Why in News?

• The Enforcement Directorate has concluded its preliminary investigation into the Hindenburg Research report.

What’s in Today’s Article?

• About Hindenburg Research (Purpose)
• Report on Adani Group (Key Highlights of the Report, Adani’s Response, etc.)
• News Summary (ED’s Findings, Short Selling)

About Hindenburg Research:

• Hindenburg Research is a US-based research team that offers services in forensic financial research, with a focus on equity, credit and derivatives analysis.
• Their fundamental research often includes studying and reporting on companies with accounting irregularities, unethical practices in business/related-party transactions, bad management etc.
• Its primary method for investment is said to be short-selling.
  • Short selling basically involves borrowing an asset now in order to sell it, only to buy it back at a lower price and then return the borrowed asset.
  • The view taken basically is bearish one.

Hindenburg’s Report on Adani Group:

• Usually, they write reports on western companies such as Nikola, Genius Brands, etc.
• However, on 24th January, 2023 they wrote a report on the Adani Group, claiming that the latter were pulling the “largest con in corporate history”.
• They also revealed that they were holding a short position on the Adani stocks, signalling their belief that the shares are overpriced and will dip in value soon.

Key points in the Hindenburg Research report on Adani Group:

• Overvalued Shares –
  • The report cites data from FactSet and Hindenburg’s own analysis to claim that the Adani shares are highly overvalued by conventional metrics.
  • Some of the extreme cases include the P/E Ratio of Adani Enterprises being 42 times the industry average and the Price/Sales ratio of Adani Total Gas being 139.3 times the industry average of 1.0x etc.
• Debt-Fuelled Business –
  • 5 out of the 7 key listed companies mentioned have reported a current ratio of less than 1.
  • This means that the total amount of current assets is less than the total amount of current liabilities in those companies.
  • This is not a healthy financial practice as this means that the companies are unlikely to have adequate assets to pay off their liabilities in the short run.
• Promoters Pledging their Stocks –
  • This means that the promoters of the company have taken on additional debt on the basis of the shares that they own.
  • As seen above, the share prices are claimed to be already high and so is the debt – therefore, promoters pledging stocks to take on more debt is not a healthy financial practice in such a context.
• Doubts regarding the Management team –
  • The report claims that some members of the management have a questionable past which includes allegations of fraud, duty evasions, scams etc.
• Excess Promoter Control of Shares –
  • It has been alleged that in addition to the already high proportion of promoter holding in shares (close to 74% in multiple cases), significant portions of the remaining public shares are also controlled by shell companies that have ties with the Adani group.
  • Many of these companies have a large majority of their shares invested solely in firms under the Adani Group.
• Pumped up Demand –
  • The preceding point also hints at deliberate pumping of the Adani stock prices through excessive buying pressure from companies that seem to be biased towards (or perhaps connected with) the Adani Group itself.
  • It is claimed that the delivery volume of Adani stocks may have been high because of possible wash trading.
    • Wash trading is the practice of buying/selling of a share by the same or related entities to pump up the trading volume numbers.
• Inadequate Compliance –
  • The report claims that one of the firms hired to book run the Adani Green Energy has had past problems with the SEBI.
  • Moreover, one of the independent auditors hired to audit Adani Enterprise and Adani Total gas seems to be too
  • small a company.
    • It comprises of professionals too young to be able to handle the auditing of such a large array of companies.

News Summary:

• The Enforcement Directorate (ED) has completed its preliminary investigation into the Hindenburg Research report and the subsequent stock market crash.
• The investigation has revealed that around 12 companies, including foreign portfolio investors and foreign institutional investors (FPIs/FIIs) based in tax havens, emerged as the main beneficiaries of short selling in shares of Adani Group companies.
• According to the ED, some of these short sellers allegedly took positions just 2-3 days before the Hindenburg Research report was published on January 24, and some others were taking short positions for the first time ever.
• The conclusion of the ED is that transactions and income tax data throw up the possibility of the FPIs and FIIs not being the “end beneficiaries” of the gains made from short selling, but actually acting as brokers for bigger players located overseas.

What is Short Selling?

• Short sellers are investors who predict and bet that share prices will decline.
• They borrow shares, sell them, and repurchase them later at a lower price, thus gaining a profit in the process.
• Both domestic investors and FPIs/FIIs registered with SEBI are allowed to participate in trading derivatives, which enable investors to hedge market risks by taking short positions.
• SEBI advocates for regulated short selling, believing that imposing restrictions may distort effective price discovery and potentially provide manipulative power to promoters.