In this article we will discuss about:- 1. Meaning of FCCBs 2. Advantages of FCCBs 3. Disadvantages of FCCBs 4. Foreign Currency Exchangeable Bonds (FCEBs).
Meaning of FCCBs:
A FCCB is issued as a bond by an Indian company is expressed in foreign currency and the principal and interest too are payable in foreign currency.
The maximum tenure of the bond is 5 years. FCCB is a quasi-debt investment, which can be converted into equity shares at the choice of investors either immediately after issue, or upon maturity or during a set period, at a predetermined strike rate or a conversion price.
It acts like a bond by making regular interest and principal payments, but these bonds also give the bond holder an option to convert the bond into shares.
The investor benefits if the conversion price is higher than the traded price and vice versa.
The conversion price is set at a premium over the current stock price, or is set by a formula based on the price at the time of redemption.
The issuer may sometimes have a call option, generally with a call hurdle, i.e., subject to a minimum stock price at the time of call, which means that invariably at the exercise of a call, the investor would opt for conversion into equity.
The convertibility of the bond is akin to a put option to the bond holder, as he can redeem the bond while opting for conversion.
As an investor in the equity, the bond holder has a call option, in the sense that he has the right to buy equity at the set price.
This hybrid product offers many of the advantages of both equity and debt.
It gives the investor much of the upside of investment in equity and the debt element protects the downside.
The FCCB is a quasi-equity instrument which accords the benefit of debt market.
The FCCB may carry a coupon rate or can be zero coupon.
In case the bond is not a zero coupon, the issuer would be under obligation to pay the coupon rate at agreed intervals.
Advantages of FCCBs:
To Issuing Company:
1. The company gains high leverage as debt is reduced and equity capital is enhanced upon conversion.
2. The impact on cash flow is positive as most companies issue FCCB with a redemption premium, which is payable on maturity, only if the stock price is less than the conversion price.
3. FCCB do not dilute ownership immediately, as the holder of ADR/GDR do not have voting rights.
4. The conversion premium adds to the capital reserve of the company.
5. The coupon rate is lower than the traditional bank finance, thereby reducing the debt financing costs.
6. The issue of FCCBs do not receive credit rating.
1. FCCB offers dual advantage of debt and equity to the investors. Thus, guaranteed returns in the form of coupon or YTM, and at the same time, an option to take advantage of upside in the price of the stock.
Disadvantages of FCCBs:
1. FCCB when converted into equity brings down the earnings per share, and will also dilute the ownership.
2. In a falling stock market, there will be no demand for FCCB.
3. FCCB may remain as debt and not get converted at all.
4. FCCB is shown as debt on balance sheet until conversion.
5. In case of redemption, cash outflow is heavy in one financial year, unlike traditional debt which has regular repayment.
6. Any depreciation in rupee against the designated foreign currency may make the interest and principal repayment costly.
7. The end use of proceeds is restricted.
8. The issuer does not control conversion.
9. The book value of converted shares depends on prevailing exchange rates.
10. The cost ultimately dependent on share price development.
Foreign Currency Exchangeable Bonds (FCEBs):
1. FCEBs are financial instruments similar to FCCBs in nature.
2. FCEBs will allow corporate to raise money from overseas markets by issuing bonds.
3. In case of FCCBs, bonds can be converted into equity shares of the issuing company. But in case FCEBs, the bonds can be converted into shares of a group company of the issuer.
4. The issuing company shall be part of the promotor group of the offered company.
5. The offered company mean an Indian company whose equity shares shall be offered in exchange of FCCB.
6. The issuing company mean an Indian company whose equity shares shall be offered in exchange of FCCB.
7. The offered company shall be a listed company which is engaged in a sector eligible to receive Foreign Direct Investment (FDI) and eligible to issue or avail of FCCB or External Commercial Borrowing (ECBs).
8. Wherever needed prior approval of Foreign Investment Promotion Board (FIPB) shall be obtained under Foreign Direct Investment Policy.