INVESTMENT PERSPECTIVE

By J Mulraj

Feb 4-10, 2023

Lessons to be learnt from the brouhaha

Since the publication of a report by US short seller, Hindenberg, there’s been a brouhaha (no laughing matter) over Adani company share prices These stocks have collapsed, causing a loss in value of the group of about $ 108 b.! There followed a series of media attacks on both the group, and on the Modi Government, which some believed to have favored it.

Any crisis must be taken as a learning experience. The group, the Government, and the people, should learn to take fair criticism with respect, whilst challenging unfair ones. Below are some of the lessons we should keep in mind.

1. Short selling is an integral and necessary part of capital market functioning. It serves to correct excesses. Consider it akin to a building inspector pointing out that the foundation of the structure needed to be strengthened. Instead of being critical of the inspector, it’s better to find out the veracity of his claim. It would be far worse if, instead of a 10 storey structure, a 50 storey one were to later collapse due to turning a deaf ear to the inspector.

In the case of Adani, the criticism that the group used offshore entities to manipulate stock prices, appears to have been believed by domestic investors, as evidenced by the rapidity and extent of their collapse. There can, and should be, an investigation whether this is true. But, if we wish to be called a developed economy, we must learn to accept mistakes, admit them, and correct them, as the Japanese do, in sumimasen.

2. Hindenburg, it seems, short sold bonds/derivatives in Adani companies. Shorting of shares would have been risky, as the group holds 65-70% and there’s a low floating stock (the balance), which is available to borrow. Some of the shares were given by Adani as a collateral against loans, though. (They’ve now been released after the group prepaid loans of $ 1.14 b.) So, when investors started selling after the release of the report, and stock prices fell, the value of the collateral was reduced, leading to margin calls. Simultaneously, bond prices also fell, spurred by the crisis of confidence displayed in falling share prices.

In this video  valuation expert Aswath Damodaran, a professor at NYUs Stern School of Business, and author of ‘Damodaran on Valuation’ has valued flagship Adani Enterprises at Rs 947/share (about half the market price). He points out that the group relies heavily on debt, as it does not want to dilute its control by issuing equity. Infrastructure businesses are, by nature, capital intensive, of long gestation, and have low margins. Low margin businesses require the stability of a wider equity base, since any bump in the road can make debt servicing difficult.

The lessons, therefore, would be to perhaps have lower leverage in such business, and also be wary about borrowing against shares in such capital intensive, low margin, long gestation businesses. Or, putting it otherwise, to have a capital structure dictated by the nature of the business more than the desire of the promoter to retain greater control and to climb the wealth ladder faster. As all children know, there are snakes where there are ladders!

3 . Then there are lessons to be learnt, for investors as well as for the polity, from the shrill media coverage that followed the report. Most of these shrill rantings can be likened to the output of an over fed bull, which is used as organic fertilizer. The rantings were (a) that $ 108 b. of national wealth had disappeared (b) that it was the hard earned money of small investors which it was the duty of the Government to protect and (c) that institutions like SBI, India’s largest bank, and LIC, its largest insurer, were at risk of collapse! Come on! Give me a break three breaks!

The lesson for investors is to separate the noise from fair comment, and to react soberly. Anyone who invests knows that stock markets fluctuate, and should be prepared for that. The $ 108 b. ‘lost’ value was earlier $ 108 b. of added value, on the way up. Was media as shrill in their accolades then as it is in the brickbats now? It is not the Government’s job to protect investors from losses, unless there is fraud. It is its duty to investigate serious allegations of fraud, and to do so swiftly. Governments, sadly, shirk their duties of, firstly, regulating, and, later, investigating and penalizing, those guilty of fraud. Many a scam, like Sarada, NSEL, Rose Valley, Sahara, have gone unpunished, for want of political resolve and judicial speed, sometime for political accommodation, or for pecuniary gain. This encourages further scams. So the lesson for the Government, the regulators, the investigators and the judiciary is to focus on protecting the victims, and not their own turf.

Politicians should practice sumimasen with sincere humility. (I know that’s wishful thinking, as most have neither sincerity nor humility).

4. Another lesson for Indian companies, especially those accessing global capital debt/equity markets for funds, is to do corporate branding. This is different from product branding. The Adani group is not known for periodic meets with analysts, as a communication exercise with investors. Had they periodically done so with both domestic and foreign investors, perhaps the fall would not have been as adverse. Indian managements view corporate branding as a wasteful expenditure, not as an insurance against such events. It would have cost a minuscule fraction of the $ 108 b. drop in valuation.

As a case in point, Amazon kept up its corporate advertising during the first six years of operation, despite making losses in each of them. This helped it get frequent rounds of funding. It is now a well entrenched, profitable e-commerce company, and founder Jeff Bezos is still the world’s third richest person in the world. So one hopes Indian companies communicate with investors better in future.

The Adani group has suffered in many ways. It has lost over $100 b. in market cap. After a steep drop in bond prices, some global banks like Credit Suisse and Citi have, justifiably, stopped accepting them as collateral, for their wealth management business. The yield on some bonds like Adani Green Energy, are around 30%, which, for investors who believe in the Adani growth story, provides a great opportunity to lock in mouth watering rates. This is the current yield; the yield to maturity would be higher.

5. Some of the commentary, especially by opposing politicians, was critical of the loans/investments by Government controlled institutions like SBI and LIC, some ignorant persons even fearing they would go bankrupt. These dotards should know that SBI, which was earlier the Imperial Bank, founded in 1806, has lasted for over 200 years, over two world wars and several crises and calamities. It is not going to collapse, after surviving this long, by investing in any group. Institutions like SBI and LIC have prudential investing norms and years of experience. The lesson we need to learn, especially the polity, is that we should not denigrate these venerable institutions thoughtlessly. Even today, LIC’s investments in Adani stocks are showing a profit.

The Adani imbroglio shall pass. Perhaps the group may need to consolidate, jettisoning some businesses, and getting in more equity. Remember, Bill Gates owned 49% of Microsoft when it made its IPO in 1986. He now owns 1.38%, having sold stock, donating the money to his Foundation. But, he is, at the end of 2022, the #6 richest in the world.

In other interesting news from India, RIL has unveiled India’s first hydrogen ICE (Internal Combustion Engine) Technology solution, which will be manufactured by Ashok Leyland. It is setting up hydrogen fueling stations and is investing ₹6 trillion to make green hydrogen. Use of hydrogen to replace crude oil will help bring down India’s import bill as also logistics costs for manufacturers. Of course, it protects the environment.

Last week the BSE Sensex dropped 159 points to close at 60682.

Global events continue to cast their shadow on stock markets. The senseless war in Ukraine continues, with avoidable loss of life and wanton destruction of property. A financial crisis is brewing in USA where the Republican controlled Senate has made some (sensible) demands on the White House, to cut expenses, so that the need to continually raise the debt ceiling is obviated. The White House refuses to negotiate. Treasury Secretary, Janet Yellen, is yelling her head off, warning about the dangers of not reaching a compromise. The USA would fail, for the first time, to meet its debt obligations. That would trigger a financial crisis. China ratchets up tensions over Taiwan, and senselessly disregards international rules of behavior by sending a balloon over USA. A balloon which USA says could be used for spying, and uses an F22, the most expensive aircraft, to shoot down. But, as Col Douglas Mcgregor points out in this video, China has over 300 satellites, spying 24X7, so why does it need an extra balloon to spy?

But, China it has the gall to protest the shooting down of the trespassing balloon! China also displays a callous disregard for international  rules by sending its boats to fish in international waters, destroying the marine ecology. The parody of global leaders talking about balloons, instead of discussing nuclear disarmament or avoiding environmental disaster, is lamentable.

Pulitzer prize winning journalist Seymour Hersh has blogged that it was USA which was responsible for blowing up the Nordstream pipelines, in order to make it impossible for Russia to use supply of gas as a carrot to break European, especially Germany, unity. This, if true, is not only an act of war but also a callous disregard for the environment! The escape of methane gas from the exploded pipelines harms it far more than does carbon emissions.

Were it not for the irresponsibility of such actions by global leaders, which further ratchets up tensions, when they ought, instead, to discuss matters of global import, one would be tempted to turn cautiously optimistic. For, such irresponsibility can puncture a slowly rising Stockmarket balloon with a tweet, faster than an F22 can a weather balloon with a missile. Sigh!

The lyrics of Bob Dylan’s Blowing In The Wind just about sums it up

“ how many seas must a white dove sail, before she sleeps in the sand?

Yes, and how many times must the cannonballs fly, before they’re forever banned?

The answer, my friend, is blowin’ in the wind”

Picture Source: Created using DALL E

Comments may be sent to jmulraj@asiaconverge.com