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SALVUS CAPITAL ADVISORS PVT. LTD.

A research report on

FOREIGN CURRENCY CONVERTIBLE BOND BY INDIAN COMPANIES

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A research report on Foreign Currency Convertible Bond by Indian Companies

TABLE OF CONTENTS
Overview ........................................................................................................................................................................................ 3 Regulations.................................................................................................................................................................................... 3 Eligible Borrowers ............................................................................................................................................................... 3 Recognized Lenders ............................................................................................................................................................ 4 Amount and Maturity ......................................................................................................................................................... 4 All-in-cost ceiling .................................................................................................................................................................. 5 End Use ...................................................................................................................................................................................... 5 Procedure ................................................................................................................................................................................. 6 Guarantees ............................................................................................................................................................................... 6 Security ...................................................................................................................................................................................... 6 Parking of FCCB proceeds overseas ............................................................................................................................ 6 Prepayment ............................................................................................................................................................................. 7 Refinance of existing FCCB .............................................................................................................................................. 7 Debt servicing ......................................................................................................................................................................... 7 Taxation on FCCB ....................................................................................................................................................................... 7 Market Analysis .......................................................................................................................................................................... 7 Amount of FCCB raised over the previous year on a monthly basis .......................................................... 7 Purpose wise distribution of FCCB during March10- februray 11 ........................................................... 8 Benefits of FCCB .................................................................................................................................................................... 8 Disadvantages of FCCB ...................................................................................................................................................... 8 Translational Lossses ......................................................................................................................................................... 8 Major Issues with FCCB .......................................................................................................................................................... 9 Major Advisors for FCCB in India ...................................................................................................................................... 9 Future Outlook ............................................................................................................................................................................ 9 REcent FCCB Issues................................................................................................................................................................ 10 Abrreviations ............................................................................................................................................................................ 10

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A research report on Foreign Currency Convertible Bond by Indian Companies

OVERVIEW
Efficient capital markets are a critical component for any developed economy and Indian capital markets today are amongst the best regulated markets wherein the regulatory framework has kept pace with the significant growth in the securities markets. The story of Indian capital market reveals an efficient trading and settlement infrastructure, high levels of disclosure and fostering an environment of innovation. In this back drop, Foreign Currency Convertible Bond (FCCB) is emerging as a preferred instrument for corporate financing with large number of FCCBs being issued over the past few years. A FCCB is a mix between a debt and equity instrument issued in a currency different than the issuers domestic currency. It acts like a bond by providing regular coupon and principal payments but at the same time gives bondholders the option to convert the bond into stock. FCCBs are generally issued by companies having high promoter shareholding in order to minimize the risk of losing control in case of conversion. Additionally, FCCB can be traded in parts (debt and equity) or in full based on the holders risk profile. They can be secured or unsecured but FCCB issues by Indian companies are generally unsecured. Also, FCCB are usually listed to increase its liquidity.

REGULATIONS
In India, FCCBs can be accessed through automatic and approval route. Major regulators governing the FCCBs in India are Exchange Control Department of RBI and FCCB Division in Department of Economic Affairs at Ministry of Finance. FCCB policy aims at keeping maturities long, costs low and encourages infrastructure and export sector financing so as to ensure overall growth of the economy. FCCB policy focuses on three aspects: Eligibility criteria for accessing external markets Total amount of borrowings to be raised and their maturity structure End use of the funds raised

The policy for ECB is also applicable to FCCB. In addition to that, issue of FCCBs is also required to adhere to FEMA regulations and in accordance with the scheme viz., "Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depositary Receipt Mechanism) Scheme, 1993.

ELIGIBLE BORROWERS AUTOMATIC ROUTE

1. Companies except financial intermediaries 2. Units in Special Economic Zones( SEZ) 3. NGOs engaged in micro finance activities

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A research report on Foreign Currency Convertible Bond by Indian Companies

APPROVAL ROUTE
1. Infrastructure or export finance companies such as IDFC, IL&FS, Power Finance Corporation, IRCON, Power trading corporation and EXIM bank 2. Banks and financial institutions which participated in the textile or steel restructuring package 3. NBFCs to finance import of infrastructure equipment for leasing 4. Multistate Co-operative society engaged in manufacturing activities 5. Housing Finance Companies which satisfies the following conditions:a. Minimum net worth of not less than Rs. 500 Crores during the past 3 years b. Listing on the BSE or NSE c. Minimum size of FCCB is USD 100 million d. Applicant should submit the purpose / plan of utilization of funds

RECOGNIZED LENDERS
1. Internationally recognized sources such as international banks, international capital markets, and multilateral financial institutions such as IFC, ADB and CDC, export credit agencies, suppliers of equipment, foreign collaborators and foreign equity holders. 2. Overseas organizations and individuals with a certificate of due diligence from overseas bank adhering to host country regulations (applicable only under the automatic route). In case of foreign equity holders to be eligible as recognized lender, it would require minimum holding of paid-up equity in the borrower company. These are:-

AUTOMATIC ROUTE
For FCCBs up to USD 5 million at least 25 percent to be held directly by the lender For FCCBs more than USD 5 million - at least 25 percent to be held directly by the lender and proposed FCCB should not exceed four times the direct foreign equity holding

APPROVAL ROUTE
At least 25 percent to be held directly by the lender but proposed FCCB exceeds four times the direct foreign equity holding.

AMOUNT AND MATURITY AUTOMATIC ROUTE

Maximum Amount of FCCB in a financial year Companies other than those in hotel, hospital and software sectors - USD 500 million

Companies in services sector viz. hotels, hospitals and software sector - USD 100 million NGOs engaged in micro finance activities - USD 5 million Page 4

A research report on Foreign Currency Convertible Bond by Indian Companies Minimum Maturity Period FCCBs up to USD 20 million FCCBs between USD 20 million and USD 500 million 3 years 5 years

APPROVAL ROUTE
Corporate can avail an additional amount of USD 250 million with average maturity of more than 10 years over and above the existing limit of USD 500 million under the automatic route.

ALL-IN-COST CEILING
All-in-cost includes rate of interest, other fees and expenses in foreign currency except commitment fee, pre-payment fee, withholding tax payment and fees payable in Indian Rupees. Currently, six month LIBOR rate is 0.43050% with all-in-cost ceiling as follows: Average Maturity Period Three to five years More than five years All-in-cost Ceilings over six month LIBOR 300 basis points 500 basis points

EFFECTIVE ALL IN COST CEILING OVER THE PAST 5 YEARS

10.00% 9.00%
8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 2005 2006 2007 2008 2009 2010 6 Month LIBOR Effective Ceiling Three to five years Effective Ceiling More than five years

END USE
Permitted for 1. Investment (such as import of capital goods, new projects, modernization/expansion of existing production units) in industrial sector including SMEs and infrastructure sector. 2. Overseas direct investment in Joint ventures and Wholly owned subsidiaries

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A research report on Foreign Currency Convertible Bond by Indian Companies 3. First stage acquisition of shares in the disinvestment process and in the mandatory second stage offer under the Governments disinvestment program of PSU shares. 4. NGOs engaged in micro finance activities can utilize the proceeds for a. lending to self-help groups b. micro credit c. bonafide micro finance activity including capacity building Not permitted for 1. On-lending or investment in capital market or acquiring a company 2. Investment in real estate 3. Working capital, general corporate purpose and repayment of existing rupee loan

PROCEDURE AUTOMATIC ROUTE

Borrower enters into a loan agreement with the lender Submits the agreement to RBI for registration

APPROVAL ROUTE
Borrower submits the application through Authorized Dealer (AD) to RBI

GUARANTEES
Issuance of guarantee, standby letter of credit, and letter of undertaking or letter of comfort by banks, financial institutions and NBFCs relating to FCCB is not permitted.

SECURITY
Choice of security is left to the borrower but in case of creation of charges over immovable assets and financial securities such as shares is subjected to FEMA regulations.

PARKING OF FCCB PROCEEDS OVERSEAS

FCCB proceeds should be invested overseas until the actual requirement in India. These investments should be liquid in nature so that they can be liquidated as and when required by the borrower. These investments include:1. Deposits or Certificate of Deposit or other products offered by banks rated not less than AA(-) by Standard and Poor/Fitch IBCA or Aa3 by Moodys 2. Deposits with overseas branch of an authorized dealer in India 3. Treasury bills and other monetary instruments of one year maturity having minimum rating as indicated above

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A research report on Foreign Currency Convertible Bond by Indian Companies

PREPAYMENT
Prepayment up to USD 200 million is allowed by ADs without prior approval of RBI but minimum average maturity period needs to be maintained. For prepayment more than USD 200 million, approval from RBI is required.

REFINANCE OF EXISTING FCCB

Refinancing of FCCBs is allowed but outstanding maturity of the original loan needs to be maintained.

DEBT SERVICING
Designated Authorized Dealers (ADs) make remittances of installments of principal, interest and other charges.

TAXATION ON FCCB
Interest payment on the bonds until the conversion option is exercised is subjected to TDS Tax on dividend on the converted portion of the bond is subjected to TDS Conversion of FCCB does not give rise to any capital gain liability in India Transfers of FCCB made by a non-resident investor to another non-resident investor does not give rise to any capital gain liability in India

MARKET ANALYSIS
AMOUNT OF FCCB RAISED OVER THE PREVIOUS YEAR ON A MONTHLY BASIS
2,000 1,800 1,600 USSD Millions 1,400 1,200 1,000 800 600 400 200 0 2009 2010

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A research report on Foreign Currency Convertible Bond by Indian Companies

PURPOSE WISE DISTRIBUTION OF FCCB DURING MARCH10- FEBRURAY 11

1%
7% Import of Capital Goods 29% 55% Modernisation

Others
Overseas Acquisition Rupee Expenditure Loc.CG 8%

BENEFITS OF FCCB
Issuers o Coupon payment on bond is lower due to equity side of bond o Conversion premium adds to the capital reserves o Fewer covenants as compared to a syndicated loan or a debenture Investors o Assured returns in the form of fixed coupon rate payments o Ability to take advantage of price appreciation in the stock by the means of warrants attached to the bonds o Lower tax liability as compared to pure debt instruments due to lower coupon rate

DISADVANTAGES OF FCCB
In a falling stock market, there is no demand When converted into equity, FCCB bring down earnings per share and dilute the ownership In the long run, equity is costlier than debt and hence when interest rates are falling, FCCB are not preferred Exchange rate risk due to conversion at a future date

TRANSLATIONAL LOSSSES
Translational losses also known as derivative losses are an important aspect of FCCB and arise due to fluctuation in the foreign exchange. In bearish market conditions, it may happen that the current market price may become less than the conversion price (price at which the company agrees to issue the issue the shares on conversion). This leads to the risk of non-conversion and if the rupee depreciates during this period. Then in such cases repayment of FCCBs will become costlier and have to book translational losses to the extent the rupee is not hedged. Page 8

A research report on Foreign Currency Convertible Bond by Indian Companies Companies should plan for the risk of non-conversion of FCCBs and keep aside some amount of money every quarter in case investors doesnt exercise their option to convert debt into equity. Foreign exchange losses are associated with such risk due to fluctuation in exchange rates. But many of the companies do not recognize or provide for forex losses with the assumption that the FCCBs will potentially get converted into equity. Companies that were impacted by translational losses due to FCCBs include Ranbaxy, Wockhardt, Ipca Labs and Orchid Chemicals. On the other hand, there are also companies which considered the translational losses while issuing FCCBs. They had agreed for fixed rate of exchange on conversion of rupee to dollar at the time of redemption of FCCBs. For example, Aurobindo Pharma at the time of FCCB issue fixed the exchange rate on conversion at Rs 45.15 per US dollar.

MAJOR ISSUES WITH FCCB

1. 2.

There is a lack of uniformity in the treatment of corporate financing convertible bonds. This makes assessing their impact on issuers difficult. Most companies either reduce redemption premium from their net worth or treat it as a contingent liability. This tends to boost profitability and suppress cost of debt. The current accounting and reporting norms do not allow investors to get a clear view on the issuer's cost of servicing the debt component of FCCBs and its ability to meet the repayment obligation if the FCCBs don't get converted into equity. Unlike many other countries, India does not require issuing companies to provide estimates of full dilution on current earning.

3.

4.

MAJOR ADVISORS FOR FCCB IN INDIA

1. 2. 3. 4. 5. 6. JP Morgan Citigroup Barclays Capital Standard Chartered Plc HSBC Holdings Plc Kotak Mahindra Capital

FUTURE OUTLOOK
We can expect an increase in FCCBs issues by the Indian Companies. This increase can be attributed to huge spending planned on infrastructure project over the next few years. Additionally, favorable expectations from stock market due to strong economic growth have also increased the willingness of foreign investors to participate in FCCBs issues.

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A research report on Foreign Currency Convertible Bond by Indian Companies

RECENT FCCB ISSUES

Borrower Videocon Industries Ltd. Gitanjali Gems Ltd. # Essar Shipping Ports & Logistics Ltd. # Saamya Biotech (India) Ltd. Shiv-Vani Oil & Gas Exploration Services Ltd. Essar Oil Ltd Valecha Engineering Ltd. Fortis Healthcare Ltd. IOL Chemicals & Pharmaceuticals Ltd. Prakash Industries Ltd. Core Projects & Technologies Ltd. Kiri Dyes And Chemicals Ltd OK Play India Ltd. Prime Focus Ltd# Murli Industries Ltd. Equivalent Purpose Amount in USD 20,00,00,000 Overseas Acquisition 11,00,00,000 Others 28,00,00,000 Overseas Acquisition 2,00,00,000 Overseas Acquisition 9,50,00,000 Import of Capital Goods 30,00,00,000 Modernisation 1,50,00,000 Rupee Expenditure Loc.CG 10,00,00,000 Overseas Acquisition 1,50,00,000 Modernisation 6,00,00,000 Modernisation 7,50,00,000 Overseas Acquisition 4,75,15,424 Overseas Acquisition 1,00,00,000 Modernisation 5,50,00,000 Overseas Acquisition 2,30,00,000 New Project Maturity Period (Appx) 5 Years 5 Years 7 Years 1 Month 5 Years 5 Years 1 Month 18 Years 6 Months 5 Years 1 Month 5 Years 5 Years 1 Month 5 Years 5 Years 5 Years 1 Month 5 Years 5 Years 5 Years Date Dec-10 Oct-10 Aug-10 Aug-10 Jul-10 Jun-10 May-10 May-10 May-10 Apr-10 Apr-10 Mar-10 Dec-10 Dec-10 Dec-10

ABRREVIATIONS
TDS ECB FCCB AD FEMA RBI SME SEZ NBFC NGO PSU Tax Deducted at Source External Commercial Borrowing Foreign Currency Convertible Borrowing Authorized Dealers Foreign Exchange Management Act Reserve Bank of India Small and Medium Enterprises Special Economic Zone Non Banking Financial Company Non Governmental Organization Public Sector Undertaking

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www.salvuscapital.com Currency Convertible Bond by Indian Companies A research report on Foreign

Vishnu Deuskar Managing Director E-mail: vdeuskar@salvuscapital.com

Kamlesh Thakur Director E-mail: kthakur@salvuscapital.com

Rahul Saxena Associate Vice President E-mail: rsaxena@salvuscapital.com

Salvus Capital Advisors Pvt. Ltd. Gool Mansion, 6 Homji Street, Fort, Mumbai 400 001, INDIA Tel: + 91 22 2267 1111/5237 Fax: + 91 22 2266

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