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Exchangeable bonds for control and funds
March, 15th 2007
An exchangeable bond, unlike a convertible bond, gives the subscriber the right to get shares in a company other than the issuer.

The Budget, while maintaining a studied silence on such burning issues as Special Economic Zones and limited liability partnerships, waxed eloquent about exchangeable bonds (EB). The Finance Ministry and the stock market regulator heSecurities and Exchange Board of India are reportedly working on the details and the corporate sector may soon have another tool to raise funds, especially to sate its growing global ambitions.

An EB, unlike a convertible bond, gives the subscriber the right to get shares in a company other than the issuer which makes it an ideal disposal mechanism for holding companies of the shares held in their subsidiaries. For instance, recently Tata Sons, the investment company for the Tatas, had to dispose of a chunk of the shares it held in Tata Consultancy Ltd to partially bankroll the gargantuan fund requirements of the acquisition of Anglo-Dutch steel major Corus. It might have rued the non-availability of the exchangeable bonds route for the purpose because it would have enabled it raise money through issue of EBs, convertible into shares of TCS say, after two-three years.

A win-win game

While at present we have only the contours of the EB before us, most probably it will turn out to be a win-win game for both the issuers and the subscribers.

The option to subscribe at, say, 10-15 per cent discount to the market price prevailing at the time of conversion would certainly endear subscribers to the issue of EB, especially if they perceive the shares on offer to be of top quality.

The interregnum between issue of EB and its conversion gives the holding company the best of both worlds continued control of the subsidiary without any dilution as well as the funds it requires. But the money that it ultimately realises for its holdings may not always be more than what it could have realised immediately because it is possible for the prices to fall sharply at the time of conversion.

One does not know whether the regulations would permit some sort of tie-in sale, as it were. For example, the terms of the EB issue could say that the investors in the EB of Tata Sons would get shares in the ratio of 4:1 in TCS and Tata Chemicals respectively. Such a permissive regime would be akin to the common market practice of tying up a slow-moving product with a fast-moving one. This would especially be beneficial if it heightens the overall realisations for the holding company without making the offer unattractive for the subscriber. All these are, as it is, in the realm of speculation.

Transparency issues

EB would also have the effect of bringing out in the open who controls whom. For, not much is in the public domain about many industrial groups in this country. But when EB is issued, the investors would come to know who is behind a company. It remains to be seen whether the Government itself will make use of the EB mechanism if and when it decides to go ahead with privatisation of government companies, especially the profit-making Navratnas. By resorting to EB, the Government may be able to unlock the huge value of its investments without, for the time being, diluting its control on these companies.

S. Murlidharan
(The author is a Delhi-based chartered accountant.)

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