FCCB Outlook: Companies have lined up to buy back outstanding FCCBs

Increasing disparity between the bond conversion price and the market price has resulted in a few companies expressing their desire to buy back outstanding foreign currency convertible bonds (FCCB). Apart from reducing the prospects of an equity overhang, a buyback will help cash-rich companies retire their debts effectively.

Radico Khaitan, Vardhaman Textiles, Man Industries, Jubilant Organosys and Aurobindo Pharma are among the companies keen to buy back their FCCBs, which are currently trading at 25%-plus discount to the conversion price.

Companies opting for (FCCB) buyback are fairly certain that the conversion price will never be reached. Moreover, there are several cash-strapped hedge funds who are amenable for a buyback at a further discount.

A premature buyback arrangement helps the company extinguish debts without hassles.

Recently RBI directive allows companies to buy back their overseas bonds before the maturity period. The decision follows share prices (of companies that have launched FCCBs) dipping way below the pre-decided conversion price, in turn pressurizing companies to redeem the bonds by utilizing own funds or to find out an alternative source of finance.

In the event of bonds not reaching the conversion price (at maturity), the company will have to repay its entire debt (on the bond, including full coupon amount), extend maturity with revised terms or issue additional equity to make good the loss arising on conversion of the bonds into equity.

As per RBI data, FCCBs raised by Indian companies in the past three years totalled $15 billion. According to some report, the maximum numbers of FCCBs were raised in the telecom sector (14%) followed by pharma (13%), IT (12%), metals (9%), construction (7%) and auto (6%) sectors.

In all, 24 FCCBs were out of the money to the extent of 40%, followed by 38 FCCBs, where stock prices were below the conversion prices up to 70% and another 102 FCCBs, where the price discount was in excess of 70%.

We believe that a majority of corporates are unlikely to take advantage of this policy change due to lack of funds and considering the fact that this window is open for just three more months.