The Adani Saga: What were the regulators doing?

I watched Harish Salve, eminent counsel, weigh in on the Adani saga on TV last week. Might I add that he has represented the Adani Group in the past. The interview left one wondering why he chose to be there in the first place, or for that matter, why was he called – he was clueless on the matter at hand and instead chose to drape it in the Indian flag.

Hindenburg was accused of having a vested interest on every news channel -- that the company significantly benefited in bringing down Adani share prices. Look at the timing, they all said. Point is, of course, that short sellers have a vested interest. The better short sellers do extensive research and then seek value in betting their own money against overvalued stocks and sectors. Short selling brought about the downfall of the housing market that brought down the global economy in 2008. Was Michael Burry, the short seller, jailed or labelled an anarchist?

Read | Adani-Hindenburg saga: A lesson to build on, say investors

The list of short selling calls that called out the BS dates back to the Dutch East India Company in the 17th century. More recently, there was Evergrande in China, Wirecard in Germany, our very own B R Shetty when he listed on the LSE, brought down by Muddy Waters, China Metals, and Enron brought down by legendary short seller Jim Chanos. In all cases, bets were made against overvalued companies that were manipulating the market and indulging in fraud. As for the timing, that’s left to the short seller. They decide when to make the call so that they benefit the most.

Hindenburg may be wrong. If it is, it will lose a limitless amount of money. But blaming it for putting out its research report and accusing it of manipulating the market, instead, is naïve. If its research did not have credibility, there would have only been a little movement in the stock prices, possibly, which would be corrected in no time, not a wiping out of $120 billion in market capitalisation!

For long, the signs were all there. Fitch released its ratings on a few Adani papers in June 2022 and characterised its long-term outlook thus: “The aggressive expansion pursued by the Adani Group has put pressure on its credit metrics and cash flow”, adding that “in the worst-case scenario, it may spiral into a debt trap and possibly a default”. At that time, shares dipped 2% or so. Now, they had no vested interest, did they?

There were many other OBVIOUS indicators that our regulators and bankers missed that should have been pointers to scrutiny, let alone the more covert matters like related company transactions through offshore entities and round-tripping. There were the purely financial:

1. Infra companies trade at 20 times PE on the Nifty. Adani group companies were trading at 400 times.

2. A typical acceptable debt-equity ratio is 1:3. In Adani’s case, it was 1:107.

3. Adani Group’s market capitalisation was higher than Tata’s and Ambani’s, a feat accomplished only in the past couple of years. In fact, in 2022, Adani’s growth in market cap contributed to half the growth of the entire BSE index. It must also be said that Tata and Ambani have a cash cow company each in the form of TCS and Reliance Petrochemicals, respectively, that deliver PATs (profit after tax) of upwards of Rs 70,000 crore each year that forms an anchor to group investments. Adani had none of the kind and relied solely on debt against inflated values of its shares.

Then there were the NOT-SO-OBVIOUS obliquely financial indicators.

1. The top 3 mutual funds in the country over the time of Adani’s meteoric 1000% growth in 2021-22 did not include any Adani stock in their portfolio – Mirae Asset, Parag Parikh and Axis Bluechip. Why? Because somewhere, fund managers felt they’d rather trade growth for security. After all, they were custodians of their investors’ wealth! Also, how is it that India’s best-known investor, Rakesh Jhunjhunwala, who had immense faith in the government of the day, had no exposure in Adani Group entities?

2. Indian private banks were exposed only to the extent of 7.5% of the total debt of about Rs 2.3 lakh crore of the group. Why was it that only the public sector SBI, PNB, etc., exposed themselves five times more than their private counterparts? The quality of security, too, varies between the categories of lenders and tells a story. Were the PSU banks nudged?

3. And finally, there are the allegations – round-tripping, share manipulation, 38 shell offshore entities, etc., that led to absurd valuations, all very serious indeed, which will take a few months to unravel, unlike Salve’s 72-hour solution.

There are striking similarities between the Enron and Adani affairs. Both were close to the head of government, both were considered vehicles to pursue a specific government agenda (liberalisation of infrastructure), both had a meteoric rise fuelled by a complex web of offshore entities and round-tripping, and finally, both being called out by a short seller as everyone else was happy making money, or felt Adani was untouchable, or both. When we forget history, we are prone to repeat it.

It is not misplaced to distrust any investigation, sadly, as the track record of SEBI or RBI in this matter has been complicit with their silence. Why would they blame themselves at the end of it all as it was their singular failure not to ask the questions that Hindenburg did? Redemption will be had, and investor confidence regained, if they go out of their way to open themselves up to a Supreme Court-led scrutiny of the Adani Group, supported by a reputed independent financial forensics firm.

The Adani Group is not a company without value. It has real assets in the form of ports, airports, power transmission, etc. This matter could well be more about fugazzi and opportunism than it is about being a fraud like Enron. The company has two options if the allegations are true.

1. The best-case scenario is that there may be hefty fines and bans levied on stock manipulation and round-tripping, etc., if found guilty. The value of Adani entities will settle, and the usual suspects will play a role in seeing it resurrected. There would be greater scrutiny in granting Adani projects going forward. Over time, if it recovers, everyone would have forgotten this episode.

2. The worst-case scenario is that Adani will choke under its debt, penalties, and the lack of confidence of lenders and investors. It may have to sell its crown jewels – media to cement to ports and airports -- to bail out.

(The writer runs a Corporate Finance practice headquartered in Bengaluru)