All you need to know about fund raising tools

Fund raising can some times be a complex issue. On CNBC-TV18's special show Informed Investor, Mitali Mukherjee helps you sort out all doubts pertaining to the matter�Why does a company need to raise funds? How do they do it? And, how do you participate as an investor in that fund raising process? Koushik Chatterjee of Tata Steel, Falguni Nayar of Kotak and Sanjay Sharma of Deutsche Equities, talk about all of that and more.

Here is the transcript of the exclusive interview on CNBC-TV18. Also watch the accompanying video. Q: What exactly does one mean when one talks about instruments of fund raising? Nayar: I think as a company looks at its growth plans and capital expenditure requirements, they obviously take care of it through internal resources first. Over and above that they have options of raising either debt or equity. Within equity also there can be pure equity or convertibles, which are equity like instruments which get converted to equity or can stay as debt. Q: Is this always done in order to do capital raising or sometimes it is also done in order to get in a strategic investor etc. In that, are there different layers to why a company chooses to do fund raising or is it just as simple as the capex issue? Chatterjee: From a pure corporate finance point of view, there would be several angles to look at it. If one looks at fund raising for capex, which is the most obvious, whether it is in capex or growth, one first one needs to ensure that the company�s long-term strategy is aligned to growth. And, within growth then to use fund raising as the enabler to make it happen. Sometimes one looks at the capital structure and the need to balance capital structure either ways, whether it is towards debt or equity, it depends on where that structure is, if it is over capitalized in terms of equity and you are paying too much taxes, you would certainly want to get some tax shield to ensure that there is a rebalancing and it can be vice-versa. The third thing is the instrument selection or the financing strategy. One looks at what instruments work for that particular company, given its track record of cash flows and earnings. And, finally one looks at the market and sees what is the right time to access the market and in which form. Did you read: Tata Power ends $300M PE fund-raising with Olympus Cap Q: From a minority shareholders point of view, how should one read these fund raising exercises by a company? Do they have an impact on the company�s core business or performance as a stock as well? Sharma: Yes, certainly. Depending on what kind of fund raising it is, whether it is equity or debt and also from perspective of which investor base it is raising. The existing minority shareholders if they do not participate in that equity offering will get diluted. So to that extent they will be impacted. As long as it is debt, they also need to look at how it impacts the capital structure and the future growth of the company. Q: On the equity side, one can raise money via an initial public offering (IPO) which is step one, but how beneficial is it going down the equity route whether it is an IPO or a preferential share issue from a company�s point of view? Chatterjee: Equity is obviously a form of capital raising where one has to be very careful in the context of two to three things. One is in the earnings per share (EPS) implications of raising equity. Whether one goes through an IPO or a private placement or bring in strategic investors, is functional of again where the capital structure wants to be. And, if one wants to have an equity-biased capital structure we need to look at raising equity. A listed company would perhaps go in for a follow-on public offer (FPO) or a private placement or induction of a strategic partner or even a preferential allotment to the existing shareholders. For an unlisted company, it could be in the form of an IPO or simple private placement by a financial or strategic partner. So, the key consideration is whether that equity which is effectively costlier than debt can be serviced and can be value accretive going forward for the shareholders. Q: What exactly should a retail investor or any shareholder actually look at when a company announces equity offering because there is a) potential dilution that will happen b) potential dilution on the earnings itself. I guess if it�s preferential you will have to wonder about which kind of parties are coming into the company. Sharma: I think from the perspective of any investors, categorized into two�one who is an existing shareholder and two is somebody who is coming in new. What they need to look at is going top down in terms of what the industry dynamics are. How the company is doing in that industry and finally what the backing of the promoters or other strategic investors is. Also they need to look at what is the planned fund raising going to be used for. That is also important consideration because it would have an impact on future growth of the company. Q: You have participated and run many follow-on offers for companies, how does one marry this mismatch that starts happening between the listed price and the way it starts reacting to news of a follow-on because immediately for many stocks especially from the public sector there is a deceleration in the price performance expecting the FPO to be at a much lower price point? Nayar: Usually follow-on have little more flexibility on pricing. Also, since it�s a more intensive an effort in terms of distribution and there is whole host of cost that go along with it, the feeling is that one will try and price it in such a way that the follow-on goes through and doesn�t lead to an overhang. Any retail investor would not like to pay a premium because they can buy that stock in the market at market related prices. So, most follow-ons always happen at a discount of about 5%. So usually in that sense investors start expecting 3-5% discount and start playing on that arbitrage. Q: How elegant an option is it when you look at equity fund raising instruments because you have to consider the retail minority shareholder, you have to consider some kind of discount and you also have to take into account the kind of pressure your stock may face because of that impending follow-on offer? Chatterjee: In India the route to access the capital markets especially in the secondary side, for a listed company, depends on how the stock performs post the announcement. The period to close fund raising is very critical to ensure that there is a balance between what the company wants and what the investor wants. I still believe that rights and FPO should be done in a shorter period of time and that would be a great benefit both to the issuer as well as the investor. _PAGEBREAK_ Q: Foreign currency convertible bonds (FCCBs) have, for the lack of a better term, had the most accidents for corporate India in the past. How do they work and why is it that so many have gone wrong in the past? Sharma: As the name suggests FCCB is a combination of debt and equity. What it tries to achieve is that a company, depending on its credit profile, would need to pay ex-percentage coupon for its debt. While if you are giving an option to the investor to buy equity at a later stage there is optionality involved and the investor is willing to pay some premium for that option. What an FCCB does is combines these two instruments and the option premium is helped to offset the coupon which the company pays. In the past it�s interesting to note how companies have viewed an FCCB. The instrument could be viewed by a company as a cheap debt because it gets debt at a cost which is less than what it would have got in the normal course of the time because of option premium, or, it could look at it as equity at a premium, because the warrant or the option which is there is to convert into equity at a premium at any point of time over a period of five years which his typical in India. So while FCCB is a very good and flexible instrument from a perspective of issuer to map what his expectations of future growth of the company is by tinkering with the coupon, the yield to maturity (YTM) and the premium, you need to be careful that ultimately it is debt. The credit rating agencies would view it as a debt. So it should be looked at in the overall context rather than hurrying it up. Q: That conversion has been a problem and then many companies have defaulted on this very redemption issue. The most glaring example is from Wockhardt. But there are still examples in corporate India where companies are defaulting on that redemption. Would you read it as a red flag when a company goes down the FCCB route via the others or does it have to be extremely case to case in terms of which company actually has the strength to go through with it and those that don�t? Sharma: I don�t think that is an issue because even if a company has taken a plain debt and it defaults, the issue remains the same. So it�s not from that perspective that we need to be careful about. But whenever a company is looking at issuing an FCCB one is to look at what the market is willing to pay. What people should look at is depending on the growth of company, look at what realistically is the premium which they would be happy with and go with that rather than look at what the maximum premium is. Q: Because of the environment we are in right now which is extremely high interest rates and a propensity for people to lean towards fixed income rather than equity, some companies over the last six to eight months have actually chosen to do company fixed deposits they have come out with bonds. L&T has done it very successfully and some of them have very lucrative rates as well, how does that sit on your shoulders in terms of option? Chatterjee: Typically FCCBs have been used more opportunistically by companies than fundamentally because they sometimes move as a flavour of the season. Primarily because it depends on the underlying equity market or the debt market and companies would tend to have in the past zero coupon FCCBs with moderate amount of equity premium or conversion premium and then assume that that conversion will happen. But from a structural point of view FCCBs are effectively underlying debt. And, because of the option value it could potentially become cheaper cost debt for sure. So I think one needs to look at from lens of seeing FCCBs as more of a debt instrument than an equity instrument because it has only got an option on top. As far as bonds are concerned or the recent history of bonds being used, I think for Indian companies especially the bond market would provide a huge amount of potential liquidity. The depth of the bond market is very critical for companies to access, because given the savings rates of India, I think the bonds are natural instruments which can be effectively used by companies for funding their growth or long-term requirements. Q: Qualified institutional placement (QIP) has been a preferred instrument in fund raising and in many cases a very successful instrument as well for companies. How does that work? Nayar: The qualified institutional placement in some ways is similar to a follow-on offering. The companies that are already listed on the market have this option. It is a quicker process than a follow-on offering because it is only offered to qualified institutional buyers, thus restricting the number of investors to whom it can be sold. It�s been an extremely useful format and also QIPs have happened at a very low discount to the existing market price. Sometimes it can happen at premium but most of the time they happen at market related prices with a very slight discount. So even for pricing it has been a better format. If you look at recent issuances there are far more issuance through QIP than GDR or ADRs. Q: Do you agree it�s elegant, it brings in a lot of blue-blooded investors and in most cases it adds some premium to the stock and where it is trading at as well? Chatterjee: Surely, I think QIPs have been a very good option for companies to raise capital quickly and in the market. As the QIP route develops, there has to be a time when at which the QIP and FPO has to converge. Q: ADR-GDR route, something that was vogue a couple of years back, but has now lost a bit of flavour. How does that work and is that positive in your eyes for a company or just a neutral kind of fund raising option? Sharma: We need to look at American depositary receipt (ADR) and global depositary receipt (GDR) slightly back into the history of how it came about. What it means is that the Indian company is issuing shares but instead of issuing directly to the investor it is issuing to a depository who then offers the depository to overseas investors. Now when it started, it was basically to tap a different investor base which is either, in case of ADR, the US retail investors who are not allowed to participate in India or both an ADR and GDR, institutional investors who are either not registered with SEBI here or for some reason not eligible to invest in India. So, it worked very well for some time. What has happened is two things�one is more and more foreign institutional investors (FIIs) have been registering in India and the pool of investors who were not allowed to invest in India has reduced. So, to that extent the kind of advantage of ADR and GDR has come off. But more importantly what has happened is QIP, which was sort of targeted by SEBI to look at GDRs has been very prevalent and the people can invest in India as well. Q: Let�s talk a bit about the IDRs and the kind of changes that have been introduced over there. You have seen what the changes both in terms of fungibility and liquidity have done for the Standard Chartered IDRs and the way FIIs are approaching that. Do you think a rethink is required on some of these depository receipts domestically as well and the rules of the game? Sharma: IDR was introduced basically to counter an ADR-GDR, which is basically allowing foreign companies to tap the Indian markets. Once again I am pretty clear that it does not offer a new investor base for any of the companies to go and list IDR which is pretty evident that since almost three to four years that these guidelines are there, only Standard Chartered has done an IDR. It is again boils down to business reasons. It basically increases the profile of a foreign company which has a large presence in India. What has happened recently on the IDR and the impact of that on the share price of Standard Chartered IDR is again going back to the liquidity point, that if you have an IDR listed here, on June 11, when the one year period was getting over there was a provision that you could actually convert the IDR into Standard Chartered shares and sell it and get the money back. Since the shares in India are frequently traded as defined by SEBI, SEBI and RBI have taken a call that fungiblity or that option of redemption would not be available. Read more on Standard Chartered IDR here. Q: This was hailed as the next big thing in the Indian equity market space. So how is corporate India reading this? Chatterjee: IDRs are essentially I guess for foreign companies, which have got significant Indian operations; this is a chance to unlock value for the investors. From that perspective this was the first IDR. So I guess one hasn�t seen more IDRs coming up, though there are many foreign companies, multinationals who have very significant operations in India. I think we got to see a few IDRs to take a view on how these instruments work. For example if I flip the other way round on GDRs for Indian companies in overseas markets, typically the key issue has been fungibility because if the GDR or ADR is of significant volume, then it has a potential to trade in that market. But if it is a small or medium sized GDR, then typically within few days if listing it actually gets fungible to the home market and that is where the investors are more comfortable playing it out. Also, there are many investors who by their own charters do not have the approvals to participate in GDRs and IDRs kind of instrument, and they would rather participate in where they are main listings are. So these are some consideration, which pan out for companies when they look at ADRs, GDRs, because there is a cost to compliance especially in ADR, GDR. IDR is more flexible to that extent I would say. But, the benefit of that listing has to translate into the opportunity to do further follow-on listing. I don�t think GDRs are very hot at this point of time. I don�t know where the IDR route will go. But, if more and more companies do come into India and do IDRs, I think that is how the Indian investors would be able to participate foreign stories.