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Caveat emptor: Indian SOEs attempt covenant changes

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By Morgan Davis
03 Dec 2019

Oil and Natural Gas Corp’s (ONGC) failed attempt to loosen change of control covenants for its dollar bond is a prime example of why investors in Indian state-owned enterprises need to keep their eyes wide open when approaching new deals.

Indian state-owned enterprises (SOEs) are entering an uncertain period. The government is under pressure to divest its holdings in some of them to raise funds and attract foreign capital. The sell-downs are no secret, with the country putting its stakes in several firms — including dollar bond issuer Bharat Petroleum, Air India, Shipping Corporation of India and Container Corporation of India — on the market.

A lack of government support does not scupper the country's state-owned companies, but it does mean that investors will eye their new bonds sceptically.

REC was the first notable casualty of the change earlier this year when it announced a consent solicitation for holders of its existing dollar bonds. The government was selling its majority stake in the power company to another state-owned electricity firm, Power Finance Corp (PFC), triggering a change of control put for REC's bonds. PFC also has state backing but is considered weaker. Investors resisted REC's initial offer for the consent solicitation, forcing the borrower to pay up to get the trade done.

The REC saga left investors on edge, and has put a magnifying glass over Indian SOEs' change of control covenants on dollar bonds.

The change of control terms that REC had, which give investors a put option should the government's ownership stake drop below 50%, are common for Indian SOEs. But with the government ready to back out of a number of firms, investors are facing uncertainty about the value of their bonds — and would be smart to double check the terms of their paper. They should also be ready to hold their ground should the issuer try to force a consent solicitation like REC.

But just as importantly, investors need to look closely at any new Indian SOE deals coming to the market, as some of the companies may be next on the government’s chopping board.

ONGC, for one, tried to overcome the problem in November by trying to tweak its change of control terms. In its past deals, ONGC used the typical covenants, riding on the government's majority stake in the company. But for its new deal, ONGC attempted to switch the language from a covenant contingent on the percentage of the company that the government holds to one that is tied to the management control.

Investors immediately reacted to the tweak — demanding either a change to the usual terms or a juicy premium from ONGC to price the deal. This forced the oil company to backtrack and tighten the covenant again.

ONGC may not have pulled off a bond with looser terms but its deal is a cautionary tale for investors, who will now study change of control covenants for Indian SOE bonds even more carefully than before. It’s also something other potential borrowers should learn from — and be ready to either pay up for different covenants, or do enough investor education to get them on board.

This shift in India will continue into 2020, as the government attempts to embark on an aggressive privatisation programme to plug some of the gaps in its fiscal deficit and infrastructure financing. It's unlikely that ONGC will be the only SOE that will try to alter the language of new bonds to account for the possible change in future ownership. Investors should be prepared.

By Morgan Davis
03 Dec 2019