In any major earthquake, the after-shocks can be as damaging as the main disaster. This is true for the Adani Group, whose share prices were initially destroyed by a damning report by Hindenburg Research on January 24, 2023. The fallout has spilled over to Adani businesses. If the prices of the nine stocks within the empire don’t hurtle back to higher levels, the group will suffer in several ways. This will impact its future investments that will sputter, debt whose management may prove to be tough, and future profits that can expose the weaknesses in operations.
Gautam Adani’s business credibility is at stake. Now, the founder of the ever-expanding group has to establish that his companies weren’t shooting stars or black holes. They were the ones whose blaze will only grow in the near future. He has to convince investors that the earlier high valuations mirrored the inherent potential of his companies. It isn’t an easy task. But it will require a deep focus on ongoing projects and revenue streams. In the end, the manner in which Adani’s businesses shape up will answer a crucial question: Is the group too big to fail or too fragile to sail?
Some projects are already on hold. This began when the massive and ambitious public offering of shares by Adani Enterprises, the group’s parent, to raise `20,000 crore was called off because of the Hindenburg effect. Later, the group admitted that some of the firms will pare down or curtail future plans. Foreign partners like Total, French energy giant, called off the $4 billion investment in green energy, which is Adani’s vision to leapfrog onto the global arena. Expansion will take a back seat, at least for the moment, until the group puts its financial house in order.
What’s in question is the ESG (Environment, Social, Governance) model touted by Gautam Adani. Aswath Damodaran, who teaches corporate finance and valuation at New York University, wrote in a recent blog that from “Adani website and sales pitch, it is quite clear that the company (group) learned to play the ESG game well, creating an entire ESG universe to underpin its companies”. Patrick Wood Uribe, CEO, Util, an ESG research firm, questioned the ESG claims of a group “with operations in commodities, utilities, gas and airports” and “engaged in some of the most controversial coal mining projects”.
Debt is a colossal four-letter word that’s staring in the face of Adani. In the recent past, the group initiated moves to manage debt and be in a position to raise more loans to fund future projects. In a counter to the Hindenburg report, it claimed that it changed the debt composition from bank loans to bonds. The former comprised 86% of debt in 2016, which came down to 51% in 2022. It raised $16 billion equity, as opposed to debt, in the past three years from “marquee investors” like Total, Warburg Pincus (private equity goliath), and International Holding Company, the UAE-based conglomerate.
Equity infusion and high stock valuations until January 2023 helped Adani to reduce the percentage of shares, which he owned and had pledged against loans. For example, the “pledge position” of Adani Enterprises came down from 50% in March 2020 to 4% in December 2022. “The leverage ratios (debt to earning levels) of Adani Portfolio companies continue to be healthy and are in line with the industry benchmarks of the respective sectors,” claimed the Adani reply to the Hindenburg report. The group’s leverage ratio was 4.57x, and ranged from 1.22x for Adani Total Gas and 5.7x for Adani Enterprises.
But the scenario has changed, thanks to the Hindenburg effect. A portion of the cancelled public offering of Adani Enterprises was meant to pre-pay a part of the debt. This will not happen. The collapse in share prices kicked in demands from lenders for more collateral. Adani faced a margin call of $500 million against loans worth $1.1 billion, which were backed by his personal holdings in group companies and used to acquire the two cement behemoths, ACC and Ambuja Cements. This prompted him to pre-pay the debt, not because of moral compulsions but because he was forced to do so.
According to Damodaran, despite the group’s claims, it “funded almost all of its growth with debt” between 2002 and 2022. In fact, his analysis shows that Adani used “debt to pay dividends (to investors) during the 2016–21 time period”. Moreover, the “operating income (of the group) is barely higher than interest expenses”. This implies a double-edged impact in the near future. The low stock prices will curtail steps to raise more equity or loans, as Adani will find it tough to use his shares as collateral. It will also force him to pre-pay loans through profits earned by the group firms.
Finally, it boils down to how Adani’s businesses fare. Let’s analyse the financials of Adani Enterprises. In 2021–22, revenues witnessed a huge jump of 75%. Yet, profit after tax as a percentage of revenues plunged to 1.1% from 2.29% in the previous year. Earnings before interest, depreciation and tax came down from 8.09% (as a percentage of revenues) in 2020–21 to 6.7% in 2021–22. Damodaran feels the same: “While the revenue part of the story is one of almost unstoppable growth… Adani Group has had low operating margins, with the trend lines in the wrong direction.”
Going forward, Adani needs to focus on the businesses to boost revenues and profits. This is the way to win back the confidence of the investors. In such a situation, a restraint on new projects and expansive growth may prove to be a boon. One of the reasons for the low profits and margins in the recent past was due to unbridled investments, which hiked interest costs. If Adani pays attention to existing operations, including ongoing projects, earnings will improve. In addition, it will send a message—the Adani power is not just cemented in stock prices, but in its businesses too.
Alam Srinivas
Independent journalist and author