Hindenburg Research is an investment research firm that specializes in short-selling, which is the practice of betting against a company's stock by borrowing shares and selling them in the hope of buying them back at a lower price and profiting from the difference.
Hindenburg Research gained widespread attention in recent years for its high-profile short-selling reports targeting companies such as Nikola Corporation, Lordstown Motors, and Clover Health, among others. The firm has gained a reputation for conducting in-depth research and publishing detailed reports that often uncover what it claims to be fraudulent or misleading practices within the companies it targets.
Hindenburg Research's reports have often led to significant declines in the targeted companies' share prices and have resulted in regulatory investigations and management changes. However, the firm has also faced criticism from some quarters for its short-selling strategy, with some accusing it of using questionable tactics to manipulate stock prices for its own gain.
Hindenburg Research recently published a scathing report on the Adani Group, accusing the Indian conglomerate of several irregularities and raising concerns about its accounting practices, corporate governance, and environmental record. The report alleged that Adani Group had inflated the value of its assets, understated its debt levels, and engaged in opaque transactions with companies linked to its founders and insiders. It also accused Adani of diverting funds meant for the development of its ports and other infrastructure to other unrelated companies.
At the same time, concerned parties are questioning on the timing of publishing the report as it was published just before the FPO of Adani Enterprise, which was supposed to be the largest FPO in Indian equity market.
How much of it is true?
1. Efficient & bold management: Adani group is known for bold actions and efficient execution. The recent logistics issue in Ambuja Cement & ACC (Himachal Pradesh) is an example of bold decision making. The truck unions in Himachal Pradesh had monopolized the freight charges to almost 3X of the national average. When Adani acquired Ambuja Cement & its subsidiary ACC Ltd. they decided to shut the plants in Himachal Pradesh until the freight rates were reduced / renegotiated with the truck unions. Not a decision that a soft management would think of.
2. Sound Creditworthiness: Creditworthiness simply means “to what extent does the entity deserve a loan”. This is decided by assessing its ability to repay the loan.
Interest Coverage Ratio is a tool showing how much the operating profit would cover the interest obligation. For e.g. a ratio of 2x (200%) says that the companies operating profit is twice that of the interest obligation, which means they can easily repay the interest in time.
In case of Adani Group, most of the businesses are capital intensive businesses and require upfront investments. Due to this capital-intensive nature, debt in the balance sheet is higher. However, all the 7 listed companies have an Interest Coverage Ratio of more than 1 (more than 100%) and a good track record of repaying the interest obligations in time despite high leverage.
3. Cash-Generating Assets: In case of Adani Group, even though there is huge debt on one side of the balance sheet, the assets on the other side are highly efficient, generating hard cash at operating level and hence are highly valuable. They have a good track record of serving their debt obligations and in the worst-case scenario, even if the company went bankrupt, the assets could be sold, and dues recovered easily. But obviously through a tedious & time-consuming process of the NCLT.
4. Big Private Player in Port Business For A Reason: When port liberalization was announced in 1990s, Adani Group and DP World (Emirati MNC) showed interest in acquisition of the port business whereas other Indian conglomerates like TATA, L&T, Reliance were wary and didn’t show any interest. As a result, Adani Group was the only Indian company in the race (at least in the initial stage).
5. National Security: Ports are entry gates to a country and if owned & managed by an Indian company, it gives a level of comfort from a national security point of view. An Indian company owning Indian Ports (strategically important for national security). So was this decision led by nudges from the Indian government?
1. Extremely High Valuation: “Adani Enterprise” the flagship company of Adani Group was trading at an unimaginable PE level of 300-400. Even with visibility of revenue growth and the expansion etc. a valuation of 400 PE is not something anybody can justify.
Similarly, comparing the valuation of Adani Total Gas with its peer Indraprastha Gas (IGL), the former is highly overvalued while IGL is undervalued despite having an efficient business model. Adani Transmission vs Power Grid Corp, Adani Green Energy vs NTPC are also similar examples of peer group valuation comparisons.
2. Float Cornering: The spike in share price is attributed mainly due to the low float in the market. There is visibility of growth and hence demand for the stock is high but at the same time there is no supply/liquidity of the stock as the free-float stocks are strategically cornered through various routes. The Hindenburg report brought this to the fore.
3. Stock Price Manipulation: Generally, stock price manipulation is beneficial if the company’s promoters/shareholders seek to raise money by selling/pledging it. It can be done in many ways but most easily through cornering the float (e.g., Harshad Mehta Scam, Ketan Parekh scam).
In the case of Adani Group also, it is alleged that the prices were manipulated through cornering the free float (buying the stocks in a shell company’s name) and as a result the prices shot up unimaginably. Now, with the inflated share price, the promoter could sell off a lesser number of shares to raise funds and the recent FPO was viewed by critics in this context.
4. High Leverage: Adani Group companies are highly leveraged. The Debt-Equity ratio which shows the level of leverage of a company is high in the case of Adani group companies. Out of the 7 listed companies, Adani Green Energy has a Debt-Equity ratio of 7.7 times and Adani Transmission has 3.16 times whereas anything below 1 is considered as the ideal D/E Ratio. Only Adani Total Gas and Adani Wilmar have D/E Ratio lower than 1.
5. Valuations Are Against Theoretical Practices: Theoretically, higher debt results in lower market cap and hence the enterprise value decreases (EV = Market cap + Debt – Cash) and when you deleverage, the debt comes down and the market cap goes up. But in case of the Adani Group companies, the opposite happened. The market cap kept on moving up even though the debt level was high.
Conclusion:
The key learning lessons from Adani issue is although it can be challenging for investors to remain calm when stocks are falling precipitously, the fundamentals of equity investing are still valid today – i.e. Diversification and Asset allocation. Let’s look at both these principles one by one.
Likewise, you need to be cautious when you have higher exposure to a single stock/ group/ industry/ sector. This exposure can either be through direct investments or benefits of ESOPs.
A bonus tip – Look for opportunities in investing in debt instruments as the interest rates are at a higher level – A better deal of risk adjusted return as compared to many risker equity investments. Read more here.
