FCCB shadow looms large over corporate profits

Several companies that have issued foreign currency convertible bonds face the prospect of not having these bonds converted into equity unless the stock markets stage a strong comeback.

This implies that these corporations may have to pay back the amounts they borrowed together with the interest.

What could compound the problem is that many of these firms do not account for the debt. In other words, they are not providing for the borrowings on an annual basis over the life of the instrument.

According to a study by a leading brokerage, accounting for the loan and the interest would, on an average, knock off at least 12 per cent of the profits in FY09 and about 10 per cent in FY10.

Should the conversion not take place, companies either have to pay from their current cash flows or borrow afresh to repay the bonds, which usually have a tenure of five years and an average yield to maturity of about 5.5 per cent. It has been seen that on an average, the outstanding amounts are equal to at least two times the cash profit earned in FY07.

Of a sample of 92 companies, data for which were sourced from Bloomberg, share prices of nearly half the companies are trading at more than 40 per cent discount to the conversion price.

Many of the FCCB issues were placed during the boom periods in 2006 and 2007 and companies were able to attract a fancy premium while arriving at the conversion price.

While most issues mature in 2011, profits for many of these companies could take a knock that is worse than what is currently being expected.

Analysts said it is not enough for the share prices to bounce back to the levels at which the conversion has been fixed because investors would only opt for a conversion if they foresee a further strong appreciation in the share price.

They may, instead, choose to hold on to the bonds till they mature because not only would their capital be protected, they would also earn interest at an average of 5.5 per cent a year.

While a general recovery in the market will help share prices move up, companies also need to keep turning in good results so that investors are tempted to convert the bonds into shares.