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By Abhimanyu Bhattacharya and Aditya Cheriyan
The drone of convertible bonds: Sounds like a good deal
India was one of the fastest growing convertible bond markets during 2006-2007. Indian listed companies had issued FCCBs worth USD 20 billion by 2009. FCCBs are foreign currency denominated debt instrument with an option provided to the bond holders to convert such bonds into equity shares of the issuer at a pre-determined conversion price. FCCBs that have been issued are typically zero coupon but offered the potential upside of equities which made it an attractive option for companies to raise low-cost debt and provided investors a higher participation in the upward movement of the underlying stock. A FCCB transaction can be launched fairly quickly. While domestic capital market options such as follow-on offers or rights issues requires the issuer to follow an elaborate regulatory process which could take between 4-6 months, a FCCB transaction could be completed within 45-60 days. The allure of raising funds quickly and cheaply was too good to resist. The qualified institutions placement route which was introduced in 2006 was nascent. The probability of a market crash could have been an urban legend during 2006-2007.
Rattle and hum: Did you hear the market fall?
The sub-prime crisis and the collapse of Lehman Brothers and Bear Sterns in 2008 amongst other banks and financial institutions started a race to the bottom with major markets indices in the red and the global economy preparing to enter a phase of recession. Indian markets had been strongly beaten down and foreign funds started leaving Indian shores. The stock prices of Indian companies who had issued FCCBs were trading at a 50-60% discount to conversion price of their FCCBs. This kept investors away from conversion. The burning optimism that market prices of the equity shares would be at an attractive premium to the conversion price was dying and Indian companies needed to focus on refinancing and redemption pressures ahead.
The Reserve Bank of India responded to the woeful situation faced by FCCB issuers in 2008 by providing a window for Indian companies to buy back their outstanding FCCBs at a discount to the book value. A handful of Indian companies were proactive and made use of this window to buy-back some of their outstanding FCCBs and certain investors sold FCCBs at steep discounts to the book value. The extent of the non-convertible pain came to a head in 2009 when Wockhardt Limited defaulted on the prepayment of its FCCBs to the tune of USD 110 million. Bondholders filed suits for winding up in the Bombay High Court. The High Court ordered a stay on the company from selling its assets and a repayment schedule was drawn up to repay the bondholders by August 2012.
India Inc. on Redemption Row
In the fiery year of the dragon as significant amount of FCCBs come up for redemption, Indian companies are running helter skelter in their bid to deal with scorching redemption pressures. News reports indicate that approximately USD 5 billion is due for redemption in 2012. This comes at a time when the rupee has depreciated against the dollar making redemption an expensive affair. In this article, we analyse buyback and redemption routes available with Indian companies to restructure or redeem their outstanding FCCBs.
Buying back the bonds:
The process of doing a plain vanilla buyback of bonds involves either an open market purchase or a tender offer. The buyback through an open market process involves the appointment of an agent (usually an investment bank) who will approach selected bondholders and conduct the buyback process. The tender offer route (not common) is somewhat complicated since a tender offer needs to be implemented under the rules of the overseas market and such offer typically needs to be made to all bondholders.
The RBI currently permits Indian companies to buyback outstanding bonds under the automatic route with a minimum discount of 8% of the book value and by utilisation of either foreign currency funds or fresh foreign currency borrowings under the ECB route. The RBI has permitted Category I authorised dealers to authorise the buyback transaction. In the event, Indian companies choose to borrow funds under the ECB route for purposes of the buyback transaction and is co-terminus with the outstanding maturity of the FCCB that is to be bought back, the all-in cost limits cannot exceed 6 months LIBOR plus 200 bps. In other cases, specified all-in cost ceilings for relevant maturity periods which have been prescribed by the RBI will apply.
Indian companies are also permitted to utilise their internal accruals to buyback bonds up to USD 100 million with specified minimum discounts for redemption value bands. For example, minimum discount of 10% of book value for redemption value up to USD 50 million and minimum discount of 15% of book value for the redemption value over USD 50 million and up to USD 75 million. The RBI has not clarified the manner in which the ‘book value’ needs to be computed. Book value can be computed either on the basis of the face value of the bonds or on the accreted value i.e. the face value of the bonds and interest accrued up to the time of the buy-back.
While, the buyback route has been used by a number of Indian companies to extinguish or reduce their bond liabilities, this route may not be useful for companies that need to redeem their bonds this year. Bondholders who have their bonds up for redemption this year may not necessarily agree to be bought out at discount given that they are entitled to receive the entire redemption amount including yields on their investment. The window for buying back bonds expires on March 31, 2012. However, the RBI has been periodically extending this period and one hopes that the RBI will do the same this year.
The RBI made an attempt to ease redemption pressures in July 2011 by permitting Indian companies to borrow monies under the ECB route or issue fresh FCCBs up to USD 500 million (under the automatic route) to refinance or redeem existing FCCBs subject to certain conditions. Indian companies are permitted to borrow such amounts (maturity periods and all in cost ceilings prescribed under the ECB regulations will apply) which cannot exceed the outstanding redemption value of the FCCBs on maturity. Indian companies are not permitted to borrow monies under this route six months prior to the redemption date.
The RBI has not permitted Indian companies to make any changes to the conversion price of the existing FCCBs. The RBI clearly indicated that proposals for restructuring FCCBs which does not involve a change in the conversion price can be considered under the approval route. The RBI had briefly permitted Indian companies to change the conversion price in 2010 (six months). The current restrictions to changes in conversion price practically means that Indian companies need to resort to fresh borrowings whether under the ECB route or otherwise to refinance or redeem the outstanding bonds. Indian companies have had a difficult time in arranging funds for this purpose on account of high borrowing rates and weak debt-equity ratios. The problem is accentuated on account of the sharp fall in the rupee in the last few months. Indian companies that have not hedged themselves against foreign exchange losses may have to bear these losses when they borrow monies to refinance or redeem their outstanding bonds.
Indian companies have utilised various routes under the buyback/refinancing framework of the RBI to restructure their outstanding FCCBs. Some of these methods have included an offer to swap of new bonds for existing ones where investors are provided with better coupon but the conversion price takes into account the issuer’s current stock price or a combination of swap and buy-back offer where bondholders can either choose to accept new bonds or be bought out.
Look before you leap: A cautionary tale for convertible bond issuers and investors
While, a number of Indian companies have been able to use the buyback/refinancing framework to reduce their debt, some others have not been fortunate. Bondholders resorted to liquidation proceedings when Wockhardt was unable to redeem its bonds. The Bombay High Court ordered the Wockhardt to pay bondholders within a stipulated schedule. Bondholders have not been fortunate where their investee companies have gone into liquidation. Bondholders’ rights to recover their dues in this case (as unsecured lenders) come after that of secured lenders and payment of statutory dues. There are other Indian companies who are wrestling with redemption pressures on account of ‘cross-default’ clauses that have triggered their redemption obligations. A handful of Indian companies are in litigation with various bondholders. The current fiasco illustrates that FCCBs have proved to be a ‘double-edged sword.’ The global investor community is keenly watching events unfold as Indian companies hunker down and deal with the redemption pressure.
Abhimanyu Bhattacharya is a Principal Associate and Aditya Cheriyan is a Senior Associate with Amarchand Mangaldas.