Asiamoney, Business, China, India - Fri March 2, 2012

Corporate India’s refinancing woes

Several leading companies face large convertible bond repayments this year. Some may be tempted to simply delay paying the debt, but doing so would badly damage India’s investment appeal. Elliot Wilson reports.

As he stepped up to a lectern to address the media in Mumbai on January 17, Anil Ambani’s broad grin was tinged with relief, and for good reason.

Just the day before, the billionaire media mogul’s flagship mobile division, Reliance Communications (RCom), had looked distinctly wobbly.

Weighed down by debts of US$7.2 billion and with its shares trading at historic lows of between INR60-INR70 just weeks earlier, RCom had been facing a refinancing crisis. It needed US$1.2 billion to pay off a 2007 foreign-currency convertible bond (FCCB), due on March 1.

Salvation came from an unlikely source: a trio of Beijing-based lenders including Industrial and Commercial Bank of China (ICBC), lending at an attractive rate of 5%, and extending the FCCB’s maturity period until March 2019. Ambani, for the time being, can breathe easily.

This audacious funding move has grabbed market attention. Chinese lenders rarely channel capital into India. Their willingness to do so now – largely as a favour to Ambani, who often employs Chinese state-run contractors – highlighted the rise of Chinese banks and the concurrent decline of European and North American lenders.

Yet a more important aspect has received far less scrutiny: the fact that Ambani was in such dire financial straits at all.

RCom’s troubles are indicative of corporate India’s high exposure to external debts, largely through FCCBs issued at the height of the market in 2007 and early 2008.

Redemption of these deals is particularly high this year. Excluding Reliance Communications, another 72 FCCBs worth a combined US$5.8 billion come due in 2012. That compares to just 13 FCCBs worth a combined US$570 million maturing in 2013.

This mass of US dollar-denominated redemptions could hardly have come at a worse time. The Indian rupee depreciated 14% against the US dollar in 2011 – the worst performer among Asia’s 10 most highly traded currencies. Meanwhile many company shares are trading at multi-year lows on the Mumbai bourses, making equity fundraising an unpalatable choice.

This cocktail of circumstance has left several Indian companies desperately seeking to emulate Ambani and refinance their convertible bonds (CBs) through a friendly loan, or to raise enough capital to repay deals in full.

It could also lead some into urgent asset sales. Some observers even believe that these repayment challenges could leave some companies facing the possibility of corporate bankruptcy, an anathema in India.

“If we are likely to see a rise in Indian bankruptcies, it’s going to be this year,” says Rajan Wadhawan, executive director of business restructuring at PricewaterhouseCoopers India.

Corporate India’s financial resolve is about to be put through the wringer.

Reaping what you sow

The heavy level of FCCB redemptions in 2012 is the consequence of a brief love affair that many Indian corporates had with the instruments back in 2007.

Typically issued in a foreign currency (usually US dollars for Indian corporates), FCCBs offer investors a coupon interest rate that rises over the bond’s lifetime. When it expires, the issuer can convert some or all of the debt into company stock at a pre-determined ‘conversion’ rate, or repay the bonds in full.

Back in 2007 western banks, awash with capital, were desperate to provide funding to Indian promoters, or families that run major local companies. And these families were happy to issue convertible bonds in US dollars because the interest costs were lower than for equivalent rupee loans. Stock prices were riding high that year too, which helped ensure that companies could issue five-year FCCBs to eager investors.

But in the five years since issuance, the markets have soured against Indian companies. Share prices have in some cases fallen by up to 90% below the FCCB conversion prices. For example, wind turbine maker Suzlon’s stock price has fallen from a brief high of INR452.2 on January 8, 2008 to INR29.45 on February 3 this year, while IT service provider Zenith Infotech’s shares have slipped from INR465.51 to INR44.6, and Indian software company Subex’s shares fell from INR349.75 to INR32.10 over the same time period. This means that a company would have to dilute its stock tenfold to drop its bond conversion price to its stock valuation; hardly a move likely to be popular with existing investors.

“The fall in share prices is the greatest problem for corporates, which mobilised funds during the era of benign markets using the FCCB route, as without that, these FCCBs would have simply been converted into equity,” says Wadhawan.

This problem is exacerbated by the weak rupee. In 2007, when the FCCBs were issued, India’s currency was trading as low as INR40 against the US dollar. Now it’s at around INR50, meaning companies need to pay 20% more to buy the same numbers of dollars to refinance the bonds.

At the same time many companies are being frustrated in their efforts to raise loans to cover these maturing deals. Banks, understandably, don’t want to lend further to companies already heavily in debt.

It’s a messy situation that has many companies desperate to find new sources of funding to avoid defaulting on maturing FCCBs.

Under pressure

Most FCCBs coming due in 2012 fall into one of three categories: large, sound companies; sizeable but struggling firms; and smaller businesses.

According to research by Kotak Institutional Equities, several reasonably sound corporates have FCCBs maturing this year. RCom was one, but there is also Tata Motors (which has a US$473 million FCCB maturing in July); Tata Steel (US$382 million in September); and Jaiprakash Associates (US$354 million, maturing in September).

Then there are companies that are less financially robust. Both JSW Steel and Suzlon Energy are in a bind.

Mumbai-based JSW will have to work hard to meet its debt obligations when its US$274 million FCCB matures on June 28. Company figures show it had cash reserves of just INR22 billion (US$44.89 million) at end-December 2011, while net debt stood at INR135 billion.

JSW’s share price has held up reasonably well compared with other companies in its situation. Yet by February 3, JSW stock was trading in Mumbai at INR708.95, or around a quarter lower than its FCCB conversion price of INR953.

Suzlon is even worse off. Once lauded as a darling of rising India, the wind turbine maker is highly indebted (INR134 billion net debt at end-September 2011), and has spent most of the past three years in loss. It reported a net INR9.83 billion loss for the 2009-2010 financial year and it lost INR13.24 billion in the 2010-2011 financial year. The Pune-based company most recently reported a profit of INR586.5 million in the financial quarter ending on September 30, 2011.

Suzlon bought itself some time when it restructured US$1 billion of its debt in 2009, but it has four FCCBs worth US$389 million maturing this calendar year. Kotak estimates that this amount will climb to US$569 million once a redemption premium is factored in too. And despite recouping INR8.9 billion from the 2011 sale of Belgium-based Hansen Transmissions, its stock was trading at INR29.45 on February 3, compared to its bonds’ dual conversion price,maturing in two sets worth INR77 and INR97.

In a January 18 note, Kotak Institutional Equities analyst Saifullah Rais said that with RCom out of the way, “focus will move to Suzlon”. He notes that with yields “in excess of 40%” for Suzlon’s four FCCB tranches, “the markets may be factoring in a risk of restructuring for the issuer”.

In other words, investors are very concerned about Suzlon’s financial outlook.

Advisers to Suzlon say the firm is looking at a “raft of options”. One notes: “They will be covered somehow, but we aren’t there yet with our plans.We are going to keep our options open with them.”

Small and struggling

It’s even bleaker for some. Overall, Kotak reckons that 15 FCCBs issued by 11 Indian corporates that come due this year have a “high probability” of default.

GTL Infrastructure has the largest outstanding FCCB on the list. Once a high-flying cellular towers firm with global aspirations, it expanded too quickly, loading up with foreign-currency debt before the financial crisis hit, including a US$228 million FCCB that matures on November 29.

At the end of the last full financial year on March 31, 2011 – the most recent point that GTL gave out figures – it had total secured and unsecured debt of INR104.8 billion, and total available cash of just INR4.71 billion.

GTL’s stock closed on February 3 at INR11.85, down from the historic 2008 high of INR101.75.

The company is evidently negotiating furiously to handle its debt burden. Ramakrishan Bellam, head of communications for GTL, tells Asiamoney by email that: “The company has taken all adequate steps in consultation with the lenders and FCCB holders and shall make a statement to the stock exchanges at an appropriate time.”

For every major company facing a debt-refinancing squeeze, a dozen smaller ones are experiencing the same pressures. Those labouring under forthcoming FCCB redemptions include outsourcer Subex, optical equipment maker Moses Baer, and Sterling Biotech (see chart below).

Kotak’s Rais notes their high FCCB redemption prices, which, he writes, “imply high probability of default” and “concerns that weaker issuers could find refinancing difficult”.

Redemption yields here range from 324% at Subex, to a dizzying 1,310% at pharma firm Sterling. Subex has two FCCBs, worth a combined US$99 million, that must be refinanced, or repaid in cash, by March 9. Sterling owes at least US$135 million, payable by May 16.

How to pay

Companies that need to repay their FCCBs have four broad-brush options.

The best and cheapest choice (chosen by a fortunate Anil Ambani) is to exchange one convertible bond issue for another that matures much later. Fees are lower, though coupon rates will be typically higher than for the previous bonds.

Next there is the option of either issuing vanilla commercial debt to overseas investors (though costs are slightly higher here, given the cost of repatriating and paying onshore taxes) or selling fresh debt to domestic investors.

“Local investors aren’t as flush with their liquidity as they once were,” notes one Mumbai banker, “but there is still capital available.”

The last two options are the least wholesome. One is gaining funding from banks. However, Indian and foreign lenders are wary about extending credit lines to highly leveraged firms merely to let them roll over debts at the best of times, let alone during a prolonged financial squeeze.

Then there is the option of simply issuing debt for equity, through a local qualified institutional placement (QIP). However this is, as noted, highly dilutive at current prices and thus unlikely to happen until stock prices rise much more than they have done this year.

“People are looking at all manner of ways of raising financing,” says Rohit Chatterjee, head of investment banking India at J.P. Morgan. “It doesn’t have to be a new bond for an old bond. In the past, we have extended a CB while bringing in new financing. But right now, clients are also exploring domestic or overseas financing. Right now, in terms of straight debt, ECBs [external commercial borrowings] are the most popular form of financing.”

Making money

Chatterjee’s view is particularly worthwhile given his bank’s experience with Suzlon.

J.P. Morgan and Rothschild charged the wind turbine maker “upwards of 4%” in fees to refinance around US$1 billion of its debt in 2009, according to people familiar with the deal.

Investment bankers like the sound of that. After some particularly grim years, the country’s deal-makers finally have a chance to charge their clients some genuinely fat fees.

One European investment banker reckons that banks will charge sturdier corporates “only 1%-2%” of an FCCB’s overall value to refinance the deal, but that number will rise to 4% and more for more heavily indebted firms.

Refinancing for all 72 FCCBs maturing this year could lead to fees north of US$200 million.

And it’s not just FCCB refinancing that is required. Total Indian external commercial borrowings stood at US$103 billion at the end of last year, or 30% of all external debts in India. And industry specialists estimate that “perhaps as much as US$50 billion worth” of corporate debt is unhedged and held in US dollars.

Add that together and, says one Mumbai investment banker, the fee pool for investment banks this year “could be closer to US$400 million”.

“Refinancing maturing debt, whether straight or convertible, will be one of the main themes of capital raising in India this year,” says Chatterjee. There is also a large IPO pipeline, but until primary markets open up, refinancing and block trades are where the action is likely to be.”

Domestic brokers are piling in too, from ICICI Securities and SBI Capital Markets, leaders in domestic debt restructuring, down to smaller brokerages such as Enam Securities, recently merged with higher-end private lender Axis Bank.

Enam managing director of investment banking S. Subramanian reckons that “every investment bank is pushing hard” to get into a potentially lucrative sector. He adds: “This is going to be a big market this year.”

To refinance, or not

The banks may look forward to these debt restructurings but several companies will struggle to refinance. Some have flirted with disaster, but so far avoided it. Chennai-based Orchid Chemicals & Pharmaceutical, facing a US$117 million FCCB due on February 28, dipped into its internal kitty and topped its finances by raising US$100 million in bank loans.

Banking services software specialist Financial Technologies India took the righteous route for its US$91 million FCCB due on December 21 2011, paying US$133.2 million in cash at a redemption premium of 147%.

But it’s looking increasingly likely that at least one or two FCCB issuers will contemplate default or even insolvency.

Will this mean companies becoming truly bankrupt? Unlikely. In India, rather like China, corporate default is rare and bankruptcy almost unthinkable (see box).

One consequence of this slap-on-the-wrist attitude towards corporate failure is that some Indian businesses may simply choose not to pay their debts. It’s a rare but not unknown tactic.

In 1999 Essar Steel infamously defaulted on US$250 million of floating notes, killing foreign investor confidence in India for several years.

Worryingly, other companies have become increasingly remiss about their repayments of late. On November 20 Assam Company India, a conglomerate combining oil exploration and tea cultivation, delayed paying a US$48 million coupon on an FCCB it holds. The company then backtracked on December 11, with president Romit Mitra promising that following “unforeseen circumstances” and “procedural delays” it would repay the FCCB coupon by December 31. The firm then admitted to its bondholders on December 30 that it could not make the redemption payment the next day, and requested an extension to February 28th. It remains to be seen whether it will be able to meet this deadline.

Zenith Infotech has gone even further. It defaulted on US$33 million in FCCBs on September 21, 2011 before selling a part of the firm, Zenith RMM, to a fund called Summit Partners at an undisclosed price. Bondholders are taking Zenith Infotech to court to recoup their money.

Earlier, Wockhardt defaulted on US$110 million in FCCBs in 2009. In October last year the Bombay High Court ordered the drugs maker to settle its debts (owed to bondholders including US hedge fund QVT Financial LP) in five tranches by October 2012.

Companies that delay their interest payments or redemptions clearly risk damaging their standing with investors.

With no bankruptcy law in place, local rules do not offer investors much protection. The Reserve Bank of India doesn’t help much either, considering such disputes “a private matter between borrowers and bondholders”, according to one senior banker.

The Securities and Exchange Board of India, India’s financial regulator, tends to stay aloof too, holding the view that FCCBs have been issued, held, and are in theory repatriated outside of India.

So investors tend to have to take legal action to get their money back. They generally seek arbitration in Singapore or London; the founder of an India-focused broker in London says that Mumbai’s legal process is simply too slow.

It’s worth noting that such payment problems are much less prevalent with vanilla international currency bonds. It’s FCCBs that are the issue, largely because they have not been hedged for currency risk, and they are maturing when stock valuations are low.

The danger is that several FCCB bond issuers choose to ‘infinitely delay’ repayment, further damaging India’s battered reputation as an investment destination.

Fund managers with no guarantee of getting their money back at the agreed dates, or indeed ever, will have little desire to support local corporates.

It’s important to remember that the FCCB payment issue affects a relatively small portion of Indian corporates. These refinancing needs are unlikely to have many ramifications for the government or Reserve Bank of India, which boasts foreign currency reserves of US$293.93 billion. Repaying these instruments remains strictly a corporate concern among a selection of companies.

And indeed, there is still hope that an unpleasant outcome for these FCCB repayments can be avoided. Much of the malaise relating to FCCBs in particular will dissipate if stock prices rise and interest rates and inflation continue to edge down.

Stocks rose 10% in January on average – but with no signs that inflation is headed down again this resurgence could prove short-lived.

As things stand, an unprecedented volume of FCCBs is coming due when the industries that have issued them are suffering from rising costs, higher competition, soaring debts, and poor equity valuations.

If heavily indebted local companies responsibly pay their FCCBs, India could yet burnish its image with foreign fund managers.

But try to avoid doing so, even temporarily, and the damage to the country’s investment appeal will be hard to repair.

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