Description
It studies the macro and micro economic developments, regulatory changes since the issue date and tries to gain a perspective on how these affects the selected companies in light of the FCCB issue and the major impact of FCCB issue on the EPS and Debt position of the company as well as some forex exposure at the time of interest payments.
Analysis of trends in FCCB issues by Indian companies Discussion of the pros and cons of issuing FCCBs with special reference to five companies in India
Project work for the subject International Corporate Finance
Submitted By: Amitrajit Sett 09P126 Gautam Siddharth 09P139 Rudranil Dutta 09P165 T Sushma 09P176 Vishal Gupta 09P179
PGPM 2009-11
Acknowledgement
We wish to express our gratitude towards our teacher professor P.C. Biswal for presenting us with the concepts of international corporate finance and currency exchange rates. This course in finance has made us more aware of the international market around us and provided us with tools to evaluate the market. We also thank him for his guidance for this project work. August 16, 2010
Executive Summary
FCCBs are increasingly becoming an attractive source of funding for Indian companies who want to raise money from the global market. FCCB is a foreign currency (usually dollar) denominated bond that, in addition to offering a return or yield, also offers investors the option of converting their principal investment into equity at a pre-decided price. The price is decided when the instrument is issued. FCCB, which is a debt instrument, is convertible into equity, either immediately after issue, or upon maturity, or during a set period. The conversion price is at a premium over the current price or is set by a formula based on price at the time of redemption. We have taken up five Indian companies which have taken up the FCCB mode of funding in the last five years or so and tried to analyze the reason behind raising money through FCCBs. The five companies are: 1) Ranbaxy Laboratories 2) Reliance Communication 3) Mahindra and Mahindra 4) Tata Motors 5) Suzlon Energy We have studied the macro and micro economic developments, regulatory changes since the issue date and tried to gain a perspective on how these affected the selected companies in light of the FCCB issue and the major impact of FCCB issue on the EPS and Debt position of the company as well as some forex exposure at the time of interest payments. FCCB dilutes the EPS for existing shareholders and like any other mode of debt funding raises the Debt/Equity (D/E) ratio of a company. We have studied the impact on EPS and D/E ratio and its repercussions for the above mentioned companies. Stock Price is also a very important variable as bond holders will only convert if the stock price at the time of redemption is higher than the conversion price. We have analyzed the price trend for these companies along with the operating cash flows to see if companies have enough cash at the time of redemption in case the conversion price is too high as compared to market price.
Introduction
Raising funds from global markets is a lucrative option for investors. There are a number of options to do this viz. foreign currency convertible bond, foreign currency exchangeable bond, global depository receipts and other money market techniques. Some of the key reasons for raising funds from global markets are: ? ? ? ? ? New Cross country/ international projects Projects requiring high amount of investment only possible to raise from global markets Expansion and Renovation of existing ventures Global mergers and or acquisitions Direct investment through Joint ventures or through subsidiaries
FCCB or a foreign currency convertible bond is a type of convertible bond issued in a currency different than the issuer's domestic currency. In other words, the money being raised by the issuing company is in the form of a foreign currency. It gives two options – one is, to get the regular interest and principal and the other is to convert the bond in to equities. A convertible bond is a mix between a debt and equity instrument. It acts like a bond by making regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock. FCCBs represent a debt obligation for the corporate. Investors have the option to convert them into GDRs or underlying shares. If investors prefer to hold the bonds till maturity date, the Corporate has to redeem the bonds on that date with the coupon rate on the FCCB would be nominal. It is generally available at US$ 1000 each. FCCBs are very effective instruments for as per recent data raised $2.88 billion in 2009-10 after raising only a paltry sum in 2008-09 raising funds overseas Indian companies raised: $ 7.96 billion through FCCBs in 2007 & Total amount raised in 2006 in $ 5.20 billion. FCCBs have advantages for both issuing company and investors. Advantage to issuing company: Some companies, banks, governments, and other sovereign bodies may decide to issue bonds in foreign currencies because: ? ? ? It may appear to be more predictable and stable than their domestic currency. Gives issuers the ability to access investment capital available in foreign markets. Companies can use the process to break into foreign markets.
?
The bond acts like both a debt and equity instrument. Like bonds it makes regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock
? ? ?
It is a low cost debt as the interest rates given to FCC Bonds are normally 30-50 percent lower than the market rate because of its equity component. Conversion price is fixed when the bond is issued. So, lower dilution of the stocks. Conversion of bonds into stocks takes place at a premium price to market price.
Advantage to investor: Advantages are not restricted to companies only. Investors too enjoy the advantages of FCCB – ? ? ? ? Safety of guaranteed payments on the bond Redeemable at maturity if not converted Can take advantage of any large price appreciation in the company's stock Easily marketable as investors enjoys option of conversion in to equity if resulting to capital appreciation Disadvantages: Like any financial instruments, FCCBs also have some disadvantages: ? Exchange risk is more in FCCBs as interest on bond would be payable in foreign currency. Thus companies with low debt equity ratios, large forex earnings potential only opted for FCCBs. ? ? ? FCCB means creation of more debt and a FOREX outgo in terms of interest which is in foreign exchange. In case of convertible bond the interest rate is low (around 3 to 4%) but there is exchange risk on interest as well as principal if the bonds are not converted in to equity. If the stock price plummets, investors will not go for conversion but redemption. So, companies have to refinance to fulfill the redemption promise which can hit earnings. It will remain as debt in the balance sheet until conversion.
FCCB Participants
? ? ? ? Issuer – (e.g. Company) Local legal advisor – (e.g. Law firms) Local accountants - (e.g. Company’s auditors) Local custodian – (typically Banks)
? ? ? ?
Lead Manager – (e.g. Investment Banks) Depository bank – (e.g. Bank of New York / State Street / Global) Overseas legal advisor – (e.g. UK Law firms) Escrow bank – (typically Overseas Banks)
Process Flow:
Pros of Using FCCB
? ? The company gains higher leverage, as debt is reduced and equity capital is enhanced upon conversion, subject to favorable stock price The impact on cash flow is positive, as most companies issue FCCB with a redemption premium, which is payable on maturity, only if the stock price is less than the conversion price ? ? ? FCCB do not dilute ownership immediately, as the holders of ADR / GDR do not have voting rights Conversion premium adds to the capital reserves FCCB carries fewer covenants a compared to a syndicated loan or debenture, hence more convenient to raise funds for Mergers and Acquisitions
Cons of using FCCB
? ? ? ?
In a falling stock market, there is no demand for FCCB. In globally listed companies, prices in other stock exchanges also impact the issue of FCCB FCCB, when converted into equity, bring down the earnings per share, and eventually, dilute the ownership In the long run, equity is costlier than debt, and hence, when interest rates are falling, FCCB are not preferred Book value of converted shares depends on prevailing exchange rate
Risks involved
? Bearish Market ? FCCBs are usually issued with the expectation that the company's stock price will continue to rise. But in case of downturn, Conversion price of FCCBs becomes several times higher than their current market price. In that case, bonds will have to be retired at a premium over their face value. ? Rupee depreciation ? Fall in rupee inflates the outstanding loan amount and interest payouts
Taxation in FCCBs
? ? ? ? Until the conversion option is exercised, all the interest payments on the bonds, is subject to deduction of tax at source at the rate of 10% Tax exercised on dividend on the converted portion of the bond is subject to deduction of tax at source at the rate of 10% If Foreign Currency Convertible Bonds ( FCCB ) is converted into shares it will not give rise to any capital gains liable to income-tax in India If Foreign Currency Convertible Bonds (FCCB) is transferred by a non-resident investor to another non-resident investor it shall not give rise to any capital gains liable to tax in India
Regulatory Mechanism
The ECB guidelines govern FCCBs. The bonds are required to be issued in accordance with the scheme viz., "Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depositary Receipt Mechanism) Scheme 1993”. According to the Circular No. 04 dated August 7, 2007 relating to External Commercial Borrowings (ECB), ECB can be accessed under two routes: (i) Automatic Route (ii) Approval Route Some salient features of the regulatory mechanism are: ? ? ECB for more than USD 20 million per borrower company per financial year would be permitted only for foreign currency expenditure for permissible end-users of ECB Up to USD 20 million for Rupee expenditure for permissible end-uses would require prior approval of the Reserve Bank under the Approval Route. Such funds shall be continued to be parked overseas until actual requirement in India ? All other aspects of ECB policy such as eligible borrower, USD 500 million limit per borrower company per financial year under the Automatic route and the Approval route Permitted End Uses ? ? ? For investment (e.g. import of capital goods) Implementation of new projects Modernization/expansion of existing production units in: o real sector o industrial sector including SME o infrastructure sector ? ? For Overseas direct investment in Joint Ventures (JV) / Wholly Owned Subsidiaries (WOS) For the first stage acquisition of shares in the disinvestment process and also in the mandatory second stage offer to the public under the Government’s disinvestment programme of PSU shares Non-Permitted End Uses ? ? On-lending or investment in capital market Acquiring a company (or a part thereof) in India by a corporate
? ? ?
For working capital For general corporate purpose For repayment of existing Rupee loans
FCCB Valuation The FCCB has two components, namely a bond component and an equity component. The Present Value of the bond component is arrived at by discounting the future cash flows at LIBOR + credit premium. The value of call option on equity is arrived at as per various evaluation models – e.g. Black Scholes model. The values so arrived are mutually exclusive – at any point of time value of the bond would be higher of the two + accrued interest in addition to credit risk, in terms of credit spread included in the YTM, and Earnings risk on the equity. For the issuer, the cost of capital would be: post-tax coupon of the bond and cost of equity.
Effect on EPS
EPS is the ratio of a company’s profit and number of shares outstanding. Number of shares owned represents the extent of a shareholder’s ownership in the company. Basic EPS = (Net Income – Preference Dividend)/(Weighted avg. no. of shares outstanding) If convertible bonds are issued, investors have an option to convert them into equity at the time of maturity of bond. Thus increasing the number of shares outstanding and diluting both the EPS and ownership of the existing. This dilution in EPS is reflected in the diluted EPS and that’s why convertible bonds are one type of Dilutive Securities. Diluted EPS is calculated under the assumption that all convertible securities will be exercised. Thus this represents a worst case scenario as all convertible security holders are unlikely to exercise all at once. On the other hand, if company’s performance is good and other macro and micro economic being favorable there is a god chance that all convertible bonds be converted into equity. Other instruments that contribute to dilution of EPS are: 1. Convertible preference shares
2. Warrants 3. Options Individual dilutive effect of each of these (including convertible bonds) has to be calculated before including the effect of conversion to common stock is incorporated into the calculation of diluted EPS. Calculation of Diluted EPS: ? If convertible bonds are dilutive (EPS decreases after converting), the after tax interest expense [interest payment * (1-t)] is added to the numerator of the basic EPS equation ? If convertible bonds are dilutive, then while calculating diluted EPS, the equivalent number of common shares are added to the denominator of Basic EPS equation
Diluted EPS = [Net Income – Preference Dividend + Convertible debt interest *(1-t)] [Weighted avg. no. of shares + Shares from conversion of conv. Bonds]
BUYBACK Companies can also go for buyback or prepayment and thereby reduce the debt. Regulations: RBI has allowed Indian companies to buyback FCCBs under the approval route till June 2010. These regulations were introduced in 2008. However, the companies must adhere to the following guidelines: ? ? ? ? The amount of the buyback is limited to US $50 mn of the redemption value per company The companies have to use either internal accruals, cash reserves or raise fresh funds overseas. If Rupee resources are used for the buyback, a minimum discount of 25% on the book value is mandatory The FCCBs such bought back must be cancelled
Companies such as Hotel Leela Venture, Tata Motors, Reliance Communications, Bhagyanagar India, 3i Infotech, Man Industries, Sical Logistics, Simbhaoli Sugars had repurchased their redeemable bonds in tranches. Three factors that can hold back a company from buyback of FCCBs: ? ? ? The price The sellers realizing the downside of buyback The lack of liquidity
INDUSTRY ANALYSIS
Many Indian Companies have used the FCCB route to raise money from the global markets because of the obvious advantages as explained in the previous section .The table below gives the list of various Indian that have raised money using FCCBs:
Name
Maturity Period
Issue Size (Mn)
Conversion Price
Bajaj Hindusthan Moser Baer Aurobindo Pharma Tata Motors Tata Motors Hind. Construction Wockhardt 3i Infotech Bharat Forge Ranbaxy Reliance communication Tata Chemicals
Feb, 2011 Jun, 2012 May, 2011 Mar, 2011 Jun, 2012 Mar, 2011 Sep, 2009 2012 Apr, 2010 Mar, 2011 May, 2011
120 USD 75 USD 150 USD 11760 JPY 450 USD 100 USD 110 USD 100 USD 60 USD 440 USD 500 USD
465 546 1014 1001 961 248 486 462 384 716 476
Jan, 2010
150 USD
231
The maturity period indicates the date on which the FCCBs are going to mature and the companies may have to redeem the bonds or convert them into shares on that day. Issue Size indicates the amount of money raised. Conversion Price indicates the price at which FCCBs will be converted to shares. If the conversion price is lower than the market price, investors will go for conversion of their bonds. In India, some sectors have very high exposure to FCCBs when compared to others as shown below:
As can be seen, Pharmaceuticals industry has a very high exposure to FCCBs. Companies such as Ranbaxy, Aurobindo Pharma has raised lot of amount from overseas.It is followed by Steel companies, telecommunication services etc. All the FCCBs followed have to redeemed if they are not converted into shares during the tenure. The table below gives the number of FCCBs that have been or will have to be redeemed in future:
Current Scenario
Till 2007, FCCB bond issuers found that it was the best alternative to raise funds. However, with the recession setting in, the stock markets plummeted. They were trading at a discount of 50% to the conversion price. This sustained dip has made the FCCB holders averse to conversion. Hence, companies will have to redeem the bonds at a premium. This will have a huge impact on the finances of the companies. A company with a high debt to equity ratio will be forced to convert the FCCBs into equity as they cannot go for more debt. We have analysed the impact of FCCBs on five companies: 1. Ranbaxy 2. Tata Motors 3. Reliance Communication 4. Mahindra & Mahindra 5. Suzlon Energy
The detailed analysis is given in the subsequent sections.
RANBAXY LABORATORIES
Ranbaxy in 2006 issued 5-year Zero Coupon Foreign Currency Convertible Bonds (FCCBs) priced at par value and raised $ 400 million with a Greenshoe option of $ 40 million. The bonds mature in 2011 and the capital raised would be used for financing international acquisition, capital expenditure and others. These FCCBs were listed on Singapore Stock Exchange. The yield to maturity of the bonds is set at 4.8 per cent per annum The Bond holders had the option to convert these into Common Shares or Global Depository Shares, at a price of ` 716.32 per share (@ 60% premium to the previous day’s issue price) with a
fixed exchange rate of ` 44.15 per US $ 1, at any time on or after April 27, 2006 and but before March 9, 2011. The Bonds may be redeemed, in whole, at the option of the Company at any time on or after March 18, 2009, but before February 6, 2011, subject to satisfaction of certain conditions. The Bonds are redeemable on March 18, 2011, at a premium of 26.765 percent of their principal amount unless previously converted, redeemed or purchased and cancelled. The company plans to utilize the capital raised through FCCBs to fund acquisitions and had set aggressive revenue targets of $2 billion by 2007 and $5 billion by 2012 at the time of the issue. Developments since the issue: ? ? Ranbaxy missed the revenue target of $2 billion for 2007 Ranbaxy acquired the entire share capital of Mundogen Farma SA, generic business of GlaxoSmithKline (GSK), in Spain, through its Spanish subsidiary, Laboratorios Ranbaxy S.L. for a total cash consideration of $ 5.73 million funded by FCCB proceeds ? FCCB proceeds were utilized for acquisition of Romania’s Terapia SA, and other acquisitions in Italy, Belgium and South Africa ? Company makes application for early redemption before March 18, 2011 which was not granted by RBI ? On 28 October 2008 Daiichi Sankyo acquired majority stake in the Company and resets the conversion price of its FCCB issue. The new conversion price is now ` 555 per share. The new conversion price is at a discount of approx 20% to the current stock price (as on Aug 13, 2010) of Ranbaxy ? The new price was arrived after adjusting for the equity dilution from fresh shares issued to Daiichi Sankyo on a preferential basis, the average price of the previous six months or six weeks, and factoring the advancement of the conversion date through a complex formula, said Malvinder Singh, chairman and managing director, Ranbaxy Laboratories ? In 2008, RBI allowed buyback of issued bonds on or before 31st Dec 2009 to help pharma companies tide over losses arising due to currency fluctuations and mark to market during the financial meltdown by lowering the interest payment burden
?
Ranbaxy was not able to avail this scheme to buy back its FCCBs as its available fund (infused by Daiichi Sankyo) cannot be used for the purpose as per guidelines. Also, its outstanding amount of $440 million is way more than the max allowed of $50 million
Analysis: Dilution of EPS: As seen from the figure below the FCCB issue hasn’t had much of an impact on the EPS of Ranbaxy. In fact in the years 2006 and 2008 the option of FCCB was anti dilutive i.e. it increased the EPS. The major dip in EPS in 2008 can be attributed to the financial crunch, the forex losses suffered by Ranbaxy because of a weak currency and patent and legal troubles in the EPS.
25 20 15 10 5 0 -5 -10 -15 -20 -25 -30 EPS (`) Fully DEPS (`)
`/Share
2005 6.87 6.84
2006* 14.09 14.09
2007 20.77 15.22
2008# -24.85 -24.85
2009 7.05 4.60
Figure 1: Dilution of EPS after FCCB issue In 2007 and 2009 the FCCB option was dilutive in nature but in 2007 because of a buoyant industry and a string of acquisitions the EPS and fully Diluted EPS were still high at `20.77 and `15.22 respectively. All of this dilution in EPS cannot be attributed to the FCCB as ESOPs were also issued which also lead to equity dilution. Debt Position: Figure 2 below shows Ranbaxy’s Debt Equity ratio and Interest Coverage Ratio over the period 2005-2009. The D/E ratio increased from 0.43 to 1.35 in 2006 because of the FCCB issue but it is still not very high and should not be an issue in case Ranbaxy wants to raise more debt from the market. D/E ratio further reduced to 1.05 in 2008 after Ranbaxy retired debt amounting to approx `3,400 crore after the stake sale to Daiichi Sankyo. Interest coverage ratios are also very high ranging 6.6-9.29 from 2005 to 2009 when compared to the alarm levels of 1.5. Interest coverage ratio was negative in 2008 as Ranbaxy reported a loss
owing to the reasons mentioned above but this can be regarded as a one off case and should not have much of an impact as the ratio improved to an impressive 27 in 2009.
35 30 25 20 15 10 5 0 -5 -10 -15 Int Coverage Ratio D/E Cash Flow (in Rs million) 12000 10000 8000 6000 4000 2000 0 -2000 -4000
2005 6.66 0.43 2037.23
2006 8.58 1.35 5292.37
2007 9.29 1.38 10232.44
2008 -10.1 1.05 -1520.21
2009 27.9 0.85 -1621.25
Figure 2: D/E Ratio and Interest Coverage Ratio Thus Ranbaxy has a healthy position as far as debt is concerned. Ranbaxy’s Cash position stands at ` 12,416 crores and net current assets at ` 18,973 crores (Dec 2009). Ranbaxy is in a comfortable position to repay the FCCB holders who chose to redeem either through cash aur by taking debt. Stock Price: FCCBs provide investors the option of converting their bond at a fixed conversion price into common stock after maturity. The conversion price is at a premium to the existing market price at the time of issuing debt so that the investors convert their debt into equity and can make capital gains by selling the stock in equity market. In this way the issuing company is saved the burden of redemption of debt which can place a huge strain on its cash position at the time of maturity. Ranbaxy’s FCCB had a conversion price of ` 716.32 per share at the time of FCCB placement but it was revalued to ` 555 per share in 2008. The stock price at maturity i.e. March 2011 should be higher than ` 555 for the investors to convert their FCCBs into equity otherwise they would want to redeem their bonds at par value, putting a huge cash burden on Ranbaxy ` 19.5 billion (approx) Ranbaxy stock’s price slipped to the levels of `133 in March 2009 but since then has staged a strong rally to trace `500+ levels in Dec-Jan after which it has shown consolidation in the 430450 range. Therefore, Ranbaxy stock has to appreciate nearly 20% from now till March 2011 (when the FCCBs mature) to make it attractive for conversion. With the economy on the rise
and Ranbaxy showing strong performance in the first half of 2010 (42% revenue growth and posting profit after loss in 2009 YoY) the prospects for the stock looks good.
Figure 3: Ranbaxy's Stock Price post FCCB placement
TATA MOTORS
After it’s rechristening from Telco to Tata motors, one of the earliest decision of this Indian automaker was to settle its high cost debt in 2003. So, it decided to go through the FCCB route and it raised 100 million USD to repay the debt. Since then, it had issued three more notes, one for the YEN currency and rest two were for USD currency only. The details of the notes are mentioned below:? April 2004 ? ? ? ? ? ? tranche I: $300-million conversion price INR 780.40 maturity on March 28, 2011 tranche II: $100 million conversion price of INR 573.10 maturity on March 28, 2009
This offering had an innovative dual tranche bull-bear structure, according to investment bankers. This was the first ever multi-tranche convertible offering by an Indian company with
the first tranche being the first ever negative yield structure offered by an Indian company and the second tranche achieving the longest tenure of seven years and the highest conversion premium of 60 per cent for an Indian convertible offering. ? March 2006 ? ? ? ? ? ? July 2008 ? ? ? ? ? raised $490 million conversion price INR 960.96 maturity comes on June 12, 2012 Repurchased 170 Zero Coupon Convertible Securities at avg. price of 50.375%. Outstanding bonds reduced from $490 million to $473 million. Excerpts from a Tata motors report in 2008 is given below ?
1% (due Issue Issued on Issue Amount (INR amount at the time of the issue) Face Value Conversion Price per share at fixed exchange rate (Note 1) Exercise Period after June 7, 2004 to June 7, 2004 May 2, 2006 to 2008) US (Rs. $ FCCN 0% (due 2009) 100 US million 4,615.6 (Rs. million) US $ 1000 $ FCCN 1% (due 2011) 100 US $ FCCN 0% FCCN (due 2011) 300 JP million million) JP ¥ 10,000,000 1001.39 ¥ 11,760
$100 million raised in Japanese Yen (JPY 11760 million) convertible at INR 1,001.39 maturity on February 19, 2011 repurchased 30 Zero Coupon Convertible Notes at an average price of 54.27% outstanding bonds reduced from JPY 11760 Mn to JPY 11460 Mn
July 31, 2003 April 27, 2004 April 27, 2004 March 20, 2006 million million) US $ 1000 Rs. million million) US $ 1000
4,385.0 (Rs.13,155.0 (Rs.4,500.3
250.745 Rs. US $ 1
573.106 Rs.
780.400 Rs. Rs.1 = JP ¥ 2.66
US $ 1 = Rs.46.16
US $ 1 = Rs. 43.85
= Rs.43.85
September 11, March 28, 2009 to 2003 upto July 1, 2008 Early redemption at the on or after on subject conditions to certain or after Not Applicable and March 2011
February 28, 2011
19,
(i) after March 20, 2009 but prior to February 8, 2011 (in whole or in part) subject to certain conditions or (ii) any time (in whole but not in part) in the event of certain changes affecting taxation in India
option of the Company July 31, 2006 April 27, 2005 (in whole but not in part)
Redeemable on the Principal Amount Amount converted
July 31, 2008 April 27, 2009 April 27, 2011 March 21, 2011 95.111% $ 121.781% 95.59 Nil 99.253% Nil
Redemption percentage of 116.824%
US $ 99.94 US million
million 73,13,842 4,410 3,37,422 3,00,000 1,68,56,740 1,176 44,14,916
Aggregate conversion into 1,83,98,095 Shares / ADSs Notes Outstanding as at 60 March 31, 2008 (Note 2) Aggregate on amount of 11,045 of shares that could be issued conversion outstanding notes
Developments of the issue ? All these were successful in getting in the confidence of the investors and in turn raised capital successfully. But then the financial crisis brought a sharp decline in market prices of its stocks. And thus, the chances of investors converting the notes into equity on maturity looked bleak. With share price of Tata Motors having fallen by around 80 per cent in 2008, the market assumes that the higher conversion prices of FCCBs will increase debt burden in the books. On January 1, 2008, Tata Motors’ share price was at Rs 741.45, while it fell to Rs 159.05 on December 31, 2008. Thus, adjustments were
asked to be made for the same. The prices were being reviewed and all these adjustments are being made because of ‘reset clauses’ attached to the convertible bonds, according to which the conversion price is revised downward when the company’s share price falls below a pre-determined level. If the share price is below the conversion price, the high likelihood is that the bonds would not get converted into shares and would end up as debt on the company’s books. ? On 15-Apr’09, Tata Motors share prices jumped 12.41% to INR 283.50 on BSE after the company repurchased and extinguished its US and Japan listed foreign currency convertible bonds at 50% discount Analysis Impact on EPSAs can be seen from the graph, most of the years, the FCCB option has been dilutive in nature except for 2008, when the markets crashed. Most of the years, there is no major difference between diluted and actual EPS, suggesting that the issues did not dilute the EPS as much as expected. In 2009, the sudden rise or the bounce back in EPS and diluted EPS is attributed to the easing of RBI guidelines on FCCB issue where a company can buy back its notes before maturity (made in December 2008). Tata motors followed suit and repurchased some of its notes on profit that is discount to the original share price. This came as a good exit option for the investors as well.
80 60 40 20 0 -20 -40 -60 -80 EPS (`) Fully DEPS (`)
`/share
2004 27.88 25.65
2005 34.38 32.23
2006 56.43 53.54
2007 56.24 51.31
2008 -56.88 -56.88
2009 48.64 44.65
Debt position As can be clearly seen from the ratios, they are particularly low for the company, thus tata motors can borrow more money and so, it is the plan phase of issuing more FCCB notes in future. The interest coverage ratio dipped in the financial year 2008 owing to the financial crunch and it started picking up in the following year. Even the cash flows were consistent throughout the years and hence shows the financial leverage the company holds and which it can utilise.
10 9 8 7 6 5 4 3 2 1 0 D/E Int Coverage Ratio
2004 0.47 8.58
2005 0.49 8 2.005
2006 0.36 7.98 1.119
2007 0.41 6.23 0.826
2008 0.51 1.68 2.397
2009 0.66 2.59 0.668
Cash Flow(in '000 crores) 0.77049
Stock pricesFrom the figure given below, the stock price of TATA motors was much in line with that of Sensex over the years. In starting of 2006, there was a sudden rise owing to the policies followed by the company and even in 2009; there was the sudden rise due to the repurchase of the securities. In 2008, market price fell to 150 ranges, speculating less chances of conversion of the bonds and thus increasing the debt burden on the company. But latest prices suggest that the company can continue the route to raise capital for its future plans and expansions.
Stock price movement vis-à-vis Sensex (2003-2009) In certain specific cases, stock prices show huge volatile movements in intra-day segment as well when key decisions are taken by the company in this regard. For example on March 23 this year, the company had offered to convert bonds worth $431 million into shares about a year before they mature. The company’s share price fell 3 per cent because the conversion would dilute the company’s share capital by 4.3 per cent.
Conversion impact on stocks This was done to reduce the debt as there is lot of redemption pressure on the company after the meltdown and also, the fact that buyback window had been closed. Road ahead The notes early conversion offer made by Tata Motors in March this year looks like a win-win situation for note holders and company. Redemption options on its yen and dollar denominated FCCBs due March and April 2011 offers the bondholders an incentive to convert it to equity. For the company, the conversion is equity dilutive in the short term. This move is a step in its latest endeavour to lower its net debt which stood at 23100 crore in December 2009. The conversion will strengthen the balance sheet by increasing equity capital. Bondholders also have an option to convert into GDS for dollar denominated bonds and ADS for yen denominated bonds. But due to the new ratios applied, additional dilution is estimated to be around 1 percent and conversion into equity will add about 30 million shares. This combined with the steady sales of Jaguar-Land rover calls for a strong growth outlook for the company as Debt-equity ratio will fall off to lower levels after this.
RELIANCE COMMUNICATIONS
Reliance Communications is India’s second largest mobile phone service provider. It raised a total of $1,500 million through two FCCB issues – one in 2006 and the other in 2007. The details of these issues are given below: 2006: ? ? Total Amount Raised No of bonds Issued : $500 million : 5 Lakh
? ? ? ? ?
Price of each bond Maturity Coupon Conversion Price Listed on
: $1000 : 5 years and one day(May 2011) : Zero : Rs 480.68 : Singapore stock exchange
The proceeds were used to refinance the old loans and for expansion. The conversion price was 50% more than the previous day’s closing price. If all the bonds are converted, then the company will have to issue 4.62 crore equity shares with a face value of Rs 5 each. 2007: ? ? ? ? ? ? ? ? Total Amount Raised No of bonds Issued Price of each bond Maturity Coupon Conversion Price Yield Rate Listed on : $1 Billion : 5 Lakh : $1000 : 5 years and one day(Feb 2012) : Zero : Rs 661 : 4.95% : Singapore stock exchange
The book runners for this issue were JP Morgan and HSBC. The issue was sold across Asia, Europe and the US and was over-subscribed by 3-4 times. They traded at a premium in the aftermarket, which illustrates strong demand. Proceeds from this issue were earmarked towards Reliance Communications’ capital expenditure of $2.5 Billion during 2007-08. The company was planning to expand its telecom network by adding new 20,000 towns across the country. Buyback: The company bought back FCCBs worth US $25 Million on Dec 29, 2008(250 FCCBs) and US $10 million (100 FCCBs) on Jan 10, 2009. The 100 FCCBs buyback resulted in a saving of Rs.1, 586 lakh which has been reflected as part of Other Income. At the time of buyback, the gap between the share price of RCom and its conversion price was less and hence, it was an opportune time for the company to buyback. Bonds were trading at 35% discount to the issue price. It means that the worth of the bonds has come down to US $650 Million from $1 Billion. It also had Rs 10,000 Crore in cash reserves. The buyback will reduce its liability and forex exposure. The amount of FCCBs repurchased by the company will
determine not only the gains to the size of the discount, but also the extent of reduction of debt from its balance sheet.
Dilution of EPS:
35 30 `/Share 25 20 15 10 EPS Fully DEPS 2007 17.56 16.71 2008 26.32 24.97 2009 29.29 28.05
As can be seen, the EPS has been steadily increasing. In 2009, the company has bought some of the outstanding FCCBs and hence the dilution has reduced. D/E Ratio, Interest Coverage Ratio and Cash Flows Figure 2 below shows Ranbaxy’s Debt Equity ratio, Interest Coverage Ratio and cash flows over the period 2007-2009. The D/E ratio increased from 0.47 to 0.77 because of FCCB issue. And then it reduced to 0.67 after the buyback. The D/E ratio is not very high.
0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 D/E Cash Flow in '000 Crs Int Coverage Ratio
2007 0.47 7.200640137 6.3
2008 0.77 0.878179993 3.99
2009 0.67 1.682900024 2.49
16 14 12 10 8 6 4 2 0
Figure 4: D/E Ratio, Interest Coverage Ratio and Cash Flows
The dip in the cash flows in 2008 and 2009 can be attributed to the buyback. The D/E ratio increased after the FCCBs were issued. Future Course of Action:
RCom has sufficient cash flow from operations to redeem FCCBs at maturity and hence need not perceive FCCB non-conversion as a risk to company. The cash flow from operations at the end of 2009 was Rs 1682.9 Cr. In case the conversion happens, it would be positive for the company, as dilution would occur at Rs 480 a share and Rs 660 a share. The dilution impact would be limited. Restructuring of FCCBs seems unlikely in case of Reliance. With a debt of about Rs 19,800 crore, raising further debt to repay the $340 million (about Rs 1,530 crore) by May 2011, also seems unlikely.
Suzlon (Market Capitalization: 10859.27) SEL on May 16, 2007 launched and priced a Foreign Currency Convertible Bonds (FCCBs) issuance for an amount of USD 300 million. The proceeds of the Bond will be utilized to fund Suzlon's various Growth Initiatives. The FCCBs, which have a maturity of 5 years and 1 day, are convertible at a conversion price of Rs 1,800 per share, (as adjusted from time to time) which is at a premium of 59.59% over the volume weighted average price (VWAP) of Rs 1,127.90 on the BSE on May 16, 2007. The FCCBs are zero coupon bonds with a yield to maturity of 7.60%, calculated on a semi-annual basis, at the end of 5 years and 1 day if not converted into shares during the period. The bond will have a Mandatory Conversion feature after 24 months. The FCCBs are expected to be listed on the Singapore Exchange Securities Trading Ltd. Deutsche Bank acted as the Sole Book runner to the transaction; and Yes Bank Ltd. has acted as an advisor to the Company. Developments of the issue ? India's largest wind turbine supplier has restructured its foreign currency convertible bonds (FCCBs). It has USD 211 million and USD 121 million bonds due in June and October 2012. The conversion price has been decided to be between Rs 95 and Rs 100 per share (according to latest Business Standard reports). Its earlier FCCB price conversion was at Rs 360 and Rs 370 per share. Suzlon will become the first company to reset the conversion price of FCCBs after the finance ministry relaxed the guidelines for companies to price their bonds based on share prices of the past six months. The covenants have been relaxed for the entire tenure. Suzlon will pay 1% fees to
bondholders for the waiver. The new price is likely to produce a dilution of 9.5% for the company. ? For the two sets of FCCBs worth $300 million and $200 million issued by the company, there were three main financial covenants. These three were – First, net borrowings to tangible net worth cannot be more than 1.5 times. Secondly, the full-year EBITDA cannot be less than 1.33 times the debt service coverage requirement, ie, repayment and service cost. Third, net borrowings to net EBITDA should not be more than four times. The last three quarters has not been beneficial for the company with the profit not being able to meet the borrowings and hence this has invited wrath from the shareholders. Suzlon had reported an EBITDA of Rs 408 crore in the nine months to December 31, 2009 down from Rs 1,996 crore a year earlier. ? In April last year, the company had fixed conversion price of Rs 76.67 per share for the bonds at an exchange rate of Rs 49.81. The $3 billion zero coupon convertible bonds issued on June 11, 2007 is due in June 2012 and $2 billion zero coupon convertible bonds, issued on October 10, 2007, are due in October 2012. The board of directors has decided to conduct a postal ballot seeking the approval of shareholders for the reduction in FCCB conversion price.
Analysis Impact on EPS As seen from the figure, there is not much difference between EPS and Diluted EPS, so it can be safely stated there has not been much conversion into equity in these bonds over the years. This was also attributed by the fact that there have been revisions of the conversion price so that investors stay invested. In 2009 figures, there has been a drastic fall owing to the financial crunch. Also, the impact of relaxation of guidelines from RBI is seen as an impact on these figures in the chart.
40 35 30 25 20 15 10 5 0 -5 -10 EPS (`) Fully DEPS (`)
2006 28.57 28.51
2007 37.65 36.82
2008 9.31 9.47
2009 3.62 -3.13
Debt position The ratios related to debt that is the debt to equity and interest coverage ratios are not favourable for the company in the recent past. The D/E ratio has increased while interest coverage ratio has dipped suggesting the company is not in shape to finance its future projects effectively. Cash flows also suggest that company issue more bonds to raise capital .
2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 D/E Int Coverage Ratio(*10) Cash Flow(in '000 crores)
2006 0.18 1.754 0.316
2007 0.23 1.252 0.351
2008 0.4 1.203 0.779
2009 0.77 0.198 0.07
Stock prices
Over the years, Suzlon stock has underperformed with respect to the Sensex. And with time, the gap has widened which shows the company is not taken well by the investors and it requires that the management take actions to win back the investors.
Mahindra & Mahindra Ltd.
Mahindra & Mahindra is one of the largest conglomerates in India and has currently issued FCCBs worth $ 189.5 million ? ? ? M & M has substantial outstanding FCCBs having issud $200 million FCCBs in 2006 and $100 Million FCCBs in 2004 After changes in regulation Mahindra & Mahindra has been buying back FCCBs that it had issued earlier and were due for redemption in 2011 and later. Earlier the company had issued FCCBs with zero coupon and 5 year maturity periods but the global downturn and plummeting stock prices had caused the company’s stock price to below the redemption price ? The company would have had to pay a larger amount to the bondholders as they would be redeemed at the set price and the debt burden of the company would go up because of this. Key reasons for the issue included global expansion plans and possible acquisitions overseas & for Rupee Expenditure in Capital Goods (CG)
2006: ? ? ? ? ? ? ? ? ? Total Amount Raised No of bonds Issued : $200 million : 2000
Face value of each bond : $100000 Maturity Coupon Conversion Price
Current Price YTM
: 5 years : Zero : Rs 922.04
: Rs 664.22 : 3.86%
Book Runners
: JM Morgan Stanley Ltd and Kotak Investment Banking
The proceeds were used to up gradation of existing facilities , expansion in current manufacturing facilities and acquisition of at an international level. 2004: ? ? ? ? ? ? ? ? Total Amount Raised No of bonds Issued Price of Bonds Current price of share Maturity Coupon Conversion Price Book Runners : $100 million : 1000 :$100000 : Rs 472.30 : 5 years : Zero : Rs 647.05 : ABN Amro Rothschild and Kotak Investment Banking
The proceeds were used to product development, upgrading and expansion of the existing manufacturing facilities and expansion through internal expansion and acquisitions abroad. Buyback: In recent times the economic turmoil and falling stock prices have been a major source of worry for the company as there will be no conversion of FCCBs if the GDR prices are less than the bond price and then the investors will go for redemption of the bond instead of conversion. This leads to an increase in the burden of debt for the company and can have an adverse effect on future borrowings of the company as well as on current financials. Hence a buyback of previously issued FCCBs are done by the company at a date before the redemption date for the bond. The company has sped up the process of buying back its FCCBs and in 2009 bought back shares worth $4 Million yet still has considerable convertible bonds outstanding.
Dilution
of
EPS:
Chart Title
50 40 30 20 10 0 EPS Dil EPS EPS & Dil EPS
2007 45.15 40.94
2008 46.24 41.52
2009 31.83 30.02
The role of foreign currency convertible bonds in dilution of EPS is critical as the exercise of the option by the bondholder’s leads to an increase in the number of shares and if the proceeds from shares are less than the earnings there is a dilution in the EPS and the value goes down. Besides the use of FCCBs there are numerous warrants and convertible bonds as well as other mixed instruments which give the option of conversion to the bond holder and may lead to dilution of EPS hence the dilution is only in part due to the effect of conversion by FCCB bond holders.
D/E
D/E over the last 4 years 0.80 0.60 0.40 0.20 0.00 D/E 2007 0.39 2008 0.54 2009 0.69 2010 0.53
Interest Coverage Ratio
80 70 60 50 40 30 20 10 0 Interest Coverage Ratio
Axis Title
2007 72.64
2008 14.79
2009 8.96
2010 19.15
As can be seen, the EPS has been steadily increasing. In 2009, the company has bought some of the outstanding FCCBs and hence the dilution has reduced.
D/E Ratio, Interest Coverage Ratio and Cash Flows
The dip in the cash flows in 2008 and 2009 can be attributed to the buyback. The D/E ratio increased after the FCCBs were issued. The company has been aggressively buying back it’s convertible bonds over the past couple of years to avoid redemption and maintain D/E ratio and this has led to a decrease in the cash flows as a result of buy back. Future Course of Action:
Monthly data for MNM stock over the past 4 years on the BSE shows the problem incurred due to a dip in stock price levels during late 2008 and early 2009 making the conversion option for convertible bonds highly unlikely. Stock prices on Indian exchanges and global GDR prices are highly co related hence conversion of FCCB into GDRs were unlikely prompting the company to buy back such bonds before conversion to equity. But clearly with resurgence in prices the company need not in invest cash in buying back its own bonds and can consider FCCB issue for future source of financing
doc_656279974.docx
It studies the macro and micro economic developments, regulatory changes since the issue date and tries to gain a perspective on how these affects the selected companies in light of the FCCB issue and the major impact of FCCB issue on the EPS and Debt position of the company as well as some forex exposure at the time of interest payments.
Analysis of trends in FCCB issues by Indian companies Discussion of the pros and cons of issuing FCCBs with special reference to five companies in India
Project work for the subject International Corporate Finance
Submitted By: Amitrajit Sett 09P126 Gautam Siddharth 09P139 Rudranil Dutta 09P165 T Sushma 09P176 Vishal Gupta 09P179
PGPM 2009-11
Acknowledgement
We wish to express our gratitude towards our teacher professor P.C. Biswal for presenting us with the concepts of international corporate finance and currency exchange rates. This course in finance has made us more aware of the international market around us and provided us with tools to evaluate the market. We also thank him for his guidance for this project work. August 16, 2010
Executive Summary
FCCBs are increasingly becoming an attractive source of funding for Indian companies who want to raise money from the global market. FCCB is a foreign currency (usually dollar) denominated bond that, in addition to offering a return or yield, also offers investors the option of converting their principal investment into equity at a pre-decided price. The price is decided when the instrument is issued. FCCB, which is a debt instrument, is convertible into equity, either immediately after issue, or upon maturity, or during a set period. The conversion price is at a premium over the current price or is set by a formula based on price at the time of redemption. We have taken up five Indian companies which have taken up the FCCB mode of funding in the last five years or so and tried to analyze the reason behind raising money through FCCBs. The five companies are: 1) Ranbaxy Laboratories 2) Reliance Communication 3) Mahindra and Mahindra 4) Tata Motors 5) Suzlon Energy We have studied the macro and micro economic developments, regulatory changes since the issue date and tried to gain a perspective on how these affected the selected companies in light of the FCCB issue and the major impact of FCCB issue on the EPS and Debt position of the company as well as some forex exposure at the time of interest payments. FCCB dilutes the EPS for existing shareholders and like any other mode of debt funding raises the Debt/Equity (D/E) ratio of a company. We have studied the impact on EPS and D/E ratio and its repercussions for the above mentioned companies. Stock Price is also a very important variable as bond holders will only convert if the stock price at the time of redemption is higher than the conversion price. We have analyzed the price trend for these companies along with the operating cash flows to see if companies have enough cash at the time of redemption in case the conversion price is too high as compared to market price.
Introduction
Raising funds from global markets is a lucrative option for investors. There are a number of options to do this viz. foreign currency convertible bond, foreign currency exchangeable bond, global depository receipts and other money market techniques. Some of the key reasons for raising funds from global markets are: ? ? ? ? ? New Cross country/ international projects Projects requiring high amount of investment only possible to raise from global markets Expansion and Renovation of existing ventures Global mergers and or acquisitions Direct investment through Joint ventures or through subsidiaries
FCCB or a foreign currency convertible bond is a type of convertible bond issued in a currency different than the issuer's domestic currency. In other words, the money being raised by the issuing company is in the form of a foreign currency. It gives two options – one is, to get the regular interest and principal and the other is to convert the bond in to equities. A convertible bond is a mix between a debt and equity instrument. It acts like a bond by making regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock. FCCBs represent a debt obligation for the corporate. Investors have the option to convert them into GDRs or underlying shares. If investors prefer to hold the bonds till maturity date, the Corporate has to redeem the bonds on that date with the coupon rate on the FCCB would be nominal. It is generally available at US$ 1000 each. FCCBs are very effective instruments for as per recent data raised $2.88 billion in 2009-10 after raising only a paltry sum in 2008-09 raising funds overseas Indian companies raised: $ 7.96 billion through FCCBs in 2007 & Total amount raised in 2006 in $ 5.20 billion. FCCBs have advantages for both issuing company and investors. Advantage to issuing company: Some companies, banks, governments, and other sovereign bodies may decide to issue bonds in foreign currencies because: ? ? ? It may appear to be more predictable and stable than their domestic currency. Gives issuers the ability to access investment capital available in foreign markets. Companies can use the process to break into foreign markets.
?
The bond acts like both a debt and equity instrument. Like bonds it makes regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock
? ? ?
It is a low cost debt as the interest rates given to FCC Bonds are normally 30-50 percent lower than the market rate because of its equity component. Conversion price is fixed when the bond is issued. So, lower dilution of the stocks. Conversion of bonds into stocks takes place at a premium price to market price.
Advantage to investor: Advantages are not restricted to companies only. Investors too enjoy the advantages of FCCB – ? ? ? ? Safety of guaranteed payments on the bond Redeemable at maturity if not converted Can take advantage of any large price appreciation in the company's stock Easily marketable as investors enjoys option of conversion in to equity if resulting to capital appreciation Disadvantages: Like any financial instruments, FCCBs also have some disadvantages: ? Exchange risk is more in FCCBs as interest on bond would be payable in foreign currency. Thus companies with low debt equity ratios, large forex earnings potential only opted for FCCBs. ? ? ? FCCB means creation of more debt and a FOREX outgo in terms of interest which is in foreign exchange. In case of convertible bond the interest rate is low (around 3 to 4%) but there is exchange risk on interest as well as principal if the bonds are not converted in to equity. If the stock price plummets, investors will not go for conversion but redemption. So, companies have to refinance to fulfill the redemption promise which can hit earnings. It will remain as debt in the balance sheet until conversion.
FCCB Participants
? ? ? ? Issuer – (e.g. Company) Local legal advisor – (e.g. Law firms) Local accountants - (e.g. Company’s auditors) Local custodian – (typically Banks)
? ? ? ?
Lead Manager – (e.g. Investment Banks) Depository bank – (e.g. Bank of New York / State Street / Global) Overseas legal advisor – (e.g. UK Law firms) Escrow bank – (typically Overseas Banks)
Process Flow:
Pros of Using FCCB
? ? The company gains higher leverage, as debt is reduced and equity capital is enhanced upon conversion, subject to favorable stock price The impact on cash flow is positive, as most companies issue FCCB with a redemption premium, which is payable on maturity, only if the stock price is less than the conversion price ? ? ? FCCB do not dilute ownership immediately, as the holders of ADR / GDR do not have voting rights Conversion premium adds to the capital reserves FCCB carries fewer covenants a compared to a syndicated loan or debenture, hence more convenient to raise funds for Mergers and Acquisitions
Cons of using FCCB
? ? ? ?
In a falling stock market, there is no demand for FCCB. In globally listed companies, prices in other stock exchanges also impact the issue of FCCB FCCB, when converted into equity, bring down the earnings per share, and eventually, dilute the ownership In the long run, equity is costlier than debt, and hence, when interest rates are falling, FCCB are not preferred Book value of converted shares depends on prevailing exchange rate
Risks involved
? Bearish Market ? FCCBs are usually issued with the expectation that the company's stock price will continue to rise. But in case of downturn, Conversion price of FCCBs becomes several times higher than their current market price. In that case, bonds will have to be retired at a premium over their face value. ? Rupee depreciation ? Fall in rupee inflates the outstanding loan amount and interest payouts
Taxation in FCCBs
? ? ? ? Until the conversion option is exercised, all the interest payments on the bonds, is subject to deduction of tax at source at the rate of 10% Tax exercised on dividend on the converted portion of the bond is subject to deduction of tax at source at the rate of 10% If Foreign Currency Convertible Bonds ( FCCB ) is converted into shares it will not give rise to any capital gains liable to income-tax in India If Foreign Currency Convertible Bonds (FCCB) is transferred by a non-resident investor to another non-resident investor it shall not give rise to any capital gains liable to tax in India
Regulatory Mechanism
The ECB guidelines govern FCCBs. The bonds are required to be issued in accordance with the scheme viz., "Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depositary Receipt Mechanism) Scheme 1993”. According to the Circular No. 04 dated August 7, 2007 relating to External Commercial Borrowings (ECB), ECB can be accessed under two routes: (i) Automatic Route (ii) Approval Route Some salient features of the regulatory mechanism are: ? ? ECB for more than USD 20 million per borrower company per financial year would be permitted only for foreign currency expenditure for permissible end-users of ECB Up to USD 20 million for Rupee expenditure for permissible end-uses would require prior approval of the Reserve Bank under the Approval Route. Such funds shall be continued to be parked overseas until actual requirement in India ? All other aspects of ECB policy such as eligible borrower, USD 500 million limit per borrower company per financial year under the Automatic route and the Approval route Permitted End Uses ? ? ? For investment (e.g. import of capital goods) Implementation of new projects Modernization/expansion of existing production units in: o real sector o industrial sector including SME o infrastructure sector ? ? For Overseas direct investment in Joint Ventures (JV) / Wholly Owned Subsidiaries (WOS) For the first stage acquisition of shares in the disinvestment process and also in the mandatory second stage offer to the public under the Government’s disinvestment programme of PSU shares Non-Permitted End Uses ? ? On-lending or investment in capital market Acquiring a company (or a part thereof) in India by a corporate
? ? ?
For working capital For general corporate purpose For repayment of existing Rupee loans
FCCB Valuation The FCCB has two components, namely a bond component and an equity component. The Present Value of the bond component is arrived at by discounting the future cash flows at LIBOR + credit premium. The value of call option on equity is arrived at as per various evaluation models – e.g. Black Scholes model. The values so arrived are mutually exclusive – at any point of time value of the bond would be higher of the two + accrued interest in addition to credit risk, in terms of credit spread included in the YTM, and Earnings risk on the equity. For the issuer, the cost of capital would be: post-tax coupon of the bond and cost of equity.
Effect on EPS
EPS is the ratio of a company’s profit and number of shares outstanding. Number of shares owned represents the extent of a shareholder’s ownership in the company. Basic EPS = (Net Income – Preference Dividend)/(Weighted avg. no. of shares outstanding) If convertible bonds are issued, investors have an option to convert them into equity at the time of maturity of bond. Thus increasing the number of shares outstanding and diluting both the EPS and ownership of the existing. This dilution in EPS is reflected in the diluted EPS and that’s why convertible bonds are one type of Dilutive Securities. Diluted EPS is calculated under the assumption that all convertible securities will be exercised. Thus this represents a worst case scenario as all convertible security holders are unlikely to exercise all at once. On the other hand, if company’s performance is good and other macro and micro economic being favorable there is a god chance that all convertible bonds be converted into equity. Other instruments that contribute to dilution of EPS are: 1. Convertible preference shares
2. Warrants 3. Options Individual dilutive effect of each of these (including convertible bonds) has to be calculated before including the effect of conversion to common stock is incorporated into the calculation of diluted EPS. Calculation of Diluted EPS: ? If convertible bonds are dilutive (EPS decreases after converting), the after tax interest expense [interest payment * (1-t)] is added to the numerator of the basic EPS equation ? If convertible bonds are dilutive, then while calculating diluted EPS, the equivalent number of common shares are added to the denominator of Basic EPS equation
Diluted EPS = [Net Income – Preference Dividend + Convertible debt interest *(1-t)] [Weighted avg. no. of shares + Shares from conversion of conv. Bonds]
BUYBACK Companies can also go for buyback or prepayment and thereby reduce the debt. Regulations: RBI has allowed Indian companies to buyback FCCBs under the approval route till June 2010. These regulations were introduced in 2008. However, the companies must adhere to the following guidelines: ? ? ? ? The amount of the buyback is limited to US $50 mn of the redemption value per company The companies have to use either internal accruals, cash reserves or raise fresh funds overseas. If Rupee resources are used for the buyback, a minimum discount of 25% on the book value is mandatory The FCCBs such bought back must be cancelled
Companies such as Hotel Leela Venture, Tata Motors, Reliance Communications, Bhagyanagar India, 3i Infotech, Man Industries, Sical Logistics, Simbhaoli Sugars had repurchased their redeemable bonds in tranches. Three factors that can hold back a company from buyback of FCCBs: ? ? ? The price The sellers realizing the downside of buyback The lack of liquidity
INDUSTRY ANALYSIS
Many Indian Companies have used the FCCB route to raise money from the global markets because of the obvious advantages as explained in the previous section .The table below gives the list of various Indian that have raised money using FCCBs:
Name
Maturity Period
Issue Size (Mn)
Conversion Price
Bajaj Hindusthan Moser Baer Aurobindo Pharma Tata Motors Tata Motors Hind. Construction Wockhardt 3i Infotech Bharat Forge Ranbaxy Reliance communication Tata Chemicals
Feb, 2011 Jun, 2012 May, 2011 Mar, 2011 Jun, 2012 Mar, 2011 Sep, 2009 2012 Apr, 2010 Mar, 2011 May, 2011
120 USD 75 USD 150 USD 11760 JPY 450 USD 100 USD 110 USD 100 USD 60 USD 440 USD 500 USD
465 546 1014 1001 961 248 486 462 384 716 476
Jan, 2010
150 USD
231
The maturity period indicates the date on which the FCCBs are going to mature and the companies may have to redeem the bonds or convert them into shares on that day. Issue Size indicates the amount of money raised. Conversion Price indicates the price at which FCCBs will be converted to shares. If the conversion price is lower than the market price, investors will go for conversion of their bonds. In India, some sectors have very high exposure to FCCBs when compared to others as shown below:
As can be seen, Pharmaceuticals industry has a very high exposure to FCCBs. Companies such as Ranbaxy, Aurobindo Pharma has raised lot of amount from overseas.It is followed by Steel companies, telecommunication services etc. All the FCCBs followed have to redeemed if they are not converted into shares during the tenure. The table below gives the number of FCCBs that have been or will have to be redeemed in future:
Current Scenario
Till 2007, FCCB bond issuers found that it was the best alternative to raise funds. However, with the recession setting in, the stock markets plummeted. They were trading at a discount of 50% to the conversion price. This sustained dip has made the FCCB holders averse to conversion. Hence, companies will have to redeem the bonds at a premium. This will have a huge impact on the finances of the companies. A company with a high debt to equity ratio will be forced to convert the FCCBs into equity as they cannot go for more debt. We have analysed the impact of FCCBs on five companies: 1. Ranbaxy 2. Tata Motors 3. Reliance Communication 4. Mahindra & Mahindra 5. Suzlon Energy
The detailed analysis is given in the subsequent sections.
RANBAXY LABORATORIES
Ranbaxy in 2006 issued 5-year Zero Coupon Foreign Currency Convertible Bonds (FCCBs) priced at par value and raised $ 400 million with a Greenshoe option of $ 40 million. The bonds mature in 2011 and the capital raised would be used for financing international acquisition, capital expenditure and others. These FCCBs were listed on Singapore Stock Exchange. The yield to maturity of the bonds is set at 4.8 per cent per annum The Bond holders had the option to convert these into Common Shares or Global Depository Shares, at a price of ` 716.32 per share (@ 60% premium to the previous day’s issue price) with a
fixed exchange rate of ` 44.15 per US $ 1, at any time on or after April 27, 2006 and but before March 9, 2011. The Bonds may be redeemed, in whole, at the option of the Company at any time on or after March 18, 2009, but before February 6, 2011, subject to satisfaction of certain conditions. The Bonds are redeemable on March 18, 2011, at a premium of 26.765 percent of their principal amount unless previously converted, redeemed or purchased and cancelled. The company plans to utilize the capital raised through FCCBs to fund acquisitions and had set aggressive revenue targets of $2 billion by 2007 and $5 billion by 2012 at the time of the issue. Developments since the issue: ? ? Ranbaxy missed the revenue target of $2 billion for 2007 Ranbaxy acquired the entire share capital of Mundogen Farma SA, generic business of GlaxoSmithKline (GSK), in Spain, through its Spanish subsidiary, Laboratorios Ranbaxy S.L. for a total cash consideration of $ 5.73 million funded by FCCB proceeds ? FCCB proceeds were utilized for acquisition of Romania’s Terapia SA, and other acquisitions in Italy, Belgium and South Africa ? Company makes application for early redemption before March 18, 2011 which was not granted by RBI ? On 28 October 2008 Daiichi Sankyo acquired majority stake in the Company and resets the conversion price of its FCCB issue. The new conversion price is now ` 555 per share. The new conversion price is at a discount of approx 20% to the current stock price (as on Aug 13, 2010) of Ranbaxy ? The new price was arrived after adjusting for the equity dilution from fresh shares issued to Daiichi Sankyo on a preferential basis, the average price of the previous six months or six weeks, and factoring the advancement of the conversion date through a complex formula, said Malvinder Singh, chairman and managing director, Ranbaxy Laboratories ? In 2008, RBI allowed buyback of issued bonds on or before 31st Dec 2009 to help pharma companies tide over losses arising due to currency fluctuations and mark to market during the financial meltdown by lowering the interest payment burden
?
Ranbaxy was not able to avail this scheme to buy back its FCCBs as its available fund (infused by Daiichi Sankyo) cannot be used for the purpose as per guidelines. Also, its outstanding amount of $440 million is way more than the max allowed of $50 million
Analysis: Dilution of EPS: As seen from the figure below the FCCB issue hasn’t had much of an impact on the EPS of Ranbaxy. In fact in the years 2006 and 2008 the option of FCCB was anti dilutive i.e. it increased the EPS. The major dip in EPS in 2008 can be attributed to the financial crunch, the forex losses suffered by Ranbaxy because of a weak currency and patent and legal troubles in the EPS.
25 20 15 10 5 0 -5 -10 -15 -20 -25 -30 EPS (`) Fully DEPS (`)
`/Share
2005 6.87 6.84
2006* 14.09 14.09
2007 20.77 15.22
2008# -24.85 -24.85
2009 7.05 4.60
Figure 1: Dilution of EPS after FCCB issue In 2007 and 2009 the FCCB option was dilutive in nature but in 2007 because of a buoyant industry and a string of acquisitions the EPS and fully Diluted EPS were still high at `20.77 and `15.22 respectively. All of this dilution in EPS cannot be attributed to the FCCB as ESOPs were also issued which also lead to equity dilution. Debt Position: Figure 2 below shows Ranbaxy’s Debt Equity ratio and Interest Coverage Ratio over the period 2005-2009. The D/E ratio increased from 0.43 to 1.35 in 2006 because of the FCCB issue but it is still not very high and should not be an issue in case Ranbaxy wants to raise more debt from the market. D/E ratio further reduced to 1.05 in 2008 after Ranbaxy retired debt amounting to approx `3,400 crore after the stake sale to Daiichi Sankyo. Interest coverage ratios are also very high ranging 6.6-9.29 from 2005 to 2009 when compared to the alarm levels of 1.5. Interest coverage ratio was negative in 2008 as Ranbaxy reported a loss
owing to the reasons mentioned above but this can be regarded as a one off case and should not have much of an impact as the ratio improved to an impressive 27 in 2009.
35 30 25 20 15 10 5 0 -5 -10 -15 Int Coverage Ratio D/E Cash Flow (in Rs million) 12000 10000 8000 6000 4000 2000 0 -2000 -4000
2005 6.66 0.43 2037.23
2006 8.58 1.35 5292.37
2007 9.29 1.38 10232.44
2008 -10.1 1.05 -1520.21
2009 27.9 0.85 -1621.25
Figure 2: D/E Ratio and Interest Coverage Ratio Thus Ranbaxy has a healthy position as far as debt is concerned. Ranbaxy’s Cash position stands at ` 12,416 crores and net current assets at ` 18,973 crores (Dec 2009). Ranbaxy is in a comfortable position to repay the FCCB holders who chose to redeem either through cash aur by taking debt. Stock Price: FCCBs provide investors the option of converting their bond at a fixed conversion price into common stock after maturity. The conversion price is at a premium to the existing market price at the time of issuing debt so that the investors convert their debt into equity and can make capital gains by selling the stock in equity market. In this way the issuing company is saved the burden of redemption of debt which can place a huge strain on its cash position at the time of maturity. Ranbaxy’s FCCB had a conversion price of ` 716.32 per share at the time of FCCB placement but it was revalued to ` 555 per share in 2008. The stock price at maturity i.e. March 2011 should be higher than ` 555 for the investors to convert their FCCBs into equity otherwise they would want to redeem their bonds at par value, putting a huge cash burden on Ranbaxy ` 19.5 billion (approx) Ranbaxy stock’s price slipped to the levels of `133 in March 2009 but since then has staged a strong rally to trace `500+ levels in Dec-Jan after which it has shown consolidation in the 430450 range. Therefore, Ranbaxy stock has to appreciate nearly 20% from now till March 2011 (when the FCCBs mature) to make it attractive for conversion. With the economy on the rise
and Ranbaxy showing strong performance in the first half of 2010 (42% revenue growth and posting profit after loss in 2009 YoY) the prospects for the stock looks good.
Figure 3: Ranbaxy's Stock Price post FCCB placement
TATA MOTORS
After it’s rechristening from Telco to Tata motors, one of the earliest decision of this Indian automaker was to settle its high cost debt in 2003. So, it decided to go through the FCCB route and it raised 100 million USD to repay the debt. Since then, it had issued three more notes, one for the YEN currency and rest two were for USD currency only. The details of the notes are mentioned below:? April 2004 ? ? ? ? ? ? tranche I: $300-million conversion price INR 780.40 maturity on March 28, 2011 tranche II: $100 million conversion price of INR 573.10 maturity on March 28, 2009
This offering had an innovative dual tranche bull-bear structure, according to investment bankers. This was the first ever multi-tranche convertible offering by an Indian company with
the first tranche being the first ever negative yield structure offered by an Indian company and the second tranche achieving the longest tenure of seven years and the highest conversion premium of 60 per cent for an Indian convertible offering. ? March 2006 ? ? ? ? ? ? July 2008 ? ? ? ? ? raised $490 million conversion price INR 960.96 maturity comes on June 12, 2012 Repurchased 170 Zero Coupon Convertible Securities at avg. price of 50.375%. Outstanding bonds reduced from $490 million to $473 million. Excerpts from a Tata motors report in 2008 is given below ?
1% (due Issue Issued on Issue Amount (INR amount at the time of the issue) Face Value Conversion Price per share at fixed exchange rate (Note 1) Exercise Period after June 7, 2004 to June 7, 2004 May 2, 2006 to 2008) US (Rs. $ FCCN 0% (due 2009) 100 US million 4,615.6 (Rs. million) US $ 1000 $ FCCN 1% (due 2011) 100 US $ FCCN 0% FCCN (due 2011) 300 JP million million) JP ¥ 10,000,000 1001.39 ¥ 11,760
$100 million raised in Japanese Yen (JPY 11760 million) convertible at INR 1,001.39 maturity on February 19, 2011 repurchased 30 Zero Coupon Convertible Notes at an average price of 54.27% outstanding bonds reduced from JPY 11760 Mn to JPY 11460 Mn
July 31, 2003 April 27, 2004 April 27, 2004 March 20, 2006 million million) US $ 1000 Rs. million million) US $ 1000
4,385.0 (Rs.13,155.0 (Rs.4,500.3
250.745 Rs. US $ 1
573.106 Rs.
780.400 Rs. Rs.1 = JP ¥ 2.66
US $ 1 = Rs.46.16
US $ 1 = Rs. 43.85
= Rs.43.85
September 11, March 28, 2009 to 2003 upto July 1, 2008 Early redemption at the on or after on subject conditions to certain or after Not Applicable and March 2011
February 28, 2011
19,
(i) after March 20, 2009 but prior to February 8, 2011 (in whole or in part) subject to certain conditions or (ii) any time (in whole but not in part) in the event of certain changes affecting taxation in India
option of the Company July 31, 2006 April 27, 2005 (in whole but not in part)
Redeemable on the Principal Amount Amount converted
July 31, 2008 April 27, 2009 April 27, 2011 March 21, 2011 95.111% $ 121.781% 95.59 Nil 99.253% Nil
Redemption percentage of 116.824%
US $ 99.94 US million
million 73,13,842 4,410 3,37,422 3,00,000 1,68,56,740 1,176 44,14,916
Aggregate conversion into 1,83,98,095 Shares / ADSs Notes Outstanding as at 60 March 31, 2008 (Note 2) Aggregate on amount of 11,045 of shares that could be issued conversion outstanding notes
Developments of the issue ? All these were successful in getting in the confidence of the investors and in turn raised capital successfully. But then the financial crisis brought a sharp decline in market prices of its stocks. And thus, the chances of investors converting the notes into equity on maturity looked bleak. With share price of Tata Motors having fallen by around 80 per cent in 2008, the market assumes that the higher conversion prices of FCCBs will increase debt burden in the books. On January 1, 2008, Tata Motors’ share price was at Rs 741.45, while it fell to Rs 159.05 on December 31, 2008. Thus, adjustments were
asked to be made for the same. The prices were being reviewed and all these adjustments are being made because of ‘reset clauses’ attached to the convertible bonds, according to which the conversion price is revised downward when the company’s share price falls below a pre-determined level. If the share price is below the conversion price, the high likelihood is that the bonds would not get converted into shares and would end up as debt on the company’s books. ? On 15-Apr’09, Tata Motors share prices jumped 12.41% to INR 283.50 on BSE after the company repurchased and extinguished its US and Japan listed foreign currency convertible bonds at 50% discount Analysis Impact on EPSAs can be seen from the graph, most of the years, the FCCB option has been dilutive in nature except for 2008, when the markets crashed. Most of the years, there is no major difference between diluted and actual EPS, suggesting that the issues did not dilute the EPS as much as expected. In 2009, the sudden rise or the bounce back in EPS and diluted EPS is attributed to the easing of RBI guidelines on FCCB issue where a company can buy back its notes before maturity (made in December 2008). Tata motors followed suit and repurchased some of its notes on profit that is discount to the original share price. This came as a good exit option for the investors as well.
80 60 40 20 0 -20 -40 -60 -80 EPS (`) Fully DEPS (`)
`/share
2004 27.88 25.65
2005 34.38 32.23
2006 56.43 53.54
2007 56.24 51.31
2008 -56.88 -56.88
2009 48.64 44.65
Debt position As can be clearly seen from the ratios, they are particularly low for the company, thus tata motors can borrow more money and so, it is the plan phase of issuing more FCCB notes in future. The interest coverage ratio dipped in the financial year 2008 owing to the financial crunch and it started picking up in the following year. Even the cash flows were consistent throughout the years and hence shows the financial leverage the company holds and which it can utilise.
10 9 8 7 6 5 4 3 2 1 0 D/E Int Coverage Ratio
2004 0.47 8.58
2005 0.49 8 2.005
2006 0.36 7.98 1.119
2007 0.41 6.23 0.826
2008 0.51 1.68 2.397
2009 0.66 2.59 0.668
Cash Flow(in '000 crores) 0.77049
Stock pricesFrom the figure given below, the stock price of TATA motors was much in line with that of Sensex over the years. In starting of 2006, there was a sudden rise owing to the policies followed by the company and even in 2009; there was the sudden rise due to the repurchase of the securities. In 2008, market price fell to 150 ranges, speculating less chances of conversion of the bonds and thus increasing the debt burden on the company. But latest prices suggest that the company can continue the route to raise capital for its future plans and expansions.
Stock price movement vis-à-vis Sensex (2003-2009) In certain specific cases, stock prices show huge volatile movements in intra-day segment as well when key decisions are taken by the company in this regard. For example on March 23 this year, the company had offered to convert bonds worth $431 million into shares about a year before they mature. The company’s share price fell 3 per cent because the conversion would dilute the company’s share capital by 4.3 per cent.
Conversion impact on stocks This was done to reduce the debt as there is lot of redemption pressure on the company after the meltdown and also, the fact that buyback window had been closed. Road ahead The notes early conversion offer made by Tata Motors in March this year looks like a win-win situation for note holders and company. Redemption options on its yen and dollar denominated FCCBs due March and April 2011 offers the bondholders an incentive to convert it to equity. For the company, the conversion is equity dilutive in the short term. This move is a step in its latest endeavour to lower its net debt which stood at 23100 crore in December 2009. The conversion will strengthen the balance sheet by increasing equity capital. Bondholders also have an option to convert into GDS for dollar denominated bonds and ADS for yen denominated bonds. But due to the new ratios applied, additional dilution is estimated to be around 1 percent and conversion into equity will add about 30 million shares. This combined with the steady sales of Jaguar-Land rover calls for a strong growth outlook for the company as Debt-equity ratio will fall off to lower levels after this.
RELIANCE COMMUNICATIONS
Reliance Communications is India’s second largest mobile phone service provider. It raised a total of $1,500 million through two FCCB issues – one in 2006 and the other in 2007. The details of these issues are given below: 2006: ? ? Total Amount Raised No of bonds Issued : $500 million : 5 Lakh
? ? ? ? ?
Price of each bond Maturity Coupon Conversion Price Listed on
: $1000 : 5 years and one day(May 2011) : Zero : Rs 480.68 : Singapore stock exchange
The proceeds were used to refinance the old loans and for expansion. The conversion price was 50% more than the previous day’s closing price. If all the bonds are converted, then the company will have to issue 4.62 crore equity shares with a face value of Rs 5 each. 2007: ? ? ? ? ? ? ? ? Total Amount Raised No of bonds Issued Price of each bond Maturity Coupon Conversion Price Yield Rate Listed on : $1 Billion : 5 Lakh : $1000 : 5 years and one day(Feb 2012) : Zero : Rs 661 : 4.95% : Singapore stock exchange
The book runners for this issue were JP Morgan and HSBC. The issue was sold across Asia, Europe and the US and was over-subscribed by 3-4 times. They traded at a premium in the aftermarket, which illustrates strong demand. Proceeds from this issue were earmarked towards Reliance Communications’ capital expenditure of $2.5 Billion during 2007-08. The company was planning to expand its telecom network by adding new 20,000 towns across the country. Buyback: The company bought back FCCBs worth US $25 Million on Dec 29, 2008(250 FCCBs) and US $10 million (100 FCCBs) on Jan 10, 2009. The 100 FCCBs buyback resulted in a saving of Rs.1, 586 lakh which has been reflected as part of Other Income. At the time of buyback, the gap between the share price of RCom and its conversion price was less and hence, it was an opportune time for the company to buyback. Bonds were trading at 35% discount to the issue price. It means that the worth of the bonds has come down to US $650 Million from $1 Billion. It also had Rs 10,000 Crore in cash reserves. The buyback will reduce its liability and forex exposure. The amount of FCCBs repurchased by the company will
determine not only the gains to the size of the discount, but also the extent of reduction of debt from its balance sheet.
Dilution of EPS:
35 30 `/Share 25 20 15 10 EPS Fully DEPS 2007 17.56 16.71 2008 26.32 24.97 2009 29.29 28.05
As can be seen, the EPS has been steadily increasing. In 2009, the company has bought some of the outstanding FCCBs and hence the dilution has reduced. D/E Ratio, Interest Coverage Ratio and Cash Flows Figure 2 below shows Ranbaxy’s Debt Equity ratio, Interest Coverage Ratio and cash flows over the period 2007-2009. The D/E ratio increased from 0.47 to 0.77 because of FCCB issue. And then it reduced to 0.67 after the buyback. The D/E ratio is not very high.
0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 D/E Cash Flow in '000 Crs Int Coverage Ratio
2007 0.47 7.200640137 6.3
2008 0.77 0.878179993 3.99
2009 0.67 1.682900024 2.49
16 14 12 10 8 6 4 2 0
Figure 4: D/E Ratio, Interest Coverage Ratio and Cash Flows
The dip in the cash flows in 2008 and 2009 can be attributed to the buyback. The D/E ratio increased after the FCCBs were issued. Future Course of Action:
RCom has sufficient cash flow from operations to redeem FCCBs at maturity and hence need not perceive FCCB non-conversion as a risk to company. The cash flow from operations at the end of 2009 was Rs 1682.9 Cr. In case the conversion happens, it would be positive for the company, as dilution would occur at Rs 480 a share and Rs 660 a share. The dilution impact would be limited. Restructuring of FCCBs seems unlikely in case of Reliance. With a debt of about Rs 19,800 crore, raising further debt to repay the $340 million (about Rs 1,530 crore) by May 2011, also seems unlikely.
Suzlon (Market Capitalization: 10859.27) SEL on May 16, 2007 launched and priced a Foreign Currency Convertible Bonds (FCCBs) issuance for an amount of USD 300 million. The proceeds of the Bond will be utilized to fund Suzlon's various Growth Initiatives. The FCCBs, which have a maturity of 5 years and 1 day, are convertible at a conversion price of Rs 1,800 per share, (as adjusted from time to time) which is at a premium of 59.59% over the volume weighted average price (VWAP) of Rs 1,127.90 on the BSE on May 16, 2007. The FCCBs are zero coupon bonds with a yield to maturity of 7.60%, calculated on a semi-annual basis, at the end of 5 years and 1 day if not converted into shares during the period. The bond will have a Mandatory Conversion feature after 24 months. The FCCBs are expected to be listed on the Singapore Exchange Securities Trading Ltd. Deutsche Bank acted as the Sole Book runner to the transaction; and Yes Bank Ltd. has acted as an advisor to the Company. Developments of the issue ? India's largest wind turbine supplier has restructured its foreign currency convertible bonds (FCCBs). It has USD 211 million and USD 121 million bonds due in June and October 2012. The conversion price has been decided to be between Rs 95 and Rs 100 per share (according to latest Business Standard reports). Its earlier FCCB price conversion was at Rs 360 and Rs 370 per share. Suzlon will become the first company to reset the conversion price of FCCBs after the finance ministry relaxed the guidelines for companies to price their bonds based on share prices of the past six months. The covenants have been relaxed for the entire tenure. Suzlon will pay 1% fees to
bondholders for the waiver. The new price is likely to produce a dilution of 9.5% for the company. ? For the two sets of FCCBs worth $300 million and $200 million issued by the company, there were three main financial covenants. These three were – First, net borrowings to tangible net worth cannot be more than 1.5 times. Secondly, the full-year EBITDA cannot be less than 1.33 times the debt service coverage requirement, ie, repayment and service cost. Third, net borrowings to net EBITDA should not be more than four times. The last three quarters has not been beneficial for the company with the profit not being able to meet the borrowings and hence this has invited wrath from the shareholders. Suzlon had reported an EBITDA of Rs 408 crore in the nine months to December 31, 2009 down from Rs 1,996 crore a year earlier. ? In April last year, the company had fixed conversion price of Rs 76.67 per share for the bonds at an exchange rate of Rs 49.81. The $3 billion zero coupon convertible bonds issued on June 11, 2007 is due in June 2012 and $2 billion zero coupon convertible bonds, issued on October 10, 2007, are due in October 2012. The board of directors has decided to conduct a postal ballot seeking the approval of shareholders for the reduction in FCCB conversion price.
Analysis Impact on EPS As seen from the figure, there is not much difference between EPS and Diluted EPS, so it can be safely stated there has not been much conversion into equity in these bonds over the years. This was also attributed by the fact that there have been revisions of the conversion price so that investors stay invested. In 2009 figures, there has been a drastic fall owing to the financial crunch. Also, the impact of relaxation of guidelines from RBI is seen as an impact on these figures in the chart.
40 35 30 25 20 15 10 5 0 -5 -10 EPS (`) Fully DEPS (`)
2006 28.57 28.51
2007 37.65 36.82
2008 9.31 9.47
2009 3.62 -3.13
Debt position The ratios related to debt that is the debt to equity and interest coverage ratios are not favourable for the company in the recent past. The D/E ratio has increased while interest coverage ratio has dipped suggesting the company is not in shape to finance its future projects effectively. Cash flows also suggest that company issue more bonds to raise capital .
2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 D/E Int Coverage Ratio(*10) Cash Flow(in '000 crores)
2006 0.18 1.754 0.316
2007 0.23 1.252 0.351
2008 0.4 1.203 0.779
2009 0.77 0.198 0.07
Stock prices
Over the years, Suzlon stock has underperformed with respect to the Sensex. And with time, the gap has widened which shows the company is not taken well by the investors and it requires that the management take actions to win back the investors.
Mahindra & Mahindra Ltd.
Mahindra & Mahindra is one of the largest conglomerates in India and has currently issued FCCBs worth $ 189.5 million ? ? ? M & M has substantial outstanding FCCBs having issud $200 million FCCBs in 2006 and $100 Million FCCBs in 2004 After changes in regulation Mahindra & Mahindra has been buying back FCCBs that it had issued earlier and were due for redemption in 2011 and later. Earlier the company had issued FCCBs with zero coupon and 5 year maturity periods but the global downturn and plummeting stock prices had caused the company’s stock price to below the redemption price ? The company would have had to pay a larger amount to the bondholders as they would be redeemed at the set price and the debt burden of the company would go up because of this. Key reasons for the issue included global expansion plans and possible acquisitions overseas & for Rupee Expenditure in Capital Goods (CG)
2006: ? ? ? ? ? ? ? ? ? Total Amount Raised No of bonds Issued : $200 million : 2000
Face value of each bond : $100000 Maturity Coupon Conversion Price
Current Price YTM
: 5 years : Zero : Rs 922.04
: Rs 664.22 : 3.86%
Book Runners
: JM Morgan Stanley Ltd and Kotak Investment Banking
The proceeds were used to up gradation of existing facilities , expansion in current manufacturing facilities and acquisition of at an international level. 2004: ? ? ? ? ? ? ? ? Total Amount Raised No of bonds Issued Price of Bonds Current price of share Maturity Coupon Conversion Price Book Runners : $100 million : 1000 :$100000 : Rs 472.30 : 5 years : Zero : Rs 647.05 : ABN Amro Rothschild and Kotak Investment Banking
The proceeds were used to product development, upgrading and expansion of the existing manufacturing facilities and expansion through internal expansion and acquisitions abroad. Buyback: In recent times the economic turmoil and falling stock prices have been a major source of worry for the company as there will be no conversion of FCCBs if the GDR prices are less than the bond price and then the investors will go for redemption of the bond instead of conversion. This leads to an increase in the burden of debt for the company and can have an adverse effect on future borrowings of the company as well as on current financials. Hence a buyback of previously issued FCCBs are done by the company at a date before the redemption date for the bond. The company has sped up the process of buying back its FCCBs and in 2009 bought back shares worth $4 Million yet still has considerable convertible bonds outstanding.
Dilution
of
EPS:
Chart Title
50 40 30 20 10 0 EPS Dil EPS EPS & Dil EPS
2007 45.15 40.94
2008 46.24 41.52
2009 31.83 30.02
The role of foreign currency convertible bonds in dilution of EPS is critical as the exercise of the option by the bondholder’s leads to an increase in the number of shares and if the proceeds from shares are less than the earnings there is a dilution in the EPS and the value goes down. Besides the use of FCCBs there are numerous warrants and convertible bonds as well as other mixed instruments which give the option of conversion to the bond holder and may lead to dilution of EPS hence the dilution is only in part due to the effect of conversion by FCCB bond holders.
D/E
D/E over the last 4 years 0.80 0.60 0.40 0.20 0.00 D/E 2007 0.39 2008 0.54 2009 0.69 2010 0.53
Interest Coverage Ratio
80 70 60 50 40 30 20 10 0 Interest Coverage Ratio
Axis Title
2007 72.64
2008 14.79
2009 8.96
2010 19.15
As can be seen, the EPS has been steadily increasing. In 2009, the company has bought some of the outstanding FCCBs and hence the dilution has reduced.
D/E Ratio, Interest Coverage Ratio and Cash Flows
The dip in the cash flows in 2008 and 2009 can be attributed to the buyback. The D/E ratio increased after the FCCBs were issued. The company has been aggressively buying back it’s convertible bonds over the past couple of years to avoid redemption and maintain D/E ratio and this has led to a decrease in the cash flows as a result of buy back. Future Course of Action:
Monthly data for MNM stock over the past 4 years on the BSE shows the problem incurred due to a dip in stock price levels during late 2008 and early 2009 making the conversion option for convertible bonds highly unlikely. Stock prices on Indian exchanges and global GDR prices are highly co related hence conversion of FCCB into GDRs were unlikely prompting the company to buy back such bonds before conversion to equity. But clearly with resurgence in prices the company need not in invest cash in buying back its own bonds and can consider FCCB issue for future source of financing
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