Ep.101: Adani Crisis & Activist Short Selling Explained

Okay, hello and welcome to episode 101 of the Market Maker podcast. And given it is this episode, I'm going to press the reset button, Piers, and I'm going to take us back to pretending this is our first episode. And if you can remember all the way back then, we used to have a pretty firm line that an episode should last only 20 minutes. And I realized as we completed episode 100, we drifted north of 60 minutes. So I just want to rein this in a little bit because I'm conscious of, um, you know, okay, even me trying to listen to you for an hour is—

no one, no one wants that. Literally no one, right?

So, you know, I'm not, I'm not going to say we're going to commit to 20, but I'm going to commit to 30 and see how we go. So let's, um, let's keep it concentrated on one key story and something that's definitely been very present in global media, and that is the Adani Group's $100 billion loss. You hear that and you kind of think, wow, that's a big loss. But then I did see Google shares are down well over that in the last 2 days after their AI, I think it's Bard, their version of their ChatGPT demonstration went a little bit awry, and then, or awry, and then their share price tanked. Pretty much, which is quite phenomenal to think about it. Um, the share price actually on that day dropped just shy of 8%, and that was more than when they missed their earnings estimates the, the week before.

That makes sense though, you know, earnings, I mean, earnings, that's quarter by quarter, right? The AI race will define the next decade plus. So yeah, I've got— there's nothing worse than doing a demo, like especially like a tech demo where you're like, check this out. And then, oh, hang on a minute. Hang on. Well, yeah, that's— I mean, that's bad. I mean, it shows you how— well, I guess how Microsoft have— well, I should say OpenAI have kind of forced their hand and really force them to kind of reveal what they've got. Where are they in this race?

Yeah, yeah. I, I, if I was Alphabet, and not just Microsoft, with all the other tech companies, I would definitely partake in corporate espionage, and I would definitely have inside moles who are feeding back to me all the time. Like, how can a company like Alphabet get blindsided? I know they've had AI for a long time, I know they've tried to coin this whole like, yeah, because we want to make sure it's for the right reasons and it does the right type of genuine result. It's like, no, no, they've caught you pretty blindsided on the timing of this, evidently. So how does that happen? Like, there's a lot of employees involved in this stuff, right?

Well, we touched on this the other day, didn't we? When all these job cuts and like stripping out of middle management and they've just become bloated. And they've got so many projects, right? Because they've got so much cash.

Yeah.

Let's just have about a million different kind of tangential projects. And then you lose— I guess you just lose focus on prioritizing. And then—

And then this happens. Yeah. All right. Well, look. Help me, boss. Let's get on to Danny and what this story is, and we're going to incorporate a few different things for a lot of people, like who is this guy, um, how important is he. I mean, very recognizable domestically, but perhaps not so much on a global level.

Yeah.

Um, Hindenburg, and we can talk a little bit there about who are they, what do they do, and what is activist short selling. We've talked about activists before, we've talked, I think, about short selling before, but let's combine the two and And then we'll go through what's actually happened, the allegations, the fallout, the stock price, bond yield reactions, and obviously intertwined into this in Indian politics as well. So perhaps we could start with who is Adani?

Yeah, I mean, most people listening to this wouldn't have heard of him till the headlines over the last couple of weeks. Couple of weeks or whatever. But if you're Indian, then you'll definitely have heard of him, this guy. I mean, Guatan— Guatan Adani. Yeah, he's kind of the self-proclaimed Rockefeller of India. Basically, he's got a sprawling empire, a sprawling kind of industrial conglomerate. He's got He owns India's biggest ports. He store— his company store about a third of its grain. He operates a fifth of its power transmission lines. He makes a fifth of the whole country's cement. Uh, he's among India's top 10 biggest non-financial firms by assets. Um, basically he touches hundreds of millions of Indians lives on a day-to-day basis.

Yeah, good extract I saw from Bloomberg to put that into context. They said that coal extracted from mines that Adani owns is shipped via his ports and railroads, then hauled to the furnaces in his power plants. Electricity produced runs on his transmission lines into homes built with his cement company, where people prepare dinner on stoves fueled by Adani Gas. Yeah, with Adani cooking oil, grains, and apples. And then later at their kitchen tables, they might discuss impending vacations, but of course they're going to use flights from his airports. Or they might even scroll through photos stored in his data centers. So basically, he's everywhere.

He is Mr. India. And maybe we'll get onto politics, but Modi, the Indian Prime Minister, is very much in his pocket. I mean, well, actually, when Modi won the election first time round, I think back, what was it, 2015, I think, he took a flight back to his sort of hometown to celebrate in Adani's private jet. And anyway, we'll get, maybe get onto the politics, but like, yeah, this guy, You get the story, right? Massive, massive industrialist and was— was, past tense— the world's third richest man. No longer. I mean, don't get me wrong, he's still disgustingly rich, but just not quite as disgustingly. Yeah, he's lost about half of his wealth in a couple of weeks. Painful. So what's going on here? Well, there's this guy— well, not guy, there's a firm called Hindenburg Research. So they're a New York-based activist short seller. OK? So maybe let's just stop and describe what that is first before we talk about exactly what they've done here and how this little, tiny little sort of hedge fund firm in New York has somehow triggered a $114 billion sell-off in Adani corporate value just by issuing one report. So what this company does, they've actually only been around since 2017, and over the past 2 years they've published 19 investigations. And what they do is they investigate companies to try and unearth wrongdoings, dodgy shenanigans, governance issues, accounting fraud, stock manipulation, insider dealing, right? They're trying to deep dive and investigate and unroot. It's a bit like investigative journalism, I guess, in a way, right? But what they do is then they— If they find examples of where they think dodgy stuff is happening, they then issue a report on their website. Prior to issuing the report, which is then— the report is a damning report with all the evidence that they've uncovered. Before they make this report public on their website, they seek to profit from issuing their own report by short selling the stock or whatever financial assets like bonds, for example, that are related to this business. So they're very much in the business of profiting from share prices, bond prices dropping. And they try to force these asset prices to drop by releasing this damning report on their website.

How on earth does that fit? Regulatory requirements.

I do want to get onto this because, you know, ultimately, obviously— well, not obviously— Adani has come out fighting big time here to say all of this is nonsense. I mean, so Hindenburg's report was 100 pages long. Yeah, right, that they issued on their website. There were 88, uh, am I right in saying I think there were 88 points, 88 pieces of evidence to show that this company is being run fraudulently. Adani, his rebuttal was a 413-page report that they issued explaining why every single one of these 88 allegations are false, and then going way over the top by saying 'Who the hell is this Hindenburg lot? They're the dodgy ones. They're the ones that aren't—' Well, actually, let me quote in the summary of this 413-page report. And no, I did not read all of it. But it kicks off by describing Hindenburg as the Madoff of Manhattan. And then he's talking about the truth of the matter is Hindenburg is an unethical short seller. He talks about the irony of basically, you know, the fact that Hindenburg are blaming Adani of covering things up and lack of transparency. But Adani's rebuke is, well, nothing is known about Hindenburg either, about their employees. It's very secretive. There's no info on their website. No one knows who their investors are. And he's basically saying they've actively concealed the details of its short positions, they've actively concealed the details of the source of its own funding. And, you know, it's quite a— I mean, this is, this is, you know, Hollywood stuff, which is why it's over the front pages of all the kind of financial media around the world. But, um, yeah, I mean, maybe we should talk about short selling first.

And yeah, and just, just with that point about these, um, type of research companies. There was one I remember when I used to cover US equities on a desk, and Citron Research was like the short-selling research firm. They are the ones who've been around for like 20-odd years or so. They're like the original short sellers. Yeah, come out with these damning reports and they'd hit a lot of US kind of small caps and you'd see them move violently on the back of these. And I remember first few days of my job monitoring these stocks, they were like, if you see a lemon on the screen, which was like the little icon that went with their posts, if that drops down in one of these chat rooms, like, you need to cover it. You need to be all over it that microsecond, right? The stock would just go poof and just hit it. It didn't matter what they said, actually. Well, it was just a track record of the fact that they would move the stock price. And importantly, whether their facts were right or wrong, the stock price moved. So there was profit to be made on the short in the very intraday kind of environment that was, at least, right?

So track— I mean, obviously track record is key, right? Yeah. So with this, with this Hindenburg Research, the— it's got a pretty Well, so of these 19 investigations they've reported over the last couple of years, most of them are quite small. They're going after companies that are tiny, mostly companies that have gone public via a SPAC. So they're kind of a special purpose acquisition company. This is where you kind of go public but circumnavigate all the usual kind of regulatory SPACs. Anyway, I won't go into SPACs now, but so most of them would be quite small fry. What is their famous one was Nikola, um, which was, um, the, uh, electric truck— oh no, sorry, battery-powered lorries. Yeah, so electric trucks, right? And they listed via a SPAC, and, um, basically Hindenburg uncovered the fact— so Nikola did this promo video of one of their trucks, you know, driving along, okay? And Hindenburg basically uncovered that they managed to get the truck to move and appear like it's driving along to show they're further down the road with regards to their, you know, R&D and getting towards a viable product.

Let me guess, some guy with a rope pulling it along.

It was just going— it was just rolling down a hill. So it looks like it was a functioning vehicle. Just wasn't. Anyway, that's their big famous one. So that was in 2020. So Nikola's stock is down 90% since then. Anyway, look, there's— let me just step back. There's two types of activist investor. You know, one I would— so, so one is an activist investor who's long the stock and then, you know, buys up a— tries to buy a significant portion and get a seat on the board. Now, if you listen to our episodes regularly, you would have heard us talking about Disney and how the activist investor, um, Nelson Peltz, um, was doing exactly this, buying up Disney shares, right? And then trying to get a seat on the board to then have a say on how the company's run and what the strategy is and to try and turn the company around. This has been in the news this week because Bob Iger, who's stepped back into the CEO role at Disney, has basically caved in and said, okay, yep, Nelson Peltz, you're right, right? We're gonna lay off a few thousand people. We're gonna cut costs. You know, our streaming service is going to be about profitability, not about winning subscribers at all costs. And, you know, we're going to set, set in place a restructuring plan. Great, right? And so Peltz the investor is trying to then profit from turning the company around and getting it onto a trajectory where it can grow profitably. Okay, so you could, could describe that as a Well, is it a healthy— I don't know, a healthy activist investor? I mean, maybe obviously the management team might disagree about what the best strategy is for growth, right?

But the activist investor, surely that at the end of the day their main incentive is to make money and a profit on their position, so they strip it down, make the money, and get out. Isn't that what—

maybe, yeah, that's true. Um, but you could say the short-selling activist investors They're like, you know, they're the ones that are looking to profit from the stock dropping. And, you know, in the case of Hindenburg, as I've described, it's about trying to uncover dodgy, dodgy stuff, um, and reveal it to the world.

You know, if I was the marketing team of Hindenburg, I'd be saying I'm doing a good thing for society to eradicate fictitious fraudulent companies. Yes, indeed.

But this does have quite— well, when it gets to people like Adani, it has some pretty powerful, you know, ripple effects out across.

Too big to fail.

Well, indeed. Um, so look, short selling— so what, what they do is prior to releasing their report, they then go short, um, various financial assets linked to Adani, right? So they might go short Adani shares. Obviously Adani has got lots of different companies in this conglomerate, right, which are listed. So these are shares on the stock exchange, there's derivatives links to this stuff, there's corporate bonds linked to these companies. And so going short, so what does that mean? Well, if you want to— if you think the share price of something is going to drop, then you can go short by borrowing those shares off a broker or an investment bank, um, then you sell the shares that you've just borrowed. Okay, let's say, let's say the shares are trading at $100, right? It's $100 a share. Let's say you think it's going to go to $50, right? So I'm going to borrow these shares and I'm going to sell them at $100. Okay, if I'm right and the price starts to drop, great, I'm in the money, right? And let's say it hits my target and goes down to $50. Right, I then buy the stock back at $50 and I give that stock back to the broker that I borrowed it from. So I sold at $50, I bought— sorry, I sold at $100, I bought back at $50, so I make a $50 profit and I give the shares back. Okay, you do have to pay a fee to borrow the shares, so brokers and investment banks you know, a big revenue stream for them is providing stock for short sellers. So the broker or the investment bank will charge a fee, and that typically— these fees range— well, sorry, vary, right? And the range can typically— it's like 0.3% up to 3% per year. So if you borrowed, you know, if you borrowed, what whatever, um, 100 of these shares that are valued at $100, that's $10,000 worth of shares, right?

Go on. I can just imagine if it's a big bank like JP Morgan and a company so large as Adani Group that we're probably lending to them, and then actually we're then short selling them in the banking division, but then in the commercial side it's like Oof.

Yeah, I mean, it's— it's— that's actually a really good point. And the lineup of banks that are lenders to these lot, I mean, it's basically all of them. It's, uh, Barclays, Citigroup, Deutsche Bank, JP Morgan, the list goes on. They're all lending. Uh, but then you're right, um, the other side of the Chinese wall of these banks, yeah, they're lending out stock for short sellers to, to kind of try and drive the price down. So yeah. It's, it's an interesting one. But, um, so yeah, you might, you might pay between 0.3% and 3%, right? So just think, for this trade to work, let's say you're paying 3% a year. For the trade to work, the stock has to drop by more than 3%, and only then are you kind of in the money, right? Um, now to, to do this, you, you have to also know what— you know, it's not— if it's not anyone, any average on the street that can go short Adani stock, right? To do this, you basically have to be a financial institution like a hedge fund, and you have to post margin on account at the broker firm. And if you— and typically on short selling, the amount of margin you need to post is 150% of the value of the shares that you're borrowing at the point that you're borrowing them. Okay, so if you want to borrow 10,000 $100,000 worth of shares, you've got to post $15,000 cash into the margin account of the broker. Okay, so look, it's quite— it's quite— yeah, you need a lot of capital, you need to be a financial institution, you need a margin account, and you need one of these big brokers or investment banks to allow you to open a margin account and deal through you.

And there's this big risk of like what happened with Citron Research, who I understand doesn't exist anymore, because guess what company forced them to close out a big short that ended them. What do you reckon? I'm gonna go— company, just think company in the last couple of years that was fundamentally a disaster but shares went to the moon and back.

Uh, uh, GameStop. GameStop killed them, right? Really? Wow. Yeah, well, there you go. I mean, the thing is about going short It's considered to be more risky, right? And the theory is because if you buy a stock, worst case you lose 100%. If the stock goes to zero, right, I've lost 100% of my money. The thing about going short is the stock price can go up. I mean, there's no limit, right? And in theory it's infinite. Of course, obviously it's not going to go to infinity, but the point is it can go up by more than 100%. You can lose more than 100% of your money. Which is why the margin requirement is 150% of the value, right? But you could lose more than that. And as the stock is moving, as the stock price is moving, unless it does start going up, and so you're losing money now, you're offside on your position, the broker's more, more than, you know, within their rights of issuing a margin call, demanding that you now post more cash into your margin account. To kind of rebalance it to make up for the loss that you're currently in. So yeah, it's a risky business for sure. And Citron obviously found that out. But so this is the play, right? Hindenburg issued this report and basically they're saying in the report that there's dodgy stuff going on. And that there's these dodgy accounts in Mauritius. And basically they're, yeah, opaque entities, to quote the report, in Mauritius where apparently they're basically accusing the Adani family of manipulating the group's stock price. They're saying that Adani have used a network of obscure offshore shell companies to buy and sell shares in the various Adani businesses, and in so doing, pumping up their share prices. Or they're kind of injecting funds into these businesses temporarily to make them appear like they're more creditworthy. And then on that positive creditworthiness footing, they're then borrowing money from public markets. And then, you know, oops, that money then disappears out of the account. And this is what Hindenburg is saying, right? It's all kind of a house of cards, and, you know, it's not what it appears, right? So this report gets issued, it's all over the press, um, the share prices of the various companies have dropped super sharply. I mean, that we're talking about down 50%, um, across— on average, across the group's listed firms, they're down around 50%, which is $114 billion worth of market cap that's been wiped off here. Um, and also on their bond yields. So if creditworthiness decreases, then the risk of lending to this entity obviously increases, right? And this gets reflected in bond yields. And so when bond yields go up, that means it's basically more expensive for you to borrow because you're less creditworthy. And, um, at its extreme at the moment, their Adani's renewables arm, their corporate bonds are now trading with a yield of 19%. Um, so yeah, it's pretty, it's pretty desperate times. Now what's happened, talking about kind of margin calls, um, because, um, Adani had a margin call because they borrowed money you know, using stock as collateral. But if the stock prices are dropping and dropping and dropping and dropping, well, then they're less valuable. That's less collateral. And so it's dropped so much that they've been requested to post more collateral to cover that. Now, they borrowed a load of money to actually get— start a share buyback program. So they borrowed money to buy back shares, which isn't in itself dodgy. And in this environment of zero interest rates, I mean, Apple have been doing that for a decade, borrowing money at super cheap kind of rates and then buying back their own stock. I mean, it's not, it's not an unusual, um, practice. Um, but yeah, um, Barclays basically issued— so they borrowed $1.1 billion for the share buyback loan, um, and Barclays issued a margin call for $500 million. Last week. Okay, well, sorry, this week, um, because the share prices have dropped. So, but here's where Adani start fighting back. So number one, they issued this 413-page rebuttal against Hindenburg. Second, rather than paying this $500 million margin call, they said, you know what, we're going to pay back the entire $1.1 billion loan. We're not in trouble here. This is all false. This is all fake. We're going to prove it. We're going to pay back that loan right now. And they have. Now, no one knows where this money's come from. Um, so that, that action doesn't necessarily prove innocence.

Yeah, because there's a precedent of this in recent times, which was the Abraaj Group. Well, if, if you are Indian, you're aware of Adani, you'll be aware of the Abraaj Group. Which was Afrif Najeeb, I think his name was. And he was doing very— it sounds very similar. It was like, you owe us back hundreds of millions. And then he came up with the money temporarily by moving a lot of things around. So yeah, to come up with a billion, shop— what do they call it? Window dressing. Yeah. Yeah, yeah, I, I don't think— well, I see what he's trying— I see the hand he's trying to play there, but as I say, it doesn't prove his innocence.

Um, look, this does set in motion a series of events because what's happened as the share prices have dropped, the MSCI indices have now reduced the weighting of Adani Group stocks in their indexes, which basically then forces ETF tracker funds to sell Adani stock because they no longer need as much because the weighting's been reduced. So it triggers this snowball which drives the stock lower and lower and lower, and hence then the margin call. And fine, they've gone, right, we're going to pay it. We've issued a rebuttal. They've just hired— like news this morning— they've just hired this new law— New York law firm Watchtower Lipton Rosen Katz, which is a super expensive, hardcore New York law firm who specialize in fighting against short sellers. So Dany has just signed up this law firm and they are going— they're not backing down. And I guess, look, you're supposed to be innocent until proven guilty. Right? I know Hindenburg have thrown up all of these sort of accusations, but, uh, has Adani started to lean on the government yet?

Because you said earlier that, yeah, he's in his pocket, you know, these free rides in my private jet don't come for free.

Well, Modi's been— he basically hasn't said anything. He's said nothing, been, been, yeah, eerily silent. Which I guess maybe speaks volumes. But the thing about Modi and broadly the Indian economy, it's got such huge potential. The demographics are awesome. They're going to be a powerhouse economy. What's held them back is their infrastructure, the lack of infrastructure, roads, bridges, railways, power plants. They It's just been the kind of thorn in their side in terms of advancing as an economy. And they've been through various kind of phases of trying to go through mega investment rounds in infrastructure, and it's not been handled well. The governance side of it hasn't been particularly strong, and there's been a lot of unfinished product projects and a lot of banks saddled with toxic debt as a result. And they've had false starts and they're miles behind when, if you compare it to China, okay, over the last couple of, let's say, 3 decades, China have just nailed it in terms of infrastructure build-out, and India have just— it's just been a bit of a disaster. So the problem Modi has is he's so reliant on these guys like Adani to advance this infrastructure project. Like, Adani had committed to $50 billion of spend and investment on Indian infrastructure. So they need people like— Modi needs the Adanis to fund India's future. I mean, it's literally like that. So yeah.

On a government level then, at what point does Modi get involved, sees this as a US attack on— Right. Indian sovereignty issues, because it's disrupting, like you said, not just a stock price, potentially the citizens of India on a wide scale. India, we know, has been maneuvering geopolitically to align and become quite friendly with the likes of China. Which adds another layer of complexity in the growing, in some way, friction with the Americans. Do you think it would ever get that far?

I, I think the fact that Modi's not come out defending him, I, I think tells you everything. That would be my hunch, in my opinion. I guess the tragedy— well, let's just for one second assume he's guilty— that, that the human tragedy of all of this is that This guy is like the worst criminal you could possibly imagine, because what's going to happen now if he is guilty, then international investment into Indian infrastructure, that is going to be set back years and years and years, which then has a very, very direct negative impact on Indian people's lives. I mean, that's, that's the real tragedy of these sort of episodes. Now, he might not be guilty, so I don't know. And actually, let's just go there for a second. If he's not guilty, then Hindenburg is the guilty party. And I mean, I— it's crazy. Like, we talk about market manipulation and how that is illegal under SEC rules, and this is exactly— I mean, this is— I'm gonna short sell, then I'm gonna post a report basically accusing this company of being fraudulent, and then I'm going to profit as the stock collapses. But if you've told a lie, if your investigation and your reporting is false, then, then surely you're the guilty party. But there don't seem to be any SEC regulations that kind of police these short sellers. And so I don't know. We'll see. The battle goes on. The lawyers have been instructed, and, um, yeah, the, the, the gloves are on. I think, ding ding, round one, here we go.

I think we've said this before in a previous episode, there's always one winner here in these situations. That's the lawyers. Yeah, it doesn't matter what side, what happens. Yes, they just print the money. But perhaps you and I went into the wrong profession. Um, well, look, hopefully that episode was useful, uh, covered a couple of different concepts there, uh, activist short selling being one of the main ones, uh, aside from the actual topic in itself. So yeah, we'll wrap it up there. Um, don't forget to share the, the pod with a friend if you think that they could benefit from it. Um, would love to have new people into the community. I had some really great messages, uh, as well since we've come back on since the new year began. So thanks everyone for listening, and Piers, thank you again, and Catch you next week.

Yep. Have a good weekend.