Adani controversy: The fallout

When Gautam Adani became India’s richest individual and the world’s third wealthiest towards the end of 2022, he shrugged off such rankings as inconsequential. The chairman of the Adani Group, a multi-billion-dollar ports-to-power conglomerate, told India Today, “I get my thrills from handling challenges—the bigger they are, the happier I am.” Standing before him now is the biggest challenge of his career and the consequences so far have been completely unfavourable for him and the Ahmedabad-based group he has built single-handedly.Adani Enterprises had been preparing to launch an FPO (follow-on public offer) when, on January 24, the New York-based short-seller Hindenburg Research came out with a sensational report that levelled a series of allegations against the group, including stock-market manipulation and accounting fraud. The group’s shares plummeted, eroding as much as $120 billion (nearly Rs 10 lakh crore) in investor wealth in nine group companies in a week. As on February 7, the market capitalisation of these nine companies listed on the exchanges stood at just Rs 9.8 lakh crore, nearly half their valuation two months ago. And Adani himself had slipped to 17th place on the Forbes Wealthiest list and lost his distinction as India’s richest. He may have temporarily succeeded in stopping his shares from haemorrhaging further, but not before the steep fall cast a foreboding shadow on the future of his group and also dragged him to the centre of a massive political controversy that has put the Modi government on the mat ahead of the 2024 general election. The Opposition, spearheaded by Congress leader Rahul Gandhi, charged the prime minister with favouring the businessman and called for a joint parliamentary committee (JPC) to investigate the matter (see accompanying story The Political Blowback). Concerns were also raised on the exposure of the largest public sector bank, the State Bank of India (SBI), and the largest state-owned insurer, the Life Insurance Corporation of India (LIC), to the group, with the Opposition alleging that public money had been squandered.On his part, the prime minister unleashed the full might of his oratorical skills in Parliament, as he lashed out at what he termed as the “ecosystem” of corruption and inefficiency that made 2004-2014 (the years of Congress-led UPA rule) a lost decade. He contrasted it with the development initiatives marking his tenure. He made no mention of Adani or any promise of a probe. Yet, it is apparent that the Adani imbroglio will not be resolved anytime soon. Apart from impairing Adani and his group, it has triggered concerns about its impact on India’s financial stability and the political damage it could likely inflict on the prime minister and the ruling Bharatiya Janata Party (BJP)..preferred-source-banner{ margin-top: 10px; margin-bottom:10px;}How Bad is the Damage to Adani?In its voluminous report, Hindenburg Research accused the Adani Group of running a “brazen stock manipulation and accounting fraud scheme over the course of decades”. The US firm, which has a history of “shorting” large corporate houses, raised 88 questions. Prime among the charges was that the group was using shell companies overseas, many managed by Gautam’s elder brother Vinod Adani, to siphon off money from its seven listed companies and routed back to generate a fake turnover, pledging shares of its artificially inflated stocks for loans. The charges took the group completely by surprise, and even as they scrambled to pull themselves together, their stocks plummeted on the bourses. It took two days for the Adani Group to come out with an exhaustive 413-page clarification, in which it maintained that the Adani portfolio companies had from time to time disclosed answers to 65 of the 88 questions in the report. Of the remaining 23 questions, 18 were related to public shareholders and third parties and five, it claimed, were baseless allegations. It dismissed the charges as being a “selective and manipulative presentation of matters already in the public domain to create a false narrative”. The Adani Group asserted that it is in complete compliance with all applicable laws and regulations and may pursue “remedies to safeguard our stakeholders before all appropriate authorities”. It also termed the allegations an attack on the nation. In a rebuttal to Adani’s explanations, Hindenburg persisted with its accusations—indeed that a few of Adani’s responses reinforced some of them—and even declared that “fraud cannot be obfuscated by nationalism”.Meanwhile, the Reserve Bank of India (RBI) and markets regulator Securities and Exchange Board of India (Sebi) are reportedly scrutinising the matter. However, every delay in assuring investors of the group’s financials leaves it vulnerable to panic-selling in the market. Even as the BSE and NSE put three Adani companies—Adani Enterprises, Adani Ports and Special Economic Zone, and Ambuja Cements—on their short-term Additional Surveillance Measure framework, ratings agency S&P red-flagged Adani Ports and Adani Electricity, Credit Suisse’s lending arm assigned zero lending value to the bonds issued by Adani companies, and the wealth investment arm of Citigroup has reportedly stopped accepting Adani Group securities as collateral for extending margin loans. French company Total Energy put its hydrogen venture with Adani on hold pending audit clearances. Some relief to Adani came by way of a statement from Fitch Ratings, which discounted any immediate impact on the ratings of Fitch-related Adani entities and their securities.There is no denying the damage, though. The Hindenburg report came just before Adani Enterprises’ FPO, which was aimed at raising Rs 20,000 crore from the markets to fuel expansion plans and repay some of the debt. But with Hindenburg’s allegations, the company’s shares were soon trading much below the floor price of the FPO, which was in the band of Rs 3,112-3,276 per share. Although the FPO was fully subscribed, especially with the support of high net worth individuals, it was called off on February 1, “in the interest of its subscribers”, and a declaration that “it would not be morally correct” to go ahead with it. The fact is its stock price had already dropped to Rs 1,500 per share and was showing signs of further depletion.Is India’s Financial Stability at Stake?The immediate concern for the Modi government was whether Adani’s plunging stock would hurt the country’s macroeconomic stability with a possible domino effect causing a financial meltdown in the stock markets. Adani is, after all, India’s largest private sector power producer, ports and airports operator, consumer gas business and electric transmission company, in addition to being the largest infrastructure developer and generator of renewable energy. It has big plans in the solar, wind and green hydrogen fields, and a scope ranging from power to edible oil, mining to data centres. If Adani falls, the reverberations will be felt across the economy. A senior finance ministry official, however, expresses confidence that there will be no major impact on the country’s financial stability. “The public sector banking and financial institutions that have invested in Adani do not have such a large exposure as to cause a first-order attack,” he says. “Moreover, Adani is no fly-by-night operator but a company that has solid valuable assets, particularly in the infrastructure sector, which they have placed as collateral for taking on debt. Of course, allegations such as stock manipulation leading to inflated prices of the group’s shares apart from its investments from offshore companies in tax havens need to be looked into.” Other experts seem to back this assessment. Two days after the Hindenburg bombshell exploded, a report by global brokerage CLSA noted that the Adani Group’s gross debt in FY22 was Rs 2.2 lakh crore. Of this, bank debt (term loans, working capital and other facilities) formed just 38 per cent of total debt, while bondscommercial paper (CP) constituted 37 per cent. Another 11 per cent came from borrowing from financial institutions, and the remaining 12-13 per cent through inter-group lending. “Within this,” the report pointed out, “private banks’ exposure is below 10 per cent of the total group debt and most banks have indicated that they have largely financed assets with strong cash flows, such as portsairports. PSU banks do have material exposure, but this debt has not increased in the past three years.” In fact, Gautam Adani, in his interview to india today last December, pointed out that the group had been steadily paring down its borrowings from Indian banks, reducing them from 86 per cent of the group debt nine years ago to 32 per cent now. Almost 50 per cent of the group’s borrowings, he added, were through international bonds and they would have subscribed only after due diligence. This has, in many ways, assuaged any panic from the investors over the falling values of his shares.Public sector financial institutions, particularly the LIC and SBI, were quick to point out that their exposure to the Adani Group was below 1 per cent of their total lending and backed by collaterals. LIC, in a statement on January 30, said its holding under equity and debt in the group was Rs 35,917 crore and assured that the credit rating of all Adani debt securities it held was in compliance with Insurance Regulatory and Development Authority of India investment regulations. SBI, meanwhile, said it has an exposure of Rs 27,000 crore. “Whatever banks like us have lent (to Adani) is a very, very small component of our total loan book,” clarified SBI chairman Dinesh Kumar Khara. “This is all supported by physical, cash-generating assets and we have never seen any default in the past.” Sources in the Indian mutual funds industry say they have no investment in Adani shares, which is why a large number of retail investors have been spared the impact of Adani share prices falling. “That’s because local investors do not have the confidence in the Adani Group. Most asset management companies believe its stocks were heavily overvalued,” says the CEO of a large mutual fund. Meanwhile, the RBI in a statement said, as per its current assessment, the banking sector remained resilient and stable and it is constantly monitoring the sector. Without mentioning the Adani Group, it added, “Various parameters relating to capital adequacy, asset quality, liquidity provision, coverage and profitability are healthy.” Union finance minister Nirmala Sitharaman also stated: “Our macroeconomic fundamentals, the image of our economy, none of it has been affected. The fact that we have had $8 billion of foreign exchange reserve growth shows that perception of India and its inherent strength is intact.” She also said regulators such as Sebi will do their job on the issue, but didn’t elaborate further.Why Sebi Needs to Step up to the PlateMost experts believe Sebi should move fast with its investigation and share its findings as early as possible. M. Damodaran, former Sebi chairman, said that red flags should have been raised when the stock prices ballooned. While the regulator often acts on complaints, and there is a time lag in its actions, independent directors should have raised caution. The Hindenburg report raises several major issues that the RBI, Sebi and other regulatory agencies need to examine.A key Hindenburg allegation is that Adani companies have taken on substantial debt, putting the group on a precarious financial footing. Sources close to the group put its overall debt at Rs 2.4 lakh crore. After discounting cash reserves of Rs 30,000 crore, that figure can be trimmed to around Rs 2.1 lakh crore. The group claims it has gross fixed assets worth Rs 3.7 lakh crore and that the assets generate a cash Ebitda (earnings before interest, taxes, depreciation and amortisation) of close to Rs 60,000 crore annually. That translates into a net debt-to-Ebitda ratio (a barometer of a company’s financial health) of 3.2x, which is said to be the industry standard. Infrastructure businesses are often structured on 70 per cent debt and 30 per cent equity, but the source says Adani has 55 per cent debt and 45 per cent equity, which makes it less vulnerable. The other allegation is that the Adani stocks have seen a phenomenal rise in their market capitalisation in the past five years and that the stock values have been artificially inflated. Experts like Aswath Damodaran, a professor of finance at the Stern School of Business at New York University, trace how the fortunes of the Adani Group took a steep upturn in recent years. At the start of 2023, four Adani companies—Adani Enterprises, Adani Total Gas, Adani Green Energy and Adani Transmission—were among the top 20 in terms of m-cap. He also points to Adani’s quest for greater family control. Sebi mandates that the maximum shareholding by promoters not exceed 75 per cent, the rest should remain public shareholding. However, per the group structure as of November 2022, the promoters held 72.6 per cent in Adani Enterprises, 75 per cent in Adani Power, and 73.9 per cent in Adani Transmission, all of which skimmed the upper limit permitted by Sebi. In Adani Ports, the promoters held 66 per cent.Not only does this betray the family’s immense control over the businesses, but also leaves room for inflating share prices if regulators and investors aren’t wary, say market sources. On February 9, Morgan Stanley Capital International said certain investors in Adani Group securities should no longer be designated as free float (shares that can be publicly traded), and it is reviewing this status, putting further pressure on Adani Group stocks. The more damaging of Hindenburg’s charges relate to the shell companies, stock manipulation and money laundering (see The ‘Shell Companies’ Shocker). The report alleges that Adani has a raft of shell companies based in Mauritius, which are used to buy shares and thus retain greater promoter control in the group. “It is unlikely that the web of shell companies was made out of thin air by Hindenburg,” says Damodaran. “There are 6,300 companies in Mauritius. It is a place where many Indian businesses, including the Adanis, go. The Indian government is trying to crack down on these companies.” The Adani Group denies it has misused the Mauritius connection and says that every dealing it has had there is above board and conforms to the existing law.Another damaging revelation in Damodaran’s analysis pertains to the price-to-earnings or PE ratio of Adani Enterprises, which has gone from just 15 times in 2016-21 to 214 times in the past two years. The PE ratio is a measure of the company’s value through a comparison of its current share price relative to its per share earnings. It gives companies better valuation and makes it easier for them to raise finance, including from pension funds that usually automate their investments based on high-value market indices. While high pricing multiples are a feature of volatile markets and have characterised tech companies in the past decade, Damodaran is surprised to see it happen in infrastructure. This is because, as he says, payoffs in infrastructure firms typically come over longer periods, and the returns on investment are relatively lower than in certain other businesses. Damodaran traces the real big jump for Adani companies between March 2021 and September 2022. Despite huge investments, Adani Enterprises saw its return on capital falling from a high of 14.69 per cent in 2002-2015 to 3.18 per cent in 2021-22. Damodaran believes that the Adani Enterprises stock has more than 40 per cent “downside” (that is, the shares could be priced 40 per cent lower), and should be ideally priced at Rs 945 per share, well below the FPO price band. The group denies any allegation of manipulating the PE ratio and maintains that experts like Damodaran are not factoring in the solidity of the group’s growth, a main reason for its high share prices. The way forward, as Damodaran sees it, is for the group to take a hard look at how it conducts business and for regulators like Sebi to clean up the system. He points out, “The ingredients that led to the Adani stock price meltdown 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 link in the chain.”Will the Fallout be Limited?Gautam Adani has faced adversity before. A fighter by instinct, he sees any crisis as an opportunity. In his worst hour in business, Adani quickly put together a four-phase strategy to correct the share prices and put the group back on a high growth trajectory. On February 6, to instil more confidence in the investor community, the promoters of the Adani Group companies repaid $1.114 billion (around Rs 9,217 crore) before time to release some pledged shares in Adani Ports & Special Economic Zone, Adani Green Energy and Adani Transmission. The conglomerate said this was done “in light of recent market volatility and in continuation of the promoters’ commitment to reduce the overall promoter leverage backed by Adani listed company shares”. The move yielded immediate results. On February 7, most of the Adani Group companies’ shares showed a sharp uptick, with Adani Enterprises gaining 14.63 per cent on the BSE to close at Rs 1,802.50. The next day, the stock closed still higher at Rs 2,158.65.Sources close to the Adani Group say that releasing the pledged shares was to demonstrate the liquidity available with the group and arrest the panic selling. This is the first phase of the group’s fire-fighting strategy. Stock markets expert Arun Kejriwal says that the releasing of pledged shares by Adani is a strong signal that the promoters are not in desperate need of money. “Whenever there are earthquakes, there will be aftershocks,” he says. “Then you have to allow the shock to subside. The same thing will happen with Adani companies. The market will find its own level and settle down. Every positive announcement from the company will be looked at with a microscope.”The next two months will be critical for Adani. One of his biggest roadblocks will be on the financing front. Experts expect that he will find refinancing the group’s existing loans difficult, as well as raising new funds from banks and the capital markets. Goodwill and trust matter a lot with both, and these have come under a cloud. Infrastructure expert Vinayak Chatterjee says, “As a group, Adani has strong liquidity and strong cash reserves. They have a good set of professional managers, strong operating projects with good cash flows. There will be a rescheduling of capital expenditure allotments. The slowdown will be visible for a year, after which the company will bounce back.” (Photo: Chandradeep Kumar) Aware of the hole they find themselves in, the group, in the second phase of its strategy, will be working very closely with banks. The group’s core relationship banks have already started infusing liquidity to honour shareholder loans. This has de-risked the Adani portfolio from volatile share price movement. The group will also come out with its capex plans and credit profile to chalk out a long-term strategy spanning six months to 10 years. Meanwhile, it has been extensively briefing 10 rating agencies—three overseas and seven at home—and they have apparently given a thumbs up to the company’s overall credit profile.In the third phase, the group plans to agree to additional covenants on what it will disclose to the market from a bondholder’s perspective, because they know they will now be held to closer scrutiny. The company’s executives are already calling bondholders directly. In the next 12 months, capex will be slow since the group wants to demonstrate its strength. The focus will be on regaining investors’ confidence, showcasing key performance indicators and quarterly performance of group companies. Its green businesses, the data centres, airports and transmission will be the key areas. In the fourth phase, the group plans to present its businesses in a completely de-risked manner and consolidate all the current ventures while going ahead with expansion plans.Adani maintains he is a born optimist and the group appears confident of weathering the storm. This, of course, hinges on several factors, including Indian regulators giving them a clean chit on all the allegations. The imbroglio has shed light on the chinks in India’s financial armour. If Sebi, for instance, is found wanting in its watchdog role, it will have serious political repercussions for the Modi government, allowing the Opposition charge that it favours businessmen to stick. The government will have to demonstrate that the country’s financial dealings are conducted fairly and transparently and the regulators will need to maintain strict vigilance so that the shine on the India story remains real. The ‘Shell Companies’ Shocker Nathan Anderson, founder of New York-based Hindenburg Research; (Photo: Getty Images) Hindenburg Research alleged that Gautam Adani’s elder brother Vinod Adani, through several close associates, managed a vast labyrinth of offshore shell entities, 38 of which were identified. It put several questions to the Adani Group regarding these firms and related-party transactions. Some of Hindenburg’s key allegations and Adani’s responses:ALLEGATION: Websites of 13 Vinod Adani entities seemed like rudimentary efforts to demonstrate that they are operational. Many websites were formed on the exact same day and listed the same set of nonsensical services such as “consumption abroad” and “commercial presence”.RESPONSE: Vinod Adani does not hold any managerial position in any Adani listed entity or subsidiaries and has no role in their day-to-day affairs. Any transactions by the Adani portfolio companies with any related party have been duly identified and disclosed as related-party transactions in compliance with Indian laws and have been carried out on arm’s length terms.ALLEGATION: Adani has a convoluted, interlinked corporate structure. The group’s seven key listed entities collectively have 578 subsidiaries and have engaged in 6,025 separate related-party transactions in FY22 alone, per the BSE disclosures.RESPONSE: For infrastructure business in India and many other jurisdictions, companies typically have to operate with a ringfenced project finance structure, wherein each project is housed in a separate company and financing is raised against the specific project assets. Banks and financial institutions also prefer this structure as it provides bankruptcy remoteness.ALLEGATION: Recent right-to-information requests confirm that Sebi is investigating Adanis’ foreign fund stock ownership.RESPONSE: In a June 14, 2021 letter to the BSE and NSE, Adani had termed a media report “blatantly erroneous” and “done to deliberately mislead the investing community” after it alleged that the National Securities Depository had frozen the accounts of three foreign funds—Albula Investment Fund, Cresta Fund and APMS Investment Fund—holding shares in Adani companies. Adani Group said it had written confirmation from the registrar and the transfer agent clarifying that the demat accounts in which the funds held the company’s shares were not frozen.ALLEGATION: Mauritius-based entities like APMS Investment Fund, Cresta Fund, LTS Investment Fund, Elara India Opportunities Fund and Opal Investments collectively and almost exclusively hold shares in Adani listed companies, totalling almost $8 billion (Rs 66,139 crore). The original source of funds for their investments in Adani companies is unclear.RESPONSE:Each of the entities referenced in the queries above are public shareholders in listed companies in the Adani portfolio. A listed entity neither has control over who buyssellsowns the publicly traded shares or how much volume is traded or the source of funds for such public shareholders nor is it required to have such information for its public shareholders under Indian laws.ALLEGATION: In 2019, Adani Green Energy Ltd (AGEL) completed two offers for sale (OFS) that were critical for ensuring its public shareholders were above the 25 per cent listing threshold requirement. Portions of these OFS deals were sold to offshore entities, including ones in Mauritius and Cyprus.RESPONSE: Under Indian laws, all listed entities are required to have a public shareholding of a minimum of 25 per cent. Since the shares of AGEL got listed after the demerger from AEL in June 2018, AGEL was required to comply with the requirements of regulation 38 [pertaining to minimum shareholding] within 12 months from the date of listing thereof. The process for OFS is a regulated one implemented through an automated order book matching process on the platform of the stock exchange.ALLEGATION: A secretive Mauritius entity called Growmore Trade and Investment netted an overnight $423 million (Rs 3,497 crore) gain through a stock merger with Adani Power. According to court records, Growmore is controlled by Chang Chung-Ling, an individual who shared a residential address with Vinod Adani and had been named in DRI fraud allegations as director of a key intermediary entity used to siphon funds out of Adani Enterprises.RESPONSE: The stock merger referred to in the allegation was undertaken after following due process as per the Companies Act and all applicable regulations, including SEBI’s. The valuation for the stock merger was supported by reputed, independent third-party valuers—Ernst & Young provided the valuation report supported by a fairness opinion from ICICI Securities. nPublished By: Arindam MukherjeePublished On: Feb 10, 2023--- ENDS ---

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Adani controversy: The fallout

Adani may yet survive the Hindenburg missile, but the industrialist will have to clean up his act and the regulators will have to do their job to ensure macroeconomic stability

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