- Last week, Hindenburg Research published a damning report into the governance of Adani Group, the world’s largest private developer of fossil fuels.
- Since then, $79bn has been knocked off the market value of Adani companies – a third of its value – and the majority of its bonds are currently trading at distressed levels.
- A one-notch downgrade by ratings agencies would force many pension funds to sell their holdings in the group.
For the last week, the world’s business pages have been dominated by a devastating report from US short-seller Hindenburg Research into India’s Adani Group, the world’s largest private developer of fossil fuels, and Gautam Adani, the group’s chairman and founder.
Following a two-year investigation, New York-based Hindenburg research accused the group of what it called the largest con in corporate history and questioned its corporate governance.
“We believe the Adani Group has been able to operate a large, flagrant fraud in broad daylight in large part because investors, journalists, citizens and even politicians have been afraid to speak out for fear of reprisal,” it said.
The fight has entered the realm of name-calling. Adani responded to the allegation in a 413-page document on Sunday night (23 January), dubbing Hindenburg Research the “Madoffs of Manhattan” in an allusion to the fraudster who ran the world’s largest Ponzi scheme in New York until his arrest in 2008, and saying that the report was an attack on India itself.
In an interview with an Indian newspaper, Adani’s chief financial officer Jugeshinder Singh went one step further and likened the stock rout to the Amritsar Massacre when British colonial authorities in India ordered soldiers to open fire on protesters in April 1919.
Hindenburg Research responded to that document doubling down on its accusations of Adani.
Rapid unwinding
The unwinding has been rapid. Almost $79bn has been knocked off the market value of Adani companies – a third of its value – and the majority of its bonds are currently trading close to distressed levels [see chart]. A distressed level is defined as below 70 cents on the dollar.
A December paper in the Journal of International Money and Finance makes clear that firms with a low ESG performance – specifically governance here – are at a competitive disadvantage and there is little doubt that Adani will soon become a much-studied case in B-schools.
“In the presence of ESG reputational risk, there is increased information asymmetry between stakeholders and managers, which leads to adverse selection and increased cost of equity and financial underperformance,” the authors note.
Tom Middleton, quantitative economist at professional services firm Grant Thornton in London, puts it into context.
“The value lost is unduly large when compared with fines and may leave directors exposed to claims,” he says.
He has researched firms in a British context and points out that fines issued by the regulator are on average equal to 0.045% of market cap.
But that is dwarfed by the average value of reputational losses which is more than 120 times higher. It equals 5.49% of a sample firm's market cap. Middleton equates this to £1.15bn ($1.4bn) worth of value loss for the average FTSE 100 firm.
Despite the rout in the stock market, from an equity point of view, Adani appears to have survived, though not with any flying colours. The group had been raising Rs200bn ($2.45bn) in a follow-on public offering (FPO) – the largest ever in the Indian stock market – which closed yesterday (31 January).
Books were covered but only just, and primarily from the institutional investors that came in, Middle Eastern names like Abu Dhabi’s International Holding (IHC), Abu Dhabi Investment Authority and Emirati state-owned holding company Mubadala Investment as well as investment banks BNP Paribas, Goldman Sachs, Morgan Stanley and Nomura.
Syed Basar Shueb, chief executive officer of IHC which now holds a 16% stake in the group, said: “We see a strong potential for growth from a long-term perspective and added value to our shareholders”.
This faith was not mirrored by retail investors. Only 10% of the retail portion of the FPO was taken up as investors steered clear of the name.
Travis Lundy, Asian analyst for Quiddity Advisors who publishes on SmartKarma, highlighted the “muted” retail demand. “I would not buy this dip. Or a larger one,” he wrote.
The spectre of Evergrande
But the outlook for bonds is even worse and the loss here could be considerably higher than the value loss for the average FTSE 100 firm. Adani currently has around $10bn worth of bonds outstanding – around a third of the company’s borrowings.
A warning shot was fired in November last year by Fitch’s CreditSights which maintained its “underperform” recommendation on Adani Ports and Special Economic Zone, its port operating arm, and highlighted the group’s “elevated leverage”.
Other investors are starting to look at Adani and the allegations. On 27 January, Bill Ackman, chief executive of US hedge fund Pershing Square ($18.5bn AUM) tweeted: “I found the Hindenburg report highly credible and extremely well researched.”
The knock-on effect on Adani investors has started. State-run Life Insurance Corporation (LIC), India’s largest insurer, has seen its share price hammered since the Hindenburg report was released. Its shares are down 6.6%.
LIC is the single largest external shareholder of the group and makes up 98% of the entire insurance industry’s investment in the Adani Group.
In a statement, it said that it had invested $4.5bn or 0.975% of LIC’s total AUM in Adani companies.
Crucially, it added that the credit rating of all of the Adani debt securities held by LIC is higher than AA “which is in compliance with the Insurance Regulatory and Development Authority of India investment regulations as applicable to all the life insurance companies”.
In an interview with news agency Reuters, LIC managing director Raj Kumar said that the group was now looking to engage with Adani.
More than just rhetoric
In a note on Monday (30 January), Stockholm-based non-profit think-tank Anthropocene Fixed Income Institute (AFII) pointed out that while Adani’s bonds have a BBB-rating, they are currently pricing at levels below that.
“A one-notch downgrade would move the names from investment grade to high-yield, with index flow implications,” it said.
Were the Adani companies to be downgraded from investment grade to junk, many of its investors like LIC would not be allowed to hold its bonds. The subsequent unwinding of its debt would be on a par with the collapse of Chinese property company Evergrande, the country’s third-largest property developer at the end of last year.
The damage done by perceived faults in a company’s governance is very real. No one is seriously asking whether Adani will default on its debt yet, but the clock is ticking.
