Adani's troubles reflect India's woes

For some Indians, the loss of more than $130 billion of market value has come as an assault on nationalist pride

By Andy Mukherjee

A New York short seller has forced India to stare at a reflection of its long-simmering frustration with shabby, inadequate infrastructure and its impatient urge to fill the gaps overnight.

The target of Hindenburg Research’s attack is the Adani Group, which aggressively marshaled capital from around the world into India’s unmet aspirations. The conglomerate has strongly denied the activist investor’s allegations of stock-price manipulation and accounting fraud.

For some Indians, the loss of more than $130 billion (Rs 10.76 lakh crore) of market value has come as an assault on nationalist pride. But even those who refuse to equate Adani with India are forced to acknowledge the larger point of the debacle: The country’s hunger for nicer airports, wider roads, faster rail journeys, more efficient ports, more reliable power supply and cleaner air is not backed by the purchasing power of the masses. Stratospheric equity values might lure debt into asset-owning firms for a while. Ultimately, though, misallocated capital won’t end the infrastructure deficit.

When it comes to channeling capital efficiently, India’s stock market offers plenty of choices. Yes, domestic savings are low, and only now getting deployed by asset managers beyond the traditional havens of gold, real estate and bank deposits. But for foreigners willing to take the risks that come with emerging markets, a 30 per cent-plus return on capital employed is par for the course. Except that these opportunities are usually not available in infrastructure outside of telecom. And that’s where the Adani Group operates.

Read | 'Sockpuppets' created puffery about Adani, says Wikipedia

Some of India’s more efficient firms are consumer multinationals that have been around a long time, such as Unilever Plc and Colgate-Palmolive Co. They rub shoulders with the likes of Tata Consultancy Services Ltd., Infosys Ltd. and Wipro Ltd., homegrown software exporters that are now multinationals in their own right. Ditto for scooter- and autorickshaw-maker Bajaj Auto Ltd., which sells half of its two-wheelers in other developing nations in Asia, Africa and Latin America. The carmaker Maruti Suzuki India Ltd. is now almost twice as large by market value as its Japanese parent.

The one thing common to all of them? They all generate reasonably high returns on capital employed, which is what you would expect in a youthful country of 1.4 billion people, teeming with cheap labor.

Look deeper into the Adani meltdown, and you’ll see the opposite pattern: Most of the group’s stocks that have crashed this year never did boast of superior capital efficiency. Adani Enterprises Ltd., the flagship, has a sub-10 per cent return on capital employed, as does Adani Green Energy Ltd., one of India’s largest producers of solar power. Even the elevated profitability of Adani Total Gas Ltd. may be a function of its city-gas business winning tenders to supply an ever-bigger geographical area — in line with the government’s desire to provide 90 per cent of the population with a cleaner energy source than diesel, coal, and cow-dung patties. Post-tax profit in nine months through December was flat; shares have collapsed by nearly three-fourths since the short seller’s attack.

This is the hard reality facing most of Adani’s business: It has a sprawling portfolio ranging from ports and airports to coal mines, power stations, solar farms, gas pipelines, wind turbines, warehouses, and a lot else besides. But the capital stuck in them is hard to sweat. Users can’t, or won’t, pay enough for natural monopolies whose size and quality is dictated by the aspirations of a small but vocal middle class, but pricing must be decided by a large swathe of less affluent users. No wonder, state-owned electricity distribution companies keep sinking into a vortex of losses and debt despite many attempts to revive them. They can’t settle power producers’ bills on time.

Read | Adani-Hindenburg row not to impact India story, says industry doyen K P Singh of DLF

No gloss of stock-market valuation can hide the wrinkles in the underlying economics. The group says refinancing its $24 billion (Rs 1.98 lakh crore) in net debt should pose no problems. However, if capital turns more expensive, the Adani juggernaut could stumble.

While high valuations have enabled the group to borrow aggressively, equity investors themselves have been less than convinced by Adani’s meteoric rise. The phenomenal gains of the last three years were underpinned by the former centi-billionaire’s acquisitive zeal and a spectacular runup in shares with low free-floats. They propelled founder Gautam Adani to near the very top of the global wealth league.

That fortune, however, was perched on wobbly foundations. Even before the short seller’s January 24 note, the group wasn’t exactly a darling of institutional investors. Equity analysts actively track only the ports and the recently acquired cement businesses, and even mutual-fund managers in Mumbai have largely stayed away. Barring TotalEnergies SE, Abu Dhabi-based International Holding Co., Qatar Investment Authority, Warburg Pincus LLC and India’s state-owned Life Insurance Corp., the behemoth hasn’t succeeded in persuading many investors of its long-term capital efficiency. And now France’s Total has put a green hydrogen partnership with Adani on hold. Norway’s largest pension fund, KLP, has dumped its entire shareholding in Adani Green.

Even though the businessman’s proximity to the Indian prime minister is well known, Adani has denied seeking or receiving any political favors. What’s true, however, is that the tycoon has aligned his expansion with Narendra Modi’s priorities.

In a developing country with low living standards, the government lacks the tax base to commit itself to expensive, long-gestation projects. To emulate a Chinese-style infrastructure boom, Modi wants to monetize existing state assets. But where’s the eager private-sector buyer of old state-owned infrastructure and the creator of new facilities, such as a second airport in Mumbai? A previous champion, the IL&FS Group, went bankrupt in 2018. Even if the IL&FS model of shadow banking didn’t work, global equity investors pour billions of dollars into India each year for mouth-watering returns. Why couldn’t the same apparatus be used by the country’s entrepreneurs to also create infrastructure?

Read | Supreme Court calls for 'transparency' in Adani case, refuses Centre's sealed cover submission

Adani showed it could be done. He came to straddle India’s traditional, coal-based energy supply-chain and made a bold bet on renewables, including green hydrogen. He bought six state-run airfields in one fell swoop, and is now constructing a second Mumbai airport to decongest the one he already operates. From one seaport in the 1990s, he has come to own a network of 13 ports and terminals encircling India’s coastline. The 60-year-old recently acquired the Haifa Port in Israel, where Prime Minister Benjamin Netanyahu is a great friend of Modi’s. Adani is also a 51 per cent owner of the new western Colombo port terminal in debt-ravaged Sri Lanka, where India wants to counter China’s influence. Bangladesh, which is supposed to start buying power from Adani, has recently asked for a review of the purchase agreement.

Overall, the group has talked in the past about investing $107 billion (Rs 8.86 lakh crores) (over a decade, music to the ears of politicians who want to spend $1.4 trillion or Rs 115.92 lakh crore on infrastructure but have no idea how to do it).

Before Adani could become synonymous with India at home and abroad, Hindenburg Research dropped its bombshell: A 106-page report alleging that the billionaire was trying to pull the largest con in corporate history. The Adani Group countered with a 413-page rebuttal, but failed to save a crucial stock sale. Since then, the group’s shares have plunged, even as the battle for corporate reputation has acquired political overtones. Ahead of Modi’s reelection bid in next year’s general election, the opposition is trying to pin him down on his relationship with the businessman from his home state of Gujarat.

Whatever the outcome of the gladiatorial contest, one thing is clear: From airports and roads to green hydrogen, data centers and mining, the five companies that the conglomerate was planning to float in the public markets between 2026 and 2028 may have to be incubated by the flagship a lot longer. That will cost. Bondholders and banks may be appeased if they see enough hard assets as collateral, but equity investors have been burnt once. Now, they will want evidence of solid underlying profitability. Since that’s harder to demonstrate than unbridled ambition, India may eventually have to look elsewhere. The country deserves superior infrastructure. It just needs to find a better way to afford it.