FCCB conversion: Threat to India Incs' fund raising plans?

Indian companies like Wockhardt, Subex and Orchid can be forced to take on some big loans in the next 18 to 28 months because their FCCBs are due for conversion. Does this pose a threat to further fund raising by India Inc?

FCCBs or convertible bonds are hybrid instruments between debt and equity. It is a bond which gives its holders right to convert for a fixed number of shares at a pre-determined price.

S Ramesh, Executive Director, Kotak Investment Banking believes some companies have provided for reset clauses and they would want to take the opportunity of looking at resetting the terms.

Ramesh also said while the dilution may go up because the premium can potentially go down, it also means that a lot of equity funds may come in.

Excerpts from CNBC-TV18's exclusive interview with S Ramesh:

Q: How serious is this conversion price being much higher than the actual current market price? Although we are a good 1.5-3 years away from actual conversion, could this pose a threat in terms of these companies having to come into a reset and having to reset a lower conversion price?

A: Many companies which have raised FCCB’s upto January and especially in the bull market phase from last April-May, there is a theoretical possibility that this would mean the conversion will not happen and this would mean debt, which poses three implications for issuers. A) There will be an interest component that will come through YTM (Yield-to-Maturity) maturity stage. B) They will have to provide money for the repayment and C) one should not forget the forex angle depending on what was the rupee when they got it and what is the rupee at the time they repay. So these are the three potential implications.

Having said that, some of the companies have also provided for reset clauses and to that extent they would want to take the opportunity of looking at resetting the terms. So there is again flexibility available then to motivate the investors to covert. The third thing is, within the average maturity period, which is at the minimum of 60 months as per the RBI guidelines, issuers do have an option of theoretically refinancing it. So that’s the way the investors will have to look at it.

But since you have talked about a number of leading corporates without going into names, I would also say that a lot of corporates when they went into FCCB programme, they really start by looking at it as debt and then just wait and see whether the conversion actually happens. So hopefully the companies with good governance would have looked at this and made provisions under the possibility that it would be debt. We will have to wait and see how all this unfolds in the next two years or so.

Q: How does this resetting work? Is it during the reset period? Is it possible that investors would chicken out and therefore want a lower conversion price and therefore the companies are staring into greater equity dilution? Given the current scenario it’s quite possible that investors will have cold feet?

A: I think the reset would eventually come from the issuer and what issuers will do is, if they decide to take the option of the resetting premium they will actually have to look at the last two months prior to the resetting of how the stock has performed and they will have to then offer the reset on this mechanism. This could eventually mean that the premiums of 50-60% at which a lot of FCCB issuances were done last year, will get reset to lower premiums. The leverage has shifted to the hands of the investors today and to that extent if they want to really motivate investors to convert the premiums to come down or potentially could come down, it means a higher dilution for promoters.

Q: The pain could be felt even before the maturity date?

A: In what terms do you say that?

Q: Sensing that there will be greater dilution?

A: I think you are right, but the way the market looks at it is that while the dilution may go up because the premium can potentially go down, it also means that a lot of equity funds may come in. So the market will counterbalance these two factors.

Q: What about future fund raising options? Given the kind of problems like the fund raising option like this FCCB has raised. What does it do for the kind of options that companies can explore in the future?

A: I would like to look at this quickly from an issuer perspective and an investor perspective. From an issuer perspective, globally the credit market is not in its best times and therefore it’s not the hottest of times for many companies to go and raise money. Second, what we are hearing from few investors who have been active in investing in FCCBs is unlike before they like some coupon upfront if they decide to invest.

Third, except for probably the very large Indian corporate, most of the midcap and the larger midcaps, I think they will have to pay the spread which is close to the ceiling prescribed by RBI. I think a little bit of the higher premiums which they could hope to aspire to get earlier is no longer available.

So all in all, it’s probably there for the issuers to tap, but it’s not going to be on the best of terms, but the silver lining is stock prices have corrected a lot. Therefore some of the active FCCB investors, once there is a better colour in the credit market, would like to look at investing in FCCBs on the back of reasonable premium. So there is clear hope that I see in the short to medium-term for this product to takeoff in a big way.

Q: A very macro question, but if you want to compare the cost of raising funds in the last 24 months and the next 24 months, by how many basis points can the cost of money rise - one for AAA and another for midcaps? Will it be 200-300 bps?

A: If I were to just restrict this question to look at it from an FCCB perspective - the RBI has got ceilings today, 250 basis points above London Inter-Bank Offered Rate (Libor) and my judgement is that a lot of the large midcaps leaving aside the few large corporates, would anyway go near the ceiling. I don’t think they will be able to do anything better. The larger Indian corporates whose rating was probably investable grade very close to India, were able to save a few basis points. Now it waits to be seen. Depending on the credit market at that point of time, if they decide to go in for a FCCB, whether they will be able to get those savings or they will also touch the ceiling and they will have to go near the ceiling to raise they money, that we will have to wait and see how the credit market unfolds at that point of time.

One last point I wanted to mention that besides the fact that stock markets have corrected, the other thing is global interest rates have also softened. So that’s also a good thing from an issuer perspective when the credit markets come back and they decide to go in for an FCCB issuance.