money via external commercial borrowings (ECBs). It was a prudent option for the companies since it would lead to equity dilution without much impacting the financials of the company. However, these companies never expected a credit crisis to unfold in US and later in Europe, or the steep depreciation in the rupee.



What are ECBs?



External commercial borrowing is a medium by which Indian companies can access foreign funds for various purposes. These include loans, terms of credit, notes, fixed rate bonds, etc. Probably the most common instrument used is an FCCB.



Foreign currency convertible bonds, or FCCBs, are debt instruments issued by companies in a foreign currency. It is a hybrid security, with both debt and equity features, meaning the FCCB has the option to be converted to the issuing company’s equity at the time of maturity.



The main advantage of an FCCB is that it allows the issuer to raise long term finance at lower interest rates. However, in turbulent times, if the share price of the equity doesn’t reach the conversion price, the company will have to refinance its debt so as to redeem the bonds.



Another method of raising finance from foreign markets is through foreign currency exchangeable bonds. FCEBs are bonds issued by an Indian company to foreign investors, however, they are not exchangeable into shares of the same company. The equity shares offered are of a company that is under the same group of companies.



For example, company X, the issuing company, issues FCEBs, which on conversion will give the bondholder equity shares of company Y, the offering company. Now, both company X and Y are under the same umbrella, which means that X is selling off a portion of its stake in Y so as to raise finance. However, under this method, there is dilution of a promoter’s equity stake in the offering company. 



FCEBs are currently the less popular means of raising foreign funds in India because it is not allowed freely. An approval is required from the RBI or from the foreign investment promotion board (FIPB) prior to issuance of FCEBs. Another drawback of the FCEB-medium is that individuals and other non-corporate entities are not allowed to invest in them.



Impact on companies:



Since FCCBs and FCEBs are funds raised in foreign currency, the company also faces the uncertainty of currency fluctuations on repayment. Sometimes it may be to the benefit of the issuer. However, due to the current strength in the dollar, companies will have to shell out more in terms of rupees.



Let’s take the case of Reliance Communications. The telecom giant issued FCCBs worth USD 1 billion on 12th March 2007, with the conversion price set at Rs 661 per share for bondholders. However, due to bearish market scenario and negative company newsflow, the current market price of the stock is languishing in double digits. This means that there is no real chance for the outstanding FCCBs worth USD 925 million being converted by maturity date. What will happen next? RCOM will have to repay its outstanding loan to bondholders.



The effect of the rupee in this scenario is with regards to the amount of cash outflow RCOM will face while replaying its outstanding bondholders. With the rupee near its lifetime high against the dollar, RCOM will have to shell out more in rupee terms so as to repay its outstanding FCCBs worth USD 925 million. For a company that is already facing several problems, this is a double whammy.



According to an IIFL report, 2012 is going to see FCCBs totaling USD 5.3 billion due for redemption. However, the actual redemption value is a whopping USD 7.2 billion, the highest ever amount yet. With stock prices of almost 90% of FCCBs significantly below conversion prices, a vast majority of companies are in for a difficult year ahead. 
– Anisha Mappat, Riken Mehta

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