The India Rising story hit some turbulence last week, as one of its biggest corporate success stories, the Adani Group, was hit with a report from Hindenburg Research, an investing group that specializes in targeting and shorting companies that it believes have dubious accounting and business practices. In response, people have fallen into two groups, with the Adani family and its supporters arguing that the short selling report is a hit job by a “foreign” entity to bring down not just the company, but also the country, and others noting that the report just reinforces what has troubled them about the company’s meteoric rise in the last decade. I will confess that I know very little about the Adani Group, and I have nothing invested financially or emotionally in the company’s fortunes. If you are looking for advice on whether you should buy or sell Adani shares, based upon my analysis, you will be disappointed. Instead, I will argue that the ingredients that led to the Adani stock price meltdown last week, which include an ambitious family group obsessed with control, a financial market where trading momentum trumps financial fundamentals and a capital market (debt and equity) where governments and regulators put their thumbs on the scale, are embedded in many Indian companies, and represent the weakest links in the India story.
The Lead In
As noted in the introductory paragraph, I start from a position of ignorance about the Adani Group, and it thus made sense to fill in that gap. In doing so, I will undoubtedly bore those of you who have followed the company closely, and know far more than I do, and I apologize.
The Adani Group, founded by Gautam Adani, started life as a commodity trading partnership business in Gujarat, and listed on stock markets in 1994, as Adani Exports, with a large chunk of its revenues coming from its operation of a local port in Mundra, with a subsequent entry into the edible oil business. The group’s investments were regionally concentrated, but over time, they have expanded into other businesses and across India, and while I seldom draw on corporate presentations, I will make an exception and use a slide from Adani’s January 2023 pitch to describe their business mix:
Link to Adani Corporate Presentation
With the exception of Adani Wilmar, a food processing business that has recently been bolstered by acquisition of leading brands, the rest of the Adani businesses share some common characteristics. First, they are infrastructure businesses, requiring large up-front investments and having long gestation periods, with regulatory and government oversight. Second, an increasing proportion of the company’s investments are related to energy, in green energy and gas transmission/distribution, but the company’s most significant investments are in logistics, especially in airports and ports . While each of these businesses is operated by a stand-alone Adani company, the businesses flow through a holding company, Adani Enterprises. The percentages of each company that is held by the Adani family is shown in brackets in the picture, and we will return to examine the implications later in this section.
The Rise to Market Prominence
The Indian economy, in general, and Indian public markets, in specific, have always been dominated by family group companies, with many of the family groups tracing their history back a century or more. Given the historical roots of the biggest Indian family groups, the Adani Group has been a recent entrant, not making the top ten list (in terms of either operating metrics like revenues or market-based numbers like market capitalization or enterprise value) as recently as ten years ago, and barely making the top ten list five or six years ago. That has clearly changed, and at the start of 2023, four Adani companies were in the top twenty Indian companies, in terms of market capitalization, and the collective value of the seven publicly traded Adani companies was $220 billion (₹ 17,600 billion), greater than the market capitalization of Reliance, the Ambani family flagship, and India’s largest company. In fact, for a brief period at the start of 2023, Gautam Adani was the second richest man in the world, based upon his holdings in his group’s companies:
Adani’s Operating History
In an attempt to understand Adani’s rise to market prominence, I started by looking at revenues and operating income at Adani Enterprises, the flagship company for the group:
Adani’s Investment Push
It is rare to see infrastructure companies grow as quickly as Adani has, and the reason is that growth in this business requires large investments in capacity. Looking at the capital invested at Adani Enterprises provides us with a sense of how much capital this company has employed over the last twenty years to get to its current standing.
Adani’s Debt Load
The investment side of the Adani story is not complete without bringing in the financing part, since the money for these investments has to come from somewhere, either internally, residual cash flows from existing operations, or externally, from new debt or equity. Using the statement of cashflows from Adani Enterprises, I present a picture of how the company funded its investments:
Adani’s Ownership Structure
It is no secret that family group companies are controlled by the families that run them, but the degree of ownership that the Adanis have in their companies is high, even by Indian family group companies. In fact, the slide that I drew from the company’s own slide deck is open about the family’s percentage ownership of each of the Adani companies. Consolidating across the Adani companies, it looks like the family owns about 73% of the outstanding equity in these companies:
(Afro Asia, Universal Trade, Worldwide Emerging and Flourishing Trade are counted as part of Adani holdings)
This not a secret and these details are available from an Adani SEBI filing, where the family also includes the holdings of four corporate bodies that they control, as extensions of their holdings. While a family controlling a significant portion of the equity in a family group may not surprise you, the fact that this ownership stake has hardly budged over a decade where the company has increased in scale more than ten-fold, with dependence on external capital for that growth, is striking. The reason, of course, lies in the earlier graph, where we looked at how dependent the Adani companies have been on debt for their funding, rather than equity. There is a control story here that needs to be told, and we will come back to it.
Of the 27.5% that is not held by the family, a significant percentage is held by foreign institutional investors, with Vanguard and Blackrock making the list, largely through their index funds holdings. Among Indian institutions, LIC is the largest holder with just over 4% of the shares, but the retail investor presence in this company is small, largely because of the low float, though the surge in the company’s price in the last two years has drawn some traders to it.
Adani’s Market Capitalization
In our final assessment, I look at how the market have priced Adani Enterprises over time, looking at the multiples that investors have been willing to pay for its operating numbers from earnings to revenues to EBITDA, as well as relative to its accounting value (book value):
With every pricing metric, the surge in the last two years is striking. The PE ratio for the stock has gone from a modest 15 times earnings in the 2016-21 time period to 214 times earnings in the most recent two years, and the enterprise value has jumped from about 12 times EBITDA during 2016-21 to 53 times EBITDA in the most recent two years. You see similar movements in the price to book, where the stock has gone from trading under book value to 6.7 times book value, and the enterprise value, which was less than revenue in 2016-21 to 2.71 times revenues in the most recent two years.
By itself, the surge in pricing multiples is a feature of volatile markets, and it is a phenomenon that we saw with technology companies in the last decade. What makes it surprising at Adani is the fact that this is an infrastructure company, and the irrational exuberance that animates pricing in tech or software usually has little play in this sector. In addition, the question of which group of investors is leading the push to higher prices is a puzzle, since, unlike an Agatha Christie mystery, the list of suspects (see ownership structure) is short. One benign explanation is that foreign institutional investors are using Adani listed shares to make a joint bet on Indian growth, infrastructure investment and Indian politics, and that the pricing is being pushed up because of the limited float, but as we will see when we get to the short sellers’ thesis, there are more malignant explanations, as well.
The Shorts Speak up
All of the information that I used in the last section came from publicly disclosed documents, and there are no secrets. In fact, it is common knowledge that the Adani Group has grown, with a disproportionate dependence on debt, and that the rise in stock prices in the last two years has worked to the family’s advantage, as it considers selling some of its ownership stake to raise fresh capital. It is also widely known that one of the competitive advantages of the group is its closeness to political power, and arguing that the company is benefiting from its political connections is neither novel nor uncommon in Indian business setting.
When the Hindenburg Research report targeting the Adani Group came out a couple of weeks ago, I was surprised for a simple reason. I have seen this group target companies before, using the game plan that they are using with Adani, but their typical target firms are usually much smaller, under-the-radar firms, where public market investors may have missed troubling aspects of operations. The Adani Group is a huge target, by the standards of any market, and it is one of most widely talked-about Indian firms. I must confess that I find the Hindenburg shock-and-awe approach of throwing up dozens, perhaps hundreds of accusations of wrong doings at a firm, hoping that something sticks, off putting, since even if I am in agreement, I find myself spending time trying to separate the wheat from the chaff, the big wrongdoings from the minor distractions. I may be doing a disservice to Hindenburg and other Adani naysayers, but it seems to me that what they call the “biggest con” in history has three legs to it, and everything in the report feeds into one of the legs:
Almost every contention in the Hindenburg report can be traced to one of these three groupings, and I will try to regroup them on that basis.
Use of Shell companies: The most damaging of the Hindenburg contentions is that Vinod Adani, Gautam Adani’s oldest brother has created a large number (38, by Hindenburg’s count) of shell companies, based in Mauritius, and used them specifically for “(1) stock parking / stock manipulation (2) and laundering money through Adani’s private companies onto the listed companies’ balance sheets in order to maintain the appearance of financial health”,Dubious intra-party transactions: Hindenburg contends that the Adani Group has used its shell companies, in conjunction with transactions among its holding companies, some of which are privately owned by the family, to “inflate revenues” and for “manipulate earnings” at their listed companies.Inexperienced (or worse) auditors: Hindenburg notes that the accounts at Adani Enterprises and Adani Total Gas are audited by a tiny and largely unknown auditing firm, Shah Dhandaria, with four partners and eleven employees, some young and inexperienced. Implicit in this statement is the contention that this auditing firm is either incapable of or unwilling to highlight the accounting irregularities at the Adani companies.Listing rules: Publicly traded companies are required to have at 25% of their shares be held by non-promoters to stay listed on exchanges. Hindenburg contends that there are some of the foreign funds that the Adani Group lists as non-promoter holding to pass the listing threshold are almost entirely invested in Adani companies, and controlled by the Adani family. In short, Adani is being accused of violating listing rules, and covering it up.Stock as collateral for debt: The motive for the stock price manipulation, at least according to Hindenburg, is that some of the debt in the Adani companies has been backed up or secured by shares in the company, with a higher market capitalization then allowing these companies to borrow more than they should.Guilt by association: Along the way, Hindenburg notes connections that the Adani Group has to a host of individuals, some within the family (Samir Vora, Vinod Adani and Rajesh Adani) and many outside, who have been accused of fraud and manipulation, or in some cases, been found found guilty and barred from trading.