Saturday, May 9, 2009

Foreign Currency Convertible Bonds (FCCB)

Companies raise money in many different ways and one of the modern methods is issuing Foreign Currency Convertible Bonds (FCCB). All the money raising methods have some advantages and disadvantages and FCCB is not an exception. Though FCCB method has been in practice for a long time, it came in to prominence in India only in recent decades. Let’s discuss in detail about the FCCB and its advantages and limitations.


What is Foreign Currency Convertible Bond (FCCB)?

Most part of the answer exists in the name itself. Let’s build an explanation from the name.

We will start with Bond. In general Bond is an agreement between two parties. In finance, it’s an agreement (Debt Security) between the issuer (Company) and investors. What is the agreement? Company raises money by issuing bonds to the investors and in return, the company agrees to pay interest / coupon in periodic intervals along with the principal or the whole amount at a maturity date listed in the agreement.

A convertible bond simply means that investors have the option to convert their bonds into common stocks at a previously fixed price (Price is fixed when the bond is issued).

Foreign Currency Convertible Bond is just a convertible bond that is issued in Foreign Currency. So, we can define the FCCB as the following.

FCCB is a quasi-debt instrument that is issued in a currency different than the issuer’s domestic currency with options to either redeem it at maturity or convert it into issuing company’s stock. It gives two options. One is, to get the regular interest and principal and the other is to convert the bond in to equities. It is a hybrid between bond and stock.

Why do companies issue FCCB’s when they are several methods around to raise money?

Companies have following advantages if they raise the money by issuing FCCB.

1) 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.

2) Conversion of bonds into stocks takes place at a premium price to market price. Conversion price is fixed when the bond is issued. So, lower dilution of the company stocks.

3) Simple regulatory process

4) Investors are mostly non-residents or hedge fund arbitrators.

5) Mostly FCCB’s are issued to suit the company needs.

If the benefits exist only for the company, then of course the term FCCB would not even have existed by now. There are benefits for the investors as well and here are few.


What is in it for Investors?

1) Like any other debt instrument, capital protection by guaranteed payments to the bond.

2) Greater return potential if the stock price appreciates more than the previously fixed conversion price.

3) Redeemable at maturity if not converted.


Even though both issuers and investors have advantages, there are some disadvantages as well in raising money through FCCB. What are they?

Limitations

1) FCC Bonds are ideal for the bull market scenario as the conversion occurs at a premium price lowering the dilution. But if the stock price plummet like what we are witnessing right now due to the economic downturn, then investors will not go for conversion and they go for redemption at maturity value. So, companies have to refinance to fulfill the redemption promise and refinancing is not that easy particularly in times like this with lot of credit crunch. Earnings will get hit because of the redemptions.

2) If the investors do not go for conversion, then companies will be forced to lower the conversion price (Previously Fixed) to entice the investors to go for conversion which will lead to higher dilution.

3) It will remain as debt in the balance sheet until conversion.

4) If the exchange rate goes up, then the issuer has to pay more to the investors. So, foreign exchange plays a role too.

5) If the stock price goes below the conversion price, then the issuer loses an opportunity to dilute at a higher price.

Example : Companies that have issued FCCB

Aurobindo Pharma
Hotel Leela
Orchid Chemicals
Tata Motors
Bharat Forge
Suzlon Energy
Amtek Auto
Ranbaxy and many more….

Link: There is a related article in "thehindubusinessline" dated May 10, 2009 and here is the link to get to know about FCCB buybacks.

http://www.thehindubusinessline.com/iw/2009/05/10/stories/2009051050320700.htm

Please share your views in the comments section.

Kumaran Seenivasan

www.stockanalysisonline.com










7 comments:

Amol May 10, 2009 at 2:57 AM  

For a bond investor, if share prices are much higher than conversion price,
company can call the bonds (forecd conersion) which limits capital appreciation potential of bonds

From an investor who has invested ina a company tha thas issued FCCB, he/she needs to study
these aspects carefully.
For example, Tata group of companies have to repay $1.37 billion worth FCCB
with interest in 2011 if these bonds dont get converted. This amount would be showed
as debt in the balance sheet. Also, in bear phase if company lowers the premium because of its reset clauses,
which would mean the greater possibility of conversion, and equity dilution.

Again, investing is all about learning all of these aspects by studying a company thoroughly
and keep a watch on its news
Happy learning :)

Sunil N. Karande May 11, 2009 at 1:19 AM  

Great Sir...Thanks for the information.....you are god of knowledge...sir you are brilliant.

vpoorni,  May 11, 2009 at 9:22 AM  

Dear Mr Kumaran,

Thank you. As usual your post is very good and easy to understand.

SheeL May 14, 2009 at 6:52 AM  

Nice article...

Can you please find the impact of outstanding FCCBs of Bharati Shipyard?
What will be the impact on the financials of the company...? how will it affect the profit of the company...?

RATHEESH.C,  January 6, 2010 at 3:13 AM  

informative....plz discuss about swap in forex

Savitree Singh September 1, 2010 at 2:56 AM  

This is very nicely explained.
Thankx a lot

Anonymous,  July 9, 2012 at 4:44 PM  

good and excellent very helpful article

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