Adani vs Hindenburg: Well, the game has just started! When a seasoned short seller takes on one of the mightiest Indian corporations, it may be a case of irresistible force meets immovable object paradox. That is pretty much how it played out, with most of the Adani Group stocks falling only in the 1-8 per cent range on January 25 – day one when the short seller targeted Adani.

Going by history, that is not a bad reaction. Typically, when such short sellers have targeted companies, it has resulted in double-digit or more declines on day one in the US markets. This tug of war will likely play out over months or years as it has in many such battles in the past.

The scope of this article is not to make a judgement on the merits or demerits of Hindenburg’sallegations against Adani Group. However, two things merit attention — one, forensic short sellers are not right all the time; two, when they are right, they are usually the first ones to identify fraudulent companies.

Whether it was the Enron scandal in the first decade of the millennium, or the Wirecard scandal of the recent decade, short sellers or investigative journalists were amongst the first to spot it and bring it to public attention. Short sellers, at times, are at least a year ahead in identifying the fraud and in taking positions. Gullible investors and regulators are usually the last to wake up and this usually happens only when the scam has already imploded or is in the verge of imploding. Remember subprime crisis?

Forensic short sellers

Short sellers can be broadly categorised into two types — one, those who short stocks because they believe a stock is over valued (like the Gamestop short sellers), or shorting stocks as part of hedging or market neutral portfolio strategy; and two, forensic short sellers — those who attempt to do a detailed forensic research on a company, spend months or years investigating about it, take positions and then try to convince the public about their view. Hindenburg comes in the latter category. Some of the other famous short sellers in that category are Muddy Waters, Citron Research and Kynikos Associates.

These short sellers are in it for the long haul, and not focussed on a hit-and-run operation for quick profits. Given vast amounts of time and other resources ploughed into their research, they come with a higher conviction in their view and hence tend to hold on to their positions till their thesis plays out or is invalidated or losses run too high.

This category of short sellers are less focussed on valuation, but more on whether, in their view, there is accounting fraud or skeletons of a unviable business model hidden under a glittering story.

Conflict of interest?

Sure, if the shares fall, the short sellers make merry. So, yes, they benefit by taking positions in a stock and then releasing their research report to the public and trying to convince them to follow their trade. But this is no different from a long-only PMS or any other fund manager taking a position in stock and then coming on TV to explain why a certain stock can do well or releasing research reports on some of their holdings.  

So this conflict-of-interest argument against short sellers doesn’t hold water. Whichever way in the markets one is positioned, and shares research with public (unless there is a hit-and-run intent), the intention is to build mass and momentum in your favour and profit from your positions. They need to be assessed on the quality of their research, historical track record, and to be held accountable only if their thesis turns out to be wrong. Not based on whether they profited or not. To the extent they are positioned, they are also exposed to potential of loss as well. And theoretically the potential to lose money in short selling is unlimited.

Hindenburg has, to its credit, a few successful calls. Their targeted research and short positions in electric vehicle companies Nikola and Lordstown Motors worked perfectly for them in the last two years, as much as the targeted companies originally tried to discredit them.

As far as targeting Indian-related companies are concerned, their call targeting Eros International (NYSE-listed, India-linked business), too, proved spot on.

At the same time, they have had short calls in stocks like Bloom Energy that have backfired. So investors need to keep in mind, as mentioned above, they are not right all the time and not make any decision without going through the research published.