End of a roll: The curious rise and fall of Adani stocks

The manufactured anger against Hindenburg for revelations about Adani share prices is quite strange.

Gautam Adani. | Photo Credit: Amir Cohen/REUTERS

The stock markets are a delicate creature, needing careful nurture and care. On February 9, prices of the global tech giant Alphabet (parent of the search behemoth Google) went into a swoon over a factual error by an artificial intelligence (AI) application the company was bringing to market. It was an error that only the specialist or interested amateur could have spotted, but the detail was a red-light warning that Alphabet was not yet in a state of preparedness for battle in AI-based search.

Sensitive to a fault in this respect, the markets can also, curiously, be casually indifferent to adverse information. For the last eight years at least, the Adani group has been India’s most storied business conglomerate, with a near-miraculous growth in market values. Lost in the euphoria of leaping share values was the awkward fact that individuals with dubious records in rigging the market were hiding in plain sight in the group corporate hierarchy.

On January 25 the New York-based forensic research firm Hindenburg released the results of its long-term investigations into the Adani group’s finances. While it put forward much information that would not have been accessible to an average Indian market watcher, there was much else that was. It was no secret, for instance, that Rajesh Adani, Vinod Adani, and Samir Vora, all near relatives of the business group head Gautam Adani, had been sanctioned, often multiple times, for playing fast and loose with market rules. Some of them had been arrested on fraud charges and granted bail, and one was known to be eluding prosecution by staying out of Indian legal jurisdictions.

All through its long years celebrating the Adani brand, the market seemingly had no use for this information. Neither was the market perturbed by the presence of Ketan Parekh in the ranks of Adani’s boosters. Parekh’s name represents a continuity in share market practices of the very worst kind that India has seen.

He began his career as an understudy to Harshad Mehta but somehow escaped the dragnet that followed the 1992 scam. Mehta died in prison awaiting trial, but Parekh successfully managed to re-enact his modus operandi, reaching into bank treasury funds to fuel a speculative splurge. He had a run of success between 1999 and 2001, promoting a clutch of shares that eponymously came to be associated with his magic.

Once the magic wore off, the bank went belly up and Parekh was prosecuted, convicted, and in 2008, banned from trading in stocks for 14 years. In market circles, though, he was known to have relocated to London and directing operations from there. Adani group shares were among his favoured few.

Valuations and returns

All this was known in market circles, but laxity in oversight and official connivance ensured that they did not impinge on market trends. The bull market in Adani shares soon got woven into the India growth story. Nobody seemed worried about the deep flaw in the scenario: that the Adani group was entirely engaged in staid old-economy sectors such as energy and infrastructure, not known to yield extravagant returns.

Sky-high valuations in the stock markets in recent years have typically pertained to companies that have been at the cutting edge of tech, although ample scepticism exists even there about how far returns justify expectations. For the Adani shares, even if expectations of solid future growth were well-founded, there was no way that returns on the shares would justify the prices paid.

An index is readily available here: operating income for the group (i.e. what is left of revenues after operating costs have been met) has been a modest 4.2 per cent of total revenues between 2015 and 2021, and an even more modest 3.6 per cent in the years since.

Revenue growth has been substantial, reflecting the group’s busy spree of acquisitions since 2015, but these have all been in low-margin enterprises. Even if the group’s profitability stabilises over the years ahead, the margins will not be very much higher. The most common metric for evaluating share values, the price-earnings (PE) ratio, yields a figure of 34 in the years to 2015, 15 in the six years afterwards, and an astronomical 214 in the years after 2021. Obviously, this manner of a progression in share price, totally misaligned with current earnings or future potential, has to be the consequence of some extraordinary intervention.

PE ratios in this range are typically a feature of new-age stocks that promise fabulous future earnings that can potentially outstrip current performance parameters. Illustratively, when Apple touched a valuation of $1 trillion in August 2018, its PE ratio was just over 18, not far from the 16 that an “old economy” stock like Exxon-Mobil had at the time. The same day, Alphabet had a PE ratio of 53, Amazon roughly 153, and Facebook, despite having suffered a sell-off just a month before, hovered around 26. Netflix had the most extravagant ratio of all: 157.

To paraphrase the 20th century economist Lord Keynes, it is hard to tell if these valuations represent a speculative bubble on a stream of enterprise, or a stream of speculation on which enterprise is a mere bubble.

Family control

Who could be the beneficiaries of a high share value in the Adani companies? First off, Adani shares are extremely narrowly held. Public documents reveal that close to 73 per cent of the shares of the relevant companies are held by trusts or companies the family directly controls. Another 21 per cent is held by foreign institutional investors, mutual funds, and Life Insurance Corporation of India, all presumably in for the long term and unlikely to engage in transactions for speculative gain.

India’s stock market regulators require that a statutory minimum of 25 per cent of shares should be available in free float in the market, outside the ownership of the promoters. In the case of the Adani companies, the figure is 27 per cent, fractionally in excess of the required figure.

Hindenburg found evidence that a substantial part of the floating shares volume, modest as it is, is held by Adani fronts. The other side of this urge for family control is that the Adani family gains very little by transacting shares within itself, whatever the applicable prices. Its gain from high valuations would then potentially lie in securing loans against shares as collateral. With debt financing having played a major role in its growth, this is an option it should be very interested in.

Debt financing

Debt financing has been key for the Adani enterprises since 2015, when they began a spectacular phase of growth. Analysis by Aswath Damodaran, professor of finance at New York University, found that over 91 per cent of its expansion between 2002 and 2015 was financed through debt. In the subsequent six years, the company pledged large volumes of equity for fresh loans to finance acquisitions.

Since 2021, the group seems to have been turning towards equity, and there are good reasons why the group should be wary of further debt-financed growth. Its operating revenue today is just a little bit more than the interest on debt. Further reliance on borrowings could push it over the edge.

Adani FPO

Adani’s follow-on public offering (FPO) of shares, scheduled to open in late January, was expected to net a substantial sum for the group. In a context of sky-high valuations, the shares would have sold at a premium, enabling a large accretion to shareholders’ funds. And since equity is only serviced at face value, the premium earned would have been a comfortable cushion for funding further expansion without significant costs attached.

Hindenburg played spoilsport, and the slide in market values that followed ensured that, despite all the mysterious entities that cropped up at a late hour to salvage the FPO, the premium achieved was virtually non-existent. This prompted Adani to cancel the issue and refund all the money that had been spent on it.

A petitioner has approached the Supreme Court in some ire, demanding Hindenburg’s prosecution for destabilising the markets. Many individual investors have lost out because the New York-based research firm shorted Adani shares.

The petition is curious in that it invokes the jurisdiction of the Supreme Court when the regulatory agencies have been asleep at the wheel. If the Adani shares had been put through appropriate levels of scrutiny during their bull phase, they would not have had to suffer the bitterness of the rapid unwinding in a seller’s market.

Markets in India escape serious oversight on the upside. When values are buoyant, the regulatory agencies choose to look the other way, since more is always regarded as better. When the downside asserts itself, there is invariably a sense of chagrin at the good times ending, a sense that everyone could have gone on enjoying the fruits of the bull market if only the short sellers had not intruded on this paradise.

Share market capitalisation in India as of December 2022 was estimated to be just a little more than the GDP. Yet, in terms of fresh capital formation its share markets contribute perhaps less than a tenth of the total of the Indian economy. And globally, share markets have been known to contribute similar quanta to total investment without the manner of speculative froth that the Indian markets generate.

Markets and politics

There is also the reality of the political voice that share markets have begun to acquire over the decades of liberalisation and deregulation. Since 2013, there have been clear correspondences between successive upward notches in the stock market and the steps taken towards political pre-eminence by Narendra Modi.

From an upswing in April 2013 in the Bombay Stock Exchange’s Sensitive Share Price Index (Sensex), when Modi broke out of the local milieu of Gujarat, to a similar exuberance in July when he was named head of the central election panel of the BJP, the pattern has continued through the electoral cycles.

Four days before the official vote count in 2014, when news channels released exit poll numbers predicting a Modi victory, the Sensex jumped 400 points. By the time the results were in, two business groups—Ambani and Adani—had added many billions to their market capitalisation figures.

The prickly political reaction to the Adani debacle today speaks of the high political stakes involved. Now that some of the market values pumped up over the years are being lost, it remains to be seen if the political capital that has been gained concurrently will also be eroded.

Sukumar Muralidharan teaches in the school of journalism, O.P. Jindal Global University, Sonipat. Views are personal.

The Crux

• On January 25 New York-based Hindenburg released results of long-term investigations into Adani group finances.
• Ketan Parekh is in the ranks of Adani’s boosters.
• Bull market in Adani shares are woven into India’s growth story.
• The Adani Group is entirely engaged in staid old-economy sectors, not known to yield extravagant returns.
• Price-earnings ratio was 34 in the years to 2015, 15 in the six years afterward, and an astronomical 214 after 2021.
• Close to 73 per cent of Adani Group shares are held by trusts or companies the family directly controls.
• The Group’s gain from high valuations potentially lies in securing loans against shares as collateral.
• Debt financing has been key for Adani Enterprises since 2015.
• Markets in India escape serious oversight on the upside.