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What are the features of the CARS?

*
Some of the features of CARS are:
A quassi equity instrument convertible to shares at later stage
Carries a coupon rate of 1%
The bond would be redeemed at 23.341% premium
Effective Yield was 5.15%
open for only one year and one need to wait for 4 years before exercising the option.
CARS are supported by Letter Credit
On conversion, voting rights are not given to the shareholders

Comment on the distinct features of the CARS and explain why Tata Steel
chose to structure the bond the way it did? *

Supported by Letter of Credit: This will make the instrument more attractive and
enhances the credit rating to next higher level. This will help in attracting foreign
lenders easily.
Option : At the time of purchasing CARS the market were bullish and surpassing the
conversion price after four years was looking pretty inevitable to many lenders.
FIIs holding was capped at 24% by local regulation and FIIS were already holding
21% at the time of issuance of the instruments. CARS was an attractive vehicle for
increasing the stake in company and also help in discovering the true price as FIIs
were trading shares amongst themselves because of the cap put by local
regulations.
The terms of the CARS include a lock-up (not to issue shares) for 90 days from
September 4, 2007. Why not more or fewer days? *

This is linked with 90 days forward rates. e.g 90 day LIBOR to ensure certainty in
terms of interest rate our exchange rate. Less than 90 days does not carry any
meaning as no instrument is available and bank settlement cycle in many cases are
also 90 days.
How would you value the CARS? *

CARS areconveritible bond and hence for valuation one need to consider this in two
parts
Value of plain bond and value of convertible part. In case the option expires below
the exercise price the value will be like any other plain bond. In case the price of
underlying rises above the exercise price and hence option is exercised, bonds can
be valued by using tools like Black-Scholes model for option pricing.
For final valuation both part can be added up.
As an analyst, would you recommend an investment in the CARS, from a
valuation viewpoint? *

Purely on the valuation point CARS look to be attractive if one simply assume that
the price of underlying is going to surpass the conversion price. But looking at the
balance sheet, uncertain market and the debt burden I would advice to convert in
FCCB at the early offer period. Also there was no long term market for Tata Steel to
have a reliable implied volatility data and I have to depend on what Tatas are
saying.
Could there be a logical argument for the pricing to be generous? *

No in absence of long term volatility data and falling credit rating one cannot be
termed generous. Also long term volatility data is not available to value option with
some degree of satisfaction. In these kind of situations these generosities or deal
sweetening are generally because of compulsion under duress.
What concerns could an investor have on the terms of the CARS and what
could be done to mitigate such concerns? *

The main concern


1. Company's credential
2. Past performance
3. Future outlook
4. The management team
Generally credit ratings agencies like Standard and Poor's, Fitch, Moody's cme out
with their ratings considering the financial position of the company. These are
reliable data. This can give the direction. As an investor one should not be passive
to what is going on around. Whether the company's leveraged position is going to
help in overcoming some hurdles or make it even worse. Management credentials
are simpler to identify based on symbolism, mission vision and past performance.
There is no substitute for a proper due diligence.

The house of Tatas is a premier name in India. Why would they seek credit
enhancement by way of a Standard Chartered Bank L/C? *

Prior to CARS the credit rating of Tatas were downgraded by various rating agencies
like Standard & Poor's, Fitch and Moody's. Standard & Poor's lowered company's
rating to BB with negative outlook in Feb 2009. In April 2009 Fitch lowered
company's rating to BB+ with negative outlook and Moody's to Ba3 with stable
outlook. In this kind of negative environment the chances of success of CARS or
attractiveness gets hampered. To ensure this should not be any hindrance the
company backed this with LC . This helps in enhancing the rating and hence the
attractiveness for the foreign investors.

If the CARS convert to depository receipts, the underlying for which is a


share, the holder will have no voting rights. Thus, the CARS provide economic
rights of the shares only. Why?
This is by design. If law permits companies can issue shares with differential
right in terms of voting right or dividends. Mainly used for capital structuring.
Investors are not generally concerned with running the management and their
concern is mainly economic value.
What would be the impact on investors in the event the L/C is invoked? *

Bank does not issue L/C just like that. This is backed by some tangible asset like
fixed deposit, securities, real estate property etc. As soon as bank L/C is invoked the
bank will cash all these tangible assets and pay off. This way the investor is largely
protected and will suffer only in terms of possible return from securities.
What can be a basis to value differential shares? How might the independent
financial institution undertake this valuation for the purpose of the CARS? If
the dividend is adjusted for the differential shares, what could be the impact
on the option value of the CARS? *

The basis for valuation for shares with or without voting right is same. It is based on
pure economics and not the control over management. Present Value method,
dividend yield etc can be used in same way.
Any independent financial institution will value stock purely based on economic
consideration.
Option value is based on exercise price, current market price and time to expiration.
Dividend yield, risk free interest rate are part of the equation. In case the dividend
yield increases the value of convesion option will decrease and hence the overall
valuation of the CARS.

CARS was required by Tata Steel to defer cash flows and also the fact that the rating agencies did not
consider this instrument as a plain debt as these were convertible to shares at a later stage. It was
therefore considered to be an Quassi equity instrument and the ratings of the company didnt fall
because of this.