Zenith Infotech and The Trouble With Convertible Bonds

The news about Zenith Infotech’s bond default and subsequent
questions about whether it’s really a stable financial partner for MSPs have
dogged channel partners and the industry since the news went public in October.
Indeed, some competitiors to Zenith Infotech have even been leveraging doubts
about company’s stability. (Is anyone really surprised by that?)

For its part, Zenith Infotech maintains that it is
financially viable and stable. But some wonder how that is possible if the
company has defaulted on $85 million in bonds. I wish I knew the answer to
that. Zenith Infotech is not elaborating.

According to Investopedia.com convertible bonds are
"essentially, corporate bonds that can be converted by the holder into the
common stock of the issuing company."  

These were apparently popular among Indian companies during
the mid-2000s.
Risk.net, a London-based publication covering financial investments and risk,
said in a May 2011 article that "FCCBs (foreign currency convertible
bonds) became the favored instrument to raise capital for Indian companies
during the bull run from 2004 to 2007. Most issuers were on a high growth
trajectory and assumed that increased future earnings would induce investors to
convert their bonds to equity at some stage."

But that didn’t really happen, Risk.net notes. Instead,
"The Indian equity market is nowhere near the levels it was during 2007
and plummeted by almost 17 percent between November 2010 and February 2011. As
a result the conversion price for most of the outstanding FCCBs is way above
the company’s current stock price."

So that means the bond holders, unsurprisingly, haven’t
converted to equity, leaving the issuing company with the problem of how to pay
off the bond holder at the end of the term.

Zenith Infotech is far from alone in this situation. In May
Risk.net stated that about 80 companies had FCCBs maturing in the next 12 to 15
months with a combined payout of $8 billion.

Issuing companies are left with the options of paying back
the bonds, raising capital to pay them back or getting additional loans to pay
them back. However, with the current economic difficulties worldwide, many
companies are experiencing difficulty doing any of these things.

In the Zenith Infotech matter, a further complication looms.
Just five days after it defaulted on the bonds, Zenith Infotech sold a majority
stake in Zenith RMM to Summit Parters, a private equity firm. 
According to this late September 2011 Redmond Partner News interview with
Zenith Infotech CEO Akash Saraf, Zenith RMM accounts for about one-third of the
former Zenith Infotech’s $80 million in annual revenues. Zenith RMM which is
based in Boston has about 600 employees and owns a network operations center
(NOC) in India that supports Zenith RMM’s 3,000 partners and 400,000 managed
endpoints.

After the spin off, Zenith Infotech has about 500 employees
and maintains a headquarters in Mumbai with a U.S. headquarters outside of
Pittsburgh in Warrendale, Pa.

In the RCP interview, Saraf said that the primary motivation
for the spinoff was to gain additional R&D resources for both businesses.
He said Zenith spent $22 million on R&D last year.

QVT Financial, the hedge fund which holds Zenith Infotech’s
bonds, hasn’t been happy about the spin off of such a big asset just five days
after the bond default. In fact, it’s taken Zenith Infotech to court, seeking
financial disclosures about the Zenith RMM deal.

A Zenith Infotech spokeswoman said that Zenith Infotech CEO
Akash Saraf "is taking the court order matter very seriously. He wants to
assure all the stakeholders that we are committed to getting the situation
resolved as quickly as possible."