Been caught stealin': Hindenburg Research is on a roll with Adani and Block (Square) short reports

It's kind of sweet to be able to grab onto the coattails of a couple of great reports on companies that justify the proctological look of Nate Anderson and Hindenburg Research.

It seems like eons ago — pre-Silvergate/SVB/Signature/Credit Suisse and pre-a Coinbase Wells notice — that we were all talking about Hindenburg Research and its dramatic short take on Indian tycoon Guatam Adani, published January 24. Nate Anderson and his caped short crusaders claim Adani the man is behind “the largest con in corporate history.”

Today we reveal the findings of our 2-year investigation, presenting evidence that the INR 17.8 trillion (U.S. $218 billion) Indian conglomerate Adani Group has engaged in a brazen stock manipulation and accounting fraud scheme over the course of decades.

Gautam Adani, Founder and Chairman of the Adani Group, has amassed a net worth of roughly $120 billion, adding over $100 billion in the past 3 years largely through stock price appreciation in the group’s 7 key listed companies, which have spiked an average of 819% in that period.

I got a lot of calls and letters about the Adani report, since the words “accounting fraud” were used in the first paragraph of the report and because, at first glance, it seemed that this circus elephant-sized sprawling conglomerate was audited by a teeny-tiny, unknown, penny-ante firm.

According to the Hindenburg Research report:

The independent auditor for Adani Enterprises and Adani Total Gas is a tiny firm called Shah Dhandharia. Shah Dhandharia seems to have no current website. Historical archives of its website show that it had only 4 partners and 11 employees. Records show it pays INR 32,000 (U.S. $435 in 2021) in monthly office rent. The only other listed entity we found that it audits has a market capitalization of about INR 640 million (U.S. $7.8 million).

Shah Dhandharia hardly seems capable of complex audit work. Adani Enterprises alone has 156 subsidiaries and many more joint ventures and affiliates, for example. Further, Adani’s 7 key listed entities collectively have 578 subsidiaries and have engaged in a total of 6,025 separate related-party transactions in fiscal year 2022 alone, per BSE disclosures.

The audit partners at Shah Dhandharia who respectively signed off on Adani Enterprises and Adani Total Gas’ annual audits were as young as 24 and 23 years old when they began approving the audits. They were essentially fresh out of school, hardly in a position to scrutinize and hold to account the financials of some of the largest companies in the country, run by one of its most powerful individuals.

However, not is all as it seems. It is not as unusual as it seems for the parent or holding company of a non-US conglomerate or huge, complex company to be audited by a small firm while Big 4 firms audit major subsidiaries and/or prefer to do consulting, M&A, and tax work rather than the audit.

I hope his mother loves him…

Greensill Financial Group

Take, for example, Greensill Capital’s situation in 2020, ahead of its listing in the UK:

Several large accountancy firms have rebuffed invitations to audit SoftBank-backed Greensill Capital, complicating the controversial financing company’s efforts to appoint a new auditor ahead of a potential stock market listing.

The London-based group, which employs former UK prime minister David Cameron as an adviser, has grown into one of Britain’s most valuable private finance firms since its was founded in 2011. However, for the past five years it has employed the relatively obscure accountancy firm Saffery Champness as its auditor, rather than one of the Big Four firms. Saffery Champness, which is the UK’s 13th-largest accounting firm by fee income, recently agreed with Greensill that the scale and complexity of its balance sheet had outgrown its services, according to people familiar with the matter.

Both KPMG and rival Deloitte turned down an invitation from Greensill to tender for its audit mandate at that time, according to the FT report, citing a conflict of interest. That means the firms wanted to continue providing other consulting or tax services to Gupta and his Greensill companies and would have been unable to do so if they took on the audit.

In May of 2021 the UK’s Serious Fraud Office launched an investigation into suspected fraud and money laundering at GFG companies, including their financing arrangements with Greensill. The GFG Alliance is the loose collection of businesses owned by Gupta and his family. SFO said it was also investigating PwC over its 2019 audit of Wyelands Bank, also owned by UK industrialist Sanjeev Gupta, and one of Greensill’s largest clients. The FT reported that PwC resigned as auditor of Wyelands Bank in November 2019, citing a potential conflict of interest. Mazars took over as the bank’s auditor for the financial year ended April 2020 for which it reported losses of £69.5m.

Greensill Capital filed for bankruptcy in March 2021 resulting in a widespread corporate and political scandal. Greensill’s lending to Gupta’s GFG Alliance is the subject of a criminal investigation in both Germany and the UK.

In 2022, the UK accounting regulator reportedly was also investigating “a little-known firm’s audits of four companies in GFG Alliance, the business empire built by metals tycoon Sanjeev Gupta. The Financial Reporting Council said on Wednesday it had begun probes in relation to audits by King & King, a two-office firm that has audited scores of companies in GFG, Gupta’s loose collection of businesses.”

Back to Adani
It turns out that an EY member firm audits one of the largest Adani subs and one that Bloomberg reporters Anders Melin and Stephen Stapczynski thought deserved a closer look.

Few places encapsulate the questions swirling around billionaire Gautam Adani like the Mundra power plant — a coal-fired colossus that for years has burned through money.

This crown jewel of his power company, which can light up millions of homes, has more liabilities than assets and has run up $1.8 billion of losses. To paper over the deficit, Adani has deployed more than $1 billion of creative debt-financing and reassured investors and lenders that profits will come soon.

But Adani Power Ltd.’s auditor can’t fully make sense of the math underpinning this claim — and neither can accounting experts who spoke with Bloomberg News.

The accounting experts referred to are Miguel Angel Minutti-Meza, the accounting department chair at the University of Miami’s Herbert Business School, and me.

Professor Minutti-Meza, a good friend, great scholar and all-around cool guy, had some interesting insights:

Inside Adani Power sits a sub-entity resembling an investment company, identified in financial statements as “Standalone.” Through this vehicle, Adani Power lent more than $600 million to Mundra, delivered through a special kind of unsecured debentures.

Filings show the securities came with 10% annual interest — but it only had to be paid if Adani Power asked. And they were perpetual, meaning there was no set date when Mundra would have to repay the principal.

The move offered Adani a crucial advantage, said Miguel Angel Minutti-Meza, the accounting department chair at the University of Miami’s Herbert Business School.

An equity investment might have needed to be written down if the plant kept losing money, he said. A standard loan would have put Mundra on the hook for regular interest payments — or else face a possible writedown. (These are fair-value adjustments, made to give investors a reasonable picture of an asset’s prospects.)

But the debentures seem custom-made to avoid such consequences, Minutti-Meza said, no matter if Mundra’s losses kept piling up. Which is key for Adani Power, he added, because “a large impairment may trigger a series of defaults” depending on its loan terms.

I spent a lot of time with the journalists, including first identifying for them that the entire investment held in Adani Power (Mundra) Limited is pledged by the Company as additional security in favor of lenders of APMuL. They can not write it down or whatever loans APMul has will be called.

I got a nice quote in the story, too:

The accounting experts concede that estimating a power plant’s future value is complex, giving Adani some leeway. Its life can span decades. Revenue is often dependent on contracts with local governments. Coal prices and currencies rise and fall. And Mundra has been generating some cash, even though it’s been losing money on paper.

Still, repeated auditor reservations (in Mundra’s case, four) are very unusual, said Francine McKenna, an accounting lecturer at the University of Pennsylvania’s Wharton School.

“If this company was listed on a US stock exchange, the auditor would not have been able to get away for several years with an opinion that has such a material limitation of scope,” she said. Such situations typically go one of two ways: either the company provides proper answers, or the auditor resigns, she added.

Another journalist, veteran financial reporter Richard Teitelbaum whom I met way back in the financial crisis era, wanted to write more about this auditor issue for Institutional Investor. Again, I spent a lot of time with him on the phone, first reminiscing, and then talking the state of the audit industry and why these alleged ginormous accounting frauds keep happening.

“In the Hunt for Fraud, the Red Flags Start with the Auditor”

Adani is on a long list of companies in which the choice of auditors and information in their reports could have provided a warning to investors. But audit firm red flags often go unheeded.

“Nobody does due diligence,” says Francine McKenna, a lecturer at the University of Pennsylvania’s Wharton School, who adds that auditors themselves are focused on billings, not uncovering fraud. “Get the client, keep the client, please the client,” she says.

On to the next for Hindenburg Research

Nate Anderson recently blew Jack Dorsey’s day, publishing a report on Block (Square) that tanked the stock.

The Wall Street Journal:

I hope his mother loves him…

Shares of the payments company formerly known as Square fell about 15% on Thursday after a short seller questioned the company’s user numbers and accused it of predatory tactics.

Hindenburg Research said a two-year investigation into Block Inc. SQ found the company “obfuscates” its Cash App service’s true user numbers by reporting misleading metrics “filled with fake and duplicate accounts.” It also accused the company of taking advantage of the demographics it claims to serve—lower-income people and minorities—with “predatory loans and fees.”

The WSJ wrote that Block(Square) said in a statement that Hindenburg’s report is “factually inaccurate and misleading” and “designed to deceive and confuse investors.” The company also said it was exploring legal action against Hindenburg Research.

I think Block (Square) is a very crypto-adjacent company that has so far been ignored by regulators who seem to want to tamp down the enthusiasm of the cryptonauts. What is the crypto-adjacency of Square/Block? How does it touch retail investors? Square’s Bitcoin revenue was down for 2022 but still dwarfs all other revenue sources. From one of my Wharton lectures:

You can read more about what I think of Block (Square) and its revenue recognition practices here:

The SEC finally posts Square's comment letter file

© Francine McKenna, The Digging Company LLC, 2023