BNP Paribas’ latest India strategy report lists its diverse pluses.
At a time when stocks of most companies are facing tremendous downward pressure, foreign currency convertible bonds, or FCCBs, may be an effective alternative for the investor community. According to BNP Paribas’ latest India strategy report, FCCBs are likely to offer capital appreciation opportunities, along with principal protection.
FCCBs, as the name suggests, are a type of convertible bonds issued by a company in a foreign currency and comprise a mix of debt and equity. An FCCB holder receives regular coupon payments and has the option of converting the bonds into equity shares.
| AN ALTERNATIVE ROUTE | ||||
| Company | Yield to maturity (%) | Conversion price (in Rs) | CMP (in Rs) | Premium to conversion price (in %) |
| Reliance Comm | 26.1 | 668.3 | 73.2 | -89 |
| Suzlon Energy | 23.2 | 97.2 | 37.8 | -61 |
| JP Associates | 22.4 | 182.5 | 75.7 | -59 |
| Videocon | 18.6 | 236.0 | 169.0 | -28 |
| Everest Kanto | 17.9 | 303.6 | 72.4 | -76 |
| Gitanjali Gems | 16.9 | 218.6 | 346.2 | 58 |
| Rolta India | 16.5 | 403.4 | 82.9 | -79 |
| Great Offshore | 16.2 | 559.8 | 124.5 | -78 |
| Shiv-Vani Oil | 14.5 | 488.2 | 195.9 | -60 |
| Source: Bloomberg | ||||
“Some FCCBs are pricing in significant financial distress. We believe these FCCBs may offer good capital appreciation opportunities, along with principal protection,” say Manishi Raychaudhuri and Gautam Mehta of BNP Paribas, in a report released in Monday. The brokerage has also short-listed companies that offer a yield to maturity of over 15 per cent and might need to access the capital markets in the near future (see table).
Meanwhile, data compiled by the BS Research Bureau shows the first round of redemption of FCCBs has progressed smoothly for India Inc, despite the volatility in global markets. At least 15 companies have paid investors around $2 billion during the first half of 2011. There are currently 135 FCCB issues worth $10.6 bn. Of these, 45 issues amounting to $3.32 bn are set to mature over the next one year.
The foreign brokerage feels that as risk aversion wanes, FCCBs may no longer price a 'bankruptcy' or significant principal haircuts, providing significant capital appreciation opportunities for investors. It views Reliance Communication, Suzlon Energy, JP Associates, Videocon Industries, Rolta India and Great Offshore as ‘safe’ FCCBs.
“The bond market seems to be discounting a situation where these companies would default on their FCCB repayment commitments or force bondholders to accept significant principal haircut. While such possibilities could arise for some companies, we believe a majority of these companies are not potential defaulters,” says the report.
Interestingly, in an earlier note in July, BNP Paribas had said non-conversion of FCCBs issued by Indian companies could lead to significant stress on the balance sheets of some of those companies. In its latest report, however, the global financial major has focused on the FCCBs themselves, with a special emphasis on the yields they are trading at. Some of these FCCBs seem significantly undervalued and, hence, could generate significant capital appreciation, says the report.
The French major further feels that the advantage of investing in a convertible bond is the principal protection it offers, with the only exception being a bankruptcy scenario. It, however, adds that since a defaulting entity is bound to lose access to international capital markets, companies foresee liquidity problems and restructure their convertible bonds in return for more favourable terms to bond holders, like higher coupon payments.
The brokerage cites the example of Tata Steel, that rolled over its convertible bonds maturing in September 2012 to November 2014 and increased its coupon rate from one per cent to 4.5 per cent. On a different note, it says some companies may prefer to default, either as a negotiating tactic or because they do not intend to access international capital markets.
According to the foreign entity, the only recourse for investors in such instances is through the slow and unpredictable Indian legal system. "There are two such ‘winding up’ petitions against Wockhardt Pharmaceuticals and Cranes Software currently," highlights the report, adding that "this underscores the need to select appropriate FCCB‘s for investment".
