Fri Feb 3

how an obscure US firm profited from triggering the Indian giant's price plunge

Written by: Mark Humphery-Jenner, Associate Professor of Finance, UNSW Sydney

A few weeks ago, Gautam Adani was indisputably India’s richest man.

Now his fortune is slipping away as the stocks of his many companies crash, thanks to the efforts of a relatively obscure US company named after the 1937 Hindenberg disaster (in which a hydrogen-filled airship caught fire, killing 98 people).

Adani’s personal fortune was an estimated US$150 billion ^[1] in 2022. He catapulted past the previous richest Indian, Mukesh Ambani, on the back of the meteoric rise of Adani Group, a multinational conglomerate with holdings in mining ^[2], energy, airports, cement ^[3], food processing ^[4] and weapons manufacturing ^[5].

Gautam Adani is no longer India’s richest person. Aijaz Rahi/AP

Since January 25, Adani Group’s stock price has fallen 45%. The catalyst? An explosive report ^[6] published on January 24 by Hindenburg Research, alleging Adani Group engaged in “brazen stock manipulation and accounting fraud scheme over the course of decades”.

What complicates this report is that Hindenburg Research isn’t just a research company. It’s an “activist short seller”, with a financial incentive in seeing Adani’s stock price fall.

Hindenburg makes its profits by identifying “man-made disasters floating around in the market”. It bets on the stock falling, then publicises that company’s negatives – including doing so in Adani’s case ^[7]:

After extensive research, we have taken a short position in Adani Group Companies through US-traded bonds and non-Indian-traded derivative instruments.

Adani’s response ^[8] includes calling the report a “calculated attack on India” and “intended only to create a false market in securities to enable Hindenburg, an admitted short seller, to book massive financial gain through wrongful means at the cost of countless investors”.

Activist short selling is certainly controversial. But it’s not necessarily illegal, nor unethical.

How does short selling work?

Short selling (also known as having a “short exposure”, or “shorting”) is essentially betting on a company’s stock falling.

The process is more complicated than betting on a share price rising, for which all you have to do is buy the stock and wait for it to appreciate.

It can be done in several ways. The most common is to sell borrowed stock. The “short seller” makes a contract with a share owner to borrow shares for an agreed period. They then sell that stock, banking the proceeds. When the time comes to return the stock, they buy shares on the market to “repay” the loan. If the price has fallen in the meantime, they make a profit.

There are also methods that involve “derivatives”. These are financial instruments that allow investors to “bet” on financial outcomes. For example, a “put option” involves betting a stock’s price will fall below a specific level (called the strike price). Similarly, a futures contract pays out the difference between the current stock price and the future stock price. This allows the investor to effectively bet on price movements.

Investors might also invest via bonds. A corporate bond is much like a loan. Investors can short sell a bond like they would a stock. Alternatively, they can buy “credit default swaps”, which enable betting on a company defaulting on on its debt repayments.

There are even more complicated strategies than these. For fun explanations, check out the 2015 movie The Big Short, about the guys who bet on the collapse of the subprime mortgage market that led to the 2008 Global Financial Crisis.

Short selling explained by Margot Robbie in ‘The Big Short’.

Is short selling legal?

There are two main legal issues arising with short selling.

Market manipulation. It is illegal in most jurisdictions for activist short sellers to profit by spreading false or misleading information. This is the case in Australia and the US (where Hindenburg and some of its positions in Adani are based). But this is relatively easy to discover.

Insider trading. it would be illegal to bet on a company’s future share price using information that is not generally available, then reveal that information.

On this, Hindenburg Research is skating on thin ice with some of its assertions. For example, its report says of Adani’s deals to build a rail line to transport coal in Queensland:

None of the transactions were specifically disclosed in the Adani Enterprises annual reports. We uncovered them only by reviewing financials for the private Singaporean Carmichael Rail entity.

If those financials were publicly available in a database or online, Hindenburg Research is in the clear. But if the financials were not generally available, it risks being accused of insider trading.

However, Hindenburg’s report contains many allegations involving a large volume of public information, which means it would be difficult to establish whether it also used any non-public information to assemble the report.

Is this ethical? Should we be concerned?

There are some concerns about the ethics of profiting from a company’s demise.

Ethics can be arbitrary. However, we can consider some guidelines. These include:

Does society benefit from information about fraud coming to light?
If there were no financial incentive, would a company really spend two years doing detailed forensic analysis?
Does anyone unfairly lose to justify rules or laws to discourage such profits?

Exposing fraud is in the public interest. There must be some financial incentive to do such work. Existing shareholders are losing from Adani’s stock tumble, but that should properly be credited to the alleged fraud, not the report.

Ultimately, then, companies such as Hindenburg are generally a net positive if they comply with all relevant laws, securities regulations and privacy guidelines.

If the report is truthful, blaming Hindenburg for Adani’s crash is like blaming an alarm for a fire.