Adani – What does it mean for markets? A risk crisis is coming!

Blain’s Morning Porridge Feb 3rd 2023: Adani – What does it mean for markets? A risk crisis is coming!

“When they are trying to punch you in face, careful they aren’t kicking you in the n*ts as well…”

This morning: The big story in the market has been the humbling of Indian conglomerate Adani. Who could have guessed? But the real issue isn’t that a company may have fooled the market over its value, but that the market never worked out how improbable the valuations were. Time to check up on risk management!

Last night Apple surprised to the downside with the first fall in sales in years due to lost production in China (due to Covid shutdowns). A few weeks ago, everyone was talking about the mass offshoring of Chinese production to India – as if it might happen overnight. This week everyone is talking about how Indian business practices and a culture of deceit makes such moves unlikely. As usual the market is havering about all the wrong things as a result of a yet another utterly predictable no-see-em: a rotten corporate being found out.

For just over a week Adani has been dominating the headlines – and the commentariat has pontificated on what it all means. The immediate effects on the company’s value have been like watching the proverbial slow motion train wreck – utterly horrifying but fascinating. More important is what it all might mean for the wider emerging economies: for India, and for investment flows into the economies of other emerging growth economies. As always, there were a host of red flags hidden in plain sight we should have spotted, but scrupulously ignored.

As always with corporate scandal, the Adani mess boils down to Corporate Governance, Due Diligence and recognising Froth. These are things investors should be hunting for – not waiting for them to hit. There is never an excuse for falling on these critical investment hurdles. Never forget Caveat Emptor.

I am no expert, or claim deep experience of the Indian economy or corporate sector – but I am increasingly keen to learn more. Just a few months ago I spoke at my first Indian conference – sadly only on a Zoom. I was explaining the effects of over-easy monetary policy on financial assets, and the damage it did to the mechanisms and functioning of capitalism – and how these created consequences and opportunity. I mentioned speculative froth and the ease with which implausible investment thesis can pass muster.

The audience of Indian investors and entrepreneurs were asking great questions about engagement with Western Markets, shifting high value production from China to India, were fascinated by the UK’s new Indian premier (Rishi Sunak) and the prospects for getting the Koo-i-noor diamond back! It wasn’t just an eye-opener, but left me enthusiastic about business prospects with India – although with some reservations.

Then, early last week, one of my colleagues asked what I knew about Adani – which was basically very little except it has links to government and was a highly regarded Indian conglomerate across private infrastructure (ports, airports, power & energy, renewables), fuelling the rise of India as a credible, even preferable alternative to China, as a manufacturer of high-grade tech.

He told me US short-seller Hindenburg had just released a critical report calling it The largest Con in Corporate History… I took note. Hindenburg has track record exposing the detritus of markets.

Since then Adani has dropped over $125 bln of it’s market capitalisation. The core company stock is down 70%. Bang.

Adani has furiously denied the attack, and claims it’s the victim of a corporate mugging by Hindenburg, calling the charges a “calculated attack on India”. It hit back at the multiple accusations of corporate malfeasance, stock manipulation and shell companies, with 400 plus pages of frothy nothing. Despite the protestations of innocence and accusations levelled by Adani against the research firm, the market has clearly decided there is no smoke without fire. The value collapse in Adani companies in the wake of the allegations of financial impropriety and cooking the books has been extraordinary.

I called a few of my Indian chums to ask what’s really happening. It very quickly became clear Adani is a highly polarised name in India. You love it or hate it – often based on politica. Give it credit – it’s delivered the infrastructure the economy needs, but growth has been because because it’s a politically linked firm – closely linked to the government of premier Narendra Modi. Adani has been able to exploit and inflate the value of that relationship for years into its market valuation.

As a result, it’s financials are not trusted by Indian financiers – I’m told many Indian banks were unwilling to lend large amounts (only lending the bear minimum to keep government sweet). Hindenburg’s comments about its Auditor being utterly inexperienced (1 qualified accountant, 11 juniors and a mangy dog) to deal with such a complex firm – hah, how many times has choosing a blind, deaf and dumb accountant been at the core of a financial scam?

In the international markets, Adani has been much more successful seeking funds. No one seems to have looked behind the curtain. It’s got outstanding debt of over $27 bln, yet only 20% of that is with Indian institutions. How? Because when money is cheap – lenders in the west have proved blind to risk or doing the in-depth work.

That’s why Hindenburg is such a success. It does the deep dives and thinks about stuff.

I’m told, but don’t have any firm evidence, certain French institutions have been particularly active lending to Adani. A quick call to some London exiles from Paris (ahem) revealed there may just be something of witch-hunt underway looking for folk to blame at a well know French bank… just reporting what I’ve heard – don’t invest on rumour and sigh.

After Credit Suisse and other banks stopped margin lending on Adani bonds, it become an immediate distressed credit – even though the firm ostentatiously made interest payments yesterday on outstanding port-company bonds, and apparently rang round the news wires to announce the fact. One Indian trader told me Adani bonds are trading at 30 cents on the dollar – “That’s 30 cents too high..”

Very quickly we’ve seen distractions ranging across the spectrum of conspiracy:

• At one extreme, Indian patriots – whipped up by Adani’s CFO – are claiming Adani is the victim of a western plot to undermine its success, that there is an Anglo-Saxon conspiracy to wreck the Indian economy through subterfuge and lies, and its all politically inspired against Modi.
• At the other extreme is the belief fraud and embezzlement remain endemic, front and centre of Indian’s corporate behaviour. No one should be surprised that Adani has levered its relationship with the Premier to construct a conflated valuation fraud. This view holds the failure of Indian business is a lack of corporate ethics, greed and a distrust of good corporate governance.

As always.. there are always going to be bad corporate apples… and doing business in India is not.. easy. I like Indians, they are engaging and funny, but they do seem to think business is the art of them getting 99% of a deal. (The difference between Scots and Indians? Indians smile. Scots don’t.) But, let me stress, this should not be about flag waving or national slurs, but about what actually happened, and how do we learn.

Give Hindenburg credit for asking the right questions about how Adani appears to have been manipulating it stock price, and overleverage within its complex shell-game roster of firms. And international lenders now caught in the crash should be asking why they didn’t ask them themselves.

The red flags were there. Founders Gautam Adani and his brother Vinod started off in diamond dealing, grew a modestly successful billion dollar business, which suddenly exploded in value from 2019. Picking a stock in a mature sector that gains 1300% should not be a cause for celebration, but for investigation!

What does it all mean?

Let’s not over think it. Adani does not mean India is un-investible. If it is – it’s because Indian stock prices are simply too high and overinflated. Its going to be years, if not decades, for significant swathes of the tech manufacturing businesses in China to transfer production to India or other recently emerged economies – overcoming bureaucracy and finding space in the most populous nation will never be open!

What it does show is the absolute need for any investments into emerging or newly developed economies to be fully investigated, tested and scoped.

And that is the real problem. Not in India, but here in the West.

Hindenburg has earned a reputation for deep diving and in-depth analysis of corporate bad-uns, but most global wealth managers – who control trillions of dollars – despite their massive scale simply don’t have these resources on board.

Pre the post Global Financial Crisis “reforms” of banks “to avoid such a crisis happening again”, risk has moved from banks (who understood it, managed it, breathed it, lived it!) to the buy side of the investment business. Pre 2007 risk expertise was concentrated in banks, with massive departments of bankers with years of expertise who really understoof risk. They had armies of bankers on the ground actually doing face-to-face lending and providing market intelligence.

Now Investment Firms see risk-management as a bureaucratic function, ticking boxes for their regulators, doing stress tests to please the board, and doing little more real risk analysis than compiling credit reports and the occasional internet searche. No wonder they get fooled.

I can guarantee Adani will not be the only shocker this year.

Finally, the collapse of Adani’s shell-game is so extraordinary that former UK prime minister Boris Johnson’s kid brother, Jo Johnson (actually Lord Johnson) has resigned as a director of Indian investment bank Elara because of its connections to the group. Hindenburg’s alleges Elara was aiding and abetting transactions to boost the stock price of the group. Gosh. Who would have guessed? I wonder what particular skills or knowledge Lord Jo Johnson shared with the bank. When the cockroaches are running away, make sure you are ahead of them..  

Five Things to Read This Morning:

Bberg               Adani Backers From New York to Tokyo Dissect and Limit Exposure

FT                    Google Advertising sales fall in sharper than expected showdown

FT                    BOE takes a newly pessimistic view of the economy

WSJ                 Apple Sales Shrink As Pandemic Rally Ends for iPhone Maker, Other Tech Giants

Businessweek How Stockpickers Finally Beat the Index Funds

Out of time, and back to the day-job. I’m off to England vs Scotland tomorrow in my Kilt, and then back travelling so Porridge may be intermittent. Have a great weekend.

Bill Blain

Shard Capital