FCCBs were perceived as low cost source of foreign funding and a host of companies tapped this channel over FY06-08. Most weak players such as Gati, 3i Infotech and Suzlon have defaulted/restructured their FCCB obligations as their business fundamentals faltered with the slowing economy and depreciating currency. Link to FCCB lure - How corporate failed?

Let us consider the case of Jaiprakash Associates, the leading cement and construction group,

which raised US$400mn in Sep-07 through FCCBs. It was a zero coupon bond with a redemption premium of 47%, representing an interest rate of 8% per annum i.e. in-case the FCCBs were not converted into shares, the company would have to re-pay US$588 upon maturity in Sep-12. The share price at the time of issuance was Rs. 145 and the conversion price was fixed at Rs. 165. The exchange rate prevailing at that time was Rs. 40/US$.

As the chart would tell us, the stock markets and business outlook for Jaiprakash Associates, both looked very promising. The stock price went much above the FCCB conversion price within months of the issuance in 2007. The rise in stock was momentary and it corrected severely over 2008 as the credit crisis unfolded. Although a recovery followed, the price never reached the conversion price again. This was because the outlook for the company business had moderated there was oversupply in cement space, road projects faced numerous hurdles and company debt had ballooned due the huge capex it undertook in 2007-10. As a result the share price remained well below the conversion price and conversion to equity never took place (except an insignificant quantity that was converted in 2007 itself)

In the meantime, India macro outlook, too, deteriorated in 2011-12 and its currency depreciated to Rs. 55/US$ and the company had no option but to re-pay the entire loan. The funds required for repayment were raised partly through internal accruals and partly through a fresh FCCB issuance.

*actual amount re-paid was US$523mn or Rs. 2,800cr since the company had re-paid some amount in 2009. However the effective interest rate calculation remains unaffected

Jaiprakash Associates, being a large company with strong balance sheet, was able to wither the FCCB time-bomb. Companies like Suzlon Energy, Subex Systems, Gati, Zenith Infotech, Cranes Software, GTL Infrastructure, etc had raised FCCBs in the bull market of 2005-2007. They were the darlings of the stock markets then and their promoters had abnormally high confidence in their stock prices. Over the years, they not only lost their market standing but also had no capacity to repay the amount due to their highly leveraged balance sheets and deteriorating business outlook. Currency depreciation only added to their woes.

Prospero Tree view

At Prospero Tree, we are of the opinion that a general approach of avoiding companies that have high debt to equity will do more good to your portfolio than otherwise. For an average investor who has little time to go through balance sheets and understand the business outlook, it is a wise thing to avoid non-government companies with debt-equity greater than 1. Our stock research process will certainly eliminate companies where balance sheet risks are high and ensure our investors dont get a nasty shock on their investments.

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