PE firms turn to FCCBs as stocks crash

As stock markets around the world continue to tumble, private equity (PE) players are sensing an opportunity in the foreign currency convertible bonds (FCCBs) issued by Indian companies.

Most of the FCCBs are trading at a discount of 30 to 70 per cent now. And given the tight financial situation internationally, many investors could be desperate to raise cash by selling them.

Some PE firms are looking at companies whose FCCBs are maturing in the near future. Vedika Bhandarkar, managing director and head of investment banking, JP Morgan India said, “If it is a fundamentally good company and the bond is available at a huge discount, it makes sense to go for it.”

From a PE firm’s perspective, besides high returns, it would allow them to diversify their portfolios. According to sources, many existing deals are under pressure due to a valuation mismatch with promoters.

One of the ways could be buying these bonds at a discount directly in the international markets from distressed sellers. Holding these bonds, in turn, will earn a yield to maturity over the balance life of bond. As a result, the returns could be quite high. In fact, much higher than the returns offered by equities.

However, while buying directly in the international market would mitigate the currency risk, this could create credit risk, in case the companies are not chosen carefully.

“Investing directly in FCCBs will always have a default risk. It may not be a good option for a private equity player, as one cannot get a seat on the company’s board in such cases,” said a managing director of a foreign PE fund.

The other option being considered is direct investment into cash-strapped companies with outstanding FCCBs. Companies would then be able to convert the bonds on maturity. By offering them to convert the bonds, the PE funds could be able to bag a seat on the company’s board.

Reliance Money, in one of its reports, has mentioned that many companies’ bonds will be up for redemption in the next year-and a-half.

“With the markets taking a beating, many calculations could go wrong. This could have a negative impact on the capital structure of these companies,” the report said.

In circumstances where a company wants to bail out investors willing to exit at a discount, but does not have the necessary cash to do so, it could approach a PE firm and pledge the FCCBs.