Chickens come home to roost
Sep 30 2012
The spectre of FCCB redemption returns to haunt investors as cumulative debt worth $1.3 billion is going to fall due during Oct-Dec
Rating agencies such as Fitch, Standard & Poor’s, Crisil and brokerages Kotak Institutional Equities have been cautioning investors about the looming FCCB threat, perhaps an indication for them to exit these stocks before the situation deteriorates. In fact, London-based KNG Securities warned on the FCCB threat way back in February 2011, in a report aptly titled, “Are the chickens coming home to roost?”
A quick recap on how Indian companies landed up in the FCCB mess is in order for the uninitiated. A large number of Indian companies raised cheap debt during the bull run in Indian stocks from 2006 to 2008. The market crash in January 2008, triggered by the global financial crisis and subsequent weak economic environment, resulted in stock prices trading well below (in several cases 50-80 per cent) conversion prices. This added to redemption pressure on the companies in question, as converting the bonds into shares would be a big loss-making proposition for foreign investors.
The bonds are usually US dollar-denominated, and have fixed maturity dates and low interest rates (zero per cent in many cases). Investors have an option to convert the bonds on maturity into equity shares at a predetermined price. “This strategy helped companies get low-cost foreign currency loans for overseas acquisitions or expansion. Issuers and investors expected India’s stock market to continue to rise and prices of the companies’ stocks to exceed the conversion rates when the bonds mature. At that point, bondholders could have converted their holdings to equity and the issuers wouldn’t have had to repay them in cash,” explained Vishal Kulkarni, primary credit analyst at Standard & Poor’s, in a report, in early June.
The steep 30 per cent drop in the value of the rupee against the US dollar over the past two years till June exacerbated the problem. “The result is that many FCCB issuers may have trouble finding funds to repay bondholders — and that those that cannot will face payment default,” he had cautioned.
Though biggies like Reliance Communications ($1.18 billion redemption in January), Tata Steel ($547 million in November, 2014), Tata Power ($300 million in November, 2014), Larsen & Toubro ($200 million in October, 2014) and Sterlite Industries ($500 million in October, 2014) will not face problems in arranging refinance, the threats were real for small and mid-cap companies. Despite the huge amount, Reliance Communications, for instance, accessed cheap funding from a consortium of Chinese banks led by Industrial and Commercial Bank of China, China Development Bank and Export Import Bank of China.
Some of the small and mid-cap firms that faced the prospect of default, according to Fitch Ratings, included Sterling Biotech ($183 million), Pyramid Saimira Theatre ($122 million), KSL and Industries ($111.58 million), 3i Infotech ($120 million), Zenith Infotech ($46 million), ICSA India ($62.74 million), KLG Systel ($31.63 million), Ankur Drugs & Pharma ($26.60 million), Gemini Communications ($20.50 million), Pioneer Embroideries ($16.41 million), GV Films ($16.38 million) and Wanbury ($27 million).
Others that also face serious stress and may be forced to restructure with significant distressed exchange include GTL Infrastructure ($320.55 million in November), Subex ($138.21 million in September), XL Energy ($46.60 million in October), Gayatri Projects ($42.34 million in March), Indowind Energy ($30 million in December), Pokarna ($17.34 million) and Murli Industries ($8.23 million in February).
According to Kotak Institutional Equities’ analyst Saifullah Rais, the redemption activity is expected to pick up over the next three months with cumulative redemptions estimated at $1.3 billion. While Suzlon has two more tranches maturing in October, Great Offshore and Everest Kanto Cylinders were among the few other issuers that were to see their FCCBs mature in September.
Clarity on FCCB repayment is still to emerge for the likes of Tulip Telecom ($140 million that matured in August) and Moser Baer ($121.38 million in June), and Sterling Biotech having convened a bondholder meeting in August to consider and approve its restructuring proposal, has postponed the meeting until further notice, says Kotak’s Rais.
According to S&P’s Kulkarni, defaults on FCCBs seem inevitable when issuers are starved for funds and bondholders insist on repayment of their money at maturity. Defaults hamper the ability of the issuers to access international capital markets. Recent defaulters are Wockhardt, Cranes Software International, Aftek, JCT, Venus Remedies, Marksans Pharma, Mascon Global, Gremach Infrastructure Equipments and Projects, Pyramid Saimira Theatre and Zenith Infotech.
“We believe the ongoing court battle between Wockhardt, which defaulted on its $110 million FCCBs in 2009, and investors in the FCCBs could set the tone for such cases. The court directed the company to repay FCCB holders before paying secured creditors of the company. The matter remains pending, with the secured creditors threatening to appeal the court decision. Another ongoing legal case involves Zenith Computers, which defaulted on its FCCBs. The trustee for the bonds (on behalf of the lenders) has filed a winding up petition against the company,” says Kulkarni.
From stock investors’ point of view, the above-mentioned cases are good indication to take a call on investment. With the exception of Wockhardt, which turned around its fortunes in a spectacular fashion, all others are still huge underperformers on the stock market, notwithstanding a 21 per cent rally in the bellwether Sensex this year.
Consider this: Subex is languishing at Rs 13.19 apiece, compared with Rs 66 in January 2011; Moser Baer dived from Rs 51 to Rs 6.77 in the same period, Zenith Computer from Rs 25 to Rs 10, Great Offshore from Rs 300 to Rs 100, Tulip Telecom from Rs 161 to Rs 46, Sterling Biotech from Rs 100 to just Rs 6, Everest Kanto from Rs 70 to Rs 35.70, GTL Infrastructure from Rs 40 to Rs 8.92, Indowind Energy from Rs 22.60 to just Rs 4.25, 3i Infotech from Rs 49.55 to Rs 8.03, Pioneer Embroideries from Rs 21.50 to Rs 8.67 and Suzlon from Rs 50 to Rs 17. The list could go on.
The moral for investors is that, there will be enough cues out there in the market for them to take a call on their investments. The smart investor will use them to exit or enter the stocks in question. The FCCB scare, red-flagged by KNG Securities back in February 2011, was just the kind of information investors required.