Devil’s in the euro detail, but god is in liquidity

The European Central Bank (ECB) may not have had the interests of Indian companies in mind when it decided to pump in over €529.50 billion — €1 = `67.45 — into the global financial system through its second Long Term Refinancing Operation (LTRO) on February 29. But the fresh liquidity is proving to be a godsend for certain Indian stocks nevertheless.

And the companies concerned — many of them are debt-ridden, cash-strapped and slowdown-hurt — can now access cheaper funds to service their Foreign Currency Convertible Bonds (FCCBs) that mature in 2012, thus precluding a potential redemption crisis.

Prices of stocks of companies that have an overhang of FCCBs have risen considerably since LTRO. For instance, KSL and Industries has skyrocketed 118.3%, Rolta India is up 57.2%, and Tata Motors has risen 49.2% since December 2011 (when the first, €489-billion LTRO was announced). Besides, Prithvi Information Solutions, Strides Arcolab, Kamat Hotels, Shri Lakshmi Cotsyn and Pokarna have risen between 30% and 45%.

Fifteen other stocks have outperformed the 5.33% Sensex rise (from 16483.45 on December 1, 2011 to 17361.74 yesterday).

The market logic works thus: Companies in need of cash sometimes borrow in a foreign currency by selling bonds to foreign financial institutions. The lenders have an option to convert the bonds into shares. They usually exercise the option if the stock price at the time of bond maturity is higher than the bond-to-share conversion price set at the beginning. If the stock price at maturity, however, is lower than the conversion price, the bond-issuing company has to repay the principal to the bond-holder.

Towards the end of 2011, imminent maturities and lower-than-conversion share prices had put pressure on many Indian borrowers. Such companies faced twin options: either redeem FCCBs or revise the conversion price downwards, which would have led to larger equity dilution.

In all, 59 Indian companies face FCCB redemptions of $7 billion (`35,000 crore) in 2012, according to Indian FCCB Redemptions in 2012, a Fitch Ratings report. About 63% of the amount due is likely to be repaid from a combination of internal accruals and fresh borrowings. Of the balance, 17% is expected to undergo restructuring (mostly maturity extensions), while the remaining 20% is likely to default with ensuing restructuring.

Rajesh Cheruvu, head of investment strategy in the private banking division at Royal Bank of Scotland, says the pressure on Indian companies had eased after the ECB first pumped money into the system in December 2011. “India’s exposure to FCCBs is mostly from European institutions which had been under some liquidity pressure. Hence, it was felt that they may seek redemption. Following the LTRO, this situation has improved.”

Agrees Sanjay Sinha, founder of Citrus Advisors. “LTRO-related liquidity could act as a facilitator (of debt-servicing),” he says. Company-specific considerations could also play a part.

Thanks to LTRO, liquidity-flush European banks extended easy refinancing to Indian companies. Refinancing, in turn, has improved the market sentiment on their stocks, as reflected in their soaring prices. In addition, the Reserve Bank of India (RBI) has made it easier for companies to borrow from overseas. In January, it raised the limit for borrowings through FCCBs by 50%, from $500 million to $750 million. What’s more, the government had also raised the limit for external commercial borrowings from $500 million to $750 million. This facility can be used to refinance existing borrowings as well. Such measures have made borrowing easier for Indian companies, making them financially able to meet capital requirements at the time of maturity of FCCBs. Higher stock prices reflect the consequent improvement in the company’s outlook.

So much so, even the FCCB space has seen heightened activity in 2012, according to The Indian Convertibles Monthly Report by Kotak Securities.

For instance, earlier this year, Reliance Communications managed to refinance its FCCB obligation worth $1.18 billion (Rs6,000 crore) through a consortium of Chinese banks.

The company had an FCCB obligation worth $925 million (Rs4,600 crore) maturing on March 1, 2012.  Elsewhere, Strides Arcolab sold 94% stake in its subsidiary Ascent Pharmahealth to Watson Pharmaceuticals for $393 million (Rs2,000 crore), in order to honour an immediate FCCB obligation of $80 million (Rs400 crore). Plus, the estimated redemptions for its FCCBs maturing on June 27, 2012 are expected to be around $116 million (Rs600 crore). Era Infrastructure redeemed all its outstanding FCCBs worth $59.73 million (Rs300 crore) on January 25, 2012.

For these Indian companies and their stocks, liquidity truly has been god, or a godsend, if you will.