SLATE. All you wanted to know about...FCCBs

Last week, foreign currency convertible bonds (FCCBs) issued by Castex Technologies made headlines after the company compulsorily converted them into shares and earned the ire of foreign investors. If you thought only banks bore the brunt of delays and defaults in loan repayments by Indian firms, think again. Overseas investors, who have lent money to Indian companies in FCCBs, can be left high and dry too, if these firms delay payments or convert bonds into shares at an unattractive price.

FCCBs are bonds issued by listed companies in the overseas market. FCCBs pay interest at a nominal rate. Starting out as bonds, FCCBs usually carry clauses which allow the issuer or bondholder the option to convert the bonds into shares mid-way during its term, at a pre-agreed price.

Often, if the FCCB is issued in a bull market, the conversion price is set high. If the shares drop to levels much below the conversion price, it may cause heartburn to the bondholders. With global interest rates far lower than those in India, domestic companies have found it cheaper to raise money through these bonds.

Once, FCCBs looked to be a win-win idea both for the buyer and the issuer. Foreign investors bought FCCBs because, apart from earning a fixed interest, they got an option to convert those bonds into shares at a fixed price, pocketing a quick gain as a result. Conversion prices were usually set at a premium to current market prices, as it was assumed that the stock price would continue to rise. Companies considered this ‘free money’ which would not have to be repaid as the bonds would inevitably get converted into equity.

But what actually transpired was different. As the market crashed, stock prices of the firms fell 50-70 per cent, and bondholders had no inclination to convert their loans into shares. The borrowing firms were saddled with large foreign currency loans they were badly placed to repay.

To get out of this hole, in 2008, many of them used a ‘reset’ option and slashed their FCCB conversion prices to make it attractive for holders to convert. But this meant much larger equity dilution for their Indian shareholders, as more shares had to be issued to match the debt.

If a company carries FCCBs on its books, you will have to keep an eagle eye on how it meets its FCCB obligation. Take Castex Technologies. This Amtek Group firm last week allotted about 3.9 crore equity shares to its FCCB bondholders at a conversion price of ₹103 a share. These bonds had a mandatory conversion clause which was triggered after the share price of Castex remained above ₹160 for a month. The shares of Castex took a sharp knock after the conversion to ₹40, which meant bonds worth ₹530 crore were now worth less than ₹160 crore of equity shares.

Bondholders have cried foul and said the share price had been manipulated to trigger the conversion clause. Subex, another listed company only recently reset its conversion price on FCCB from ₹22.79 to ₹13 a share, close to its current market price. Non-conversion of FCCBs can pose a risk to investors too. As FCCBs are dollar denominated, a depreciating rupee can bloat these loan obligations.

In a bull market, FCCBs look like a low-cost option for Indian companies to raise funds. But if something looks too good to be true, it usually is.

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