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Don't panic when a firm defaults

Source : BUSINESS_STANDARD
Last Updated: Wed, Oct 17, 2012 19:21 hrs
Sensex provisionally closes down 1.2 pct

Shareholders of Suzlon would be a worried lot after the wind-turbine maker announced it was to default on redemption of $200 million of foreign currency convertible bonds (FCCBs). But is the concern unwarranted?

In the past, companies like Wockhardt have faced similar situations but recovered sharply.

When companies issued FCCBs during the 2006-08 boom, it seemed a good idea. The rupee was at 40-to-the-dollar levels and the Sensex around 20,000. The steep drop in the value of the rupee against the dollar over the past two years has exacerbated the problem. "The result is many FCCB issuers may have trouble finding funds to repay bondholders. Those who can't will face payment default," said a Standard & Poor's (S&P) report.

DON'T FORGET THE REALITY CHECK
Company Price set for conversion at time of issuance (Rs) Price on date of conversion (Rs) &Current market price (Rs)
JSW Steel 953.4 669 746.85
Tata Motors 181.4 236.65 262.30
Suzlon Energy 97.3 16.20 15.70
GTL Infrastructure 53 - 8.58
Karuturi Global 19 - 4.46
Easun Reyrolle 315 - 73.75
Sterling Biotech 163 8.10 6.12
&FCCBs already reached maturity
Source: S&P Report & BS Research Bureau

Some of the companies, which have their FCCBs up for conversion in the remainder of 2012, include Pidilite Industries, Prime Focus, GTL Infrastructure and GV Films.

Marketmen are of the view that investors should not press the panic button yet. Arun Kejriwal of Kejriwal Research and Investment Services says one should look at the difference between the conversion price and the current share price. "If the conversion price is higher by 30-50 per cent, then the chances of a turnaround of the shares could be less. One should exit such companies completely," he says.

If the conversion price is slightly higher or is the same as the current market price, then one need not worry. However, new investors should avoid companies with FCCBs coming up for conversion any time soon, says Kejriwal.

Financial advisors say even if one were to exit, there could be opportunities to re-enter the scrip later. V K Sharma, business head, private broking and wealth management, HDFC Securities, says, "Once there are signs of a turnaround by these companies and there is more clarity with regard to the FCCB situation, one can enter the scrip again. Entering these stocks at a lower level can help make profits in the long run."

There are other companies likely to default as well. According to a research report issued by S&P in June, of the 48 companies which have their FCCBs coming up for conversion in the rest of 2012, half could default. The report says investors do not want to convert the $5 billion in FCCBs into stock worth 20-90 per cent less than the conversion price.

Companies such as Zenith Infotech and Sterling Biotech have defaulted on payments to bondholders. In such a case, bondholders have the option to take the company to court if they fail to pay and request that it be wound up.

FCCBs could burden some companies, but that will depend on the company, its rating and the industry it belongs to.

For example, Wockhardt defaulted on FCCB payments in 2009, following which the bondholders filed a winding-up plea in court. At that point its share traded at Rs 67. But now, the company is almost done paying off the bondholders, is planning to repay its bank loans and has seen an improvement in its profits. Its shares are trading at Rs 1,470 as of today.

JSW Steel redeemed its FCCBs at a much higher price. The conversion price of Rs 953.4 was almost 30 per cent higher than the price as on the date of conversion, which was Rs 669. But its shares are trading higher now. Its current market price is Rs 724.8. Though the company's balance sheet did take a hit, it is not a big concern, say analysts.

One should also look at performance. "Look at the top line and the profit over the last year. Also, check the company's ability to refinance," says Sharma.

Ideally, one should start analysing the scrip a year before the date of conversion and not wait for the eventuality to happen and then decide whether to sell. You should keep track of the date when the FCCB would be up for conversion, Sharma adds.

In the case of Suzlon, brokerages have a 'hold' view, as there are chances of a turnaround if the company comes up with a plan to get itself out of its financial mess. Manish Sonthalia, vice-president and fund manager, Motilal Oswal AMC, says in the long run things could turn around for the company, though it will still be a risky proposition for most small investors.


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