Irreconcilable: Why CreditSights and Adani group can't agree

The above statement, by famous American engineer W.E. Deming, was popularised in India by N.R. Narayana Murthy, the founder of Infosys Ltd, who said that he always relied on data when confronted with a difficult decision to make. 

Numbers are what go into making a good data set which helps one arrive at a conclusion. 

But what if there are two competing sets of numbers to pick from? 

This issue is at the heart of the current brouhaha between CreditSights, a unit of Fitch, the global ratings giant, and the Adani group, owned by the world’s third-richest businessman, Gautam Adani. 

On August 23, CreditSights, a debt research firm, put out a detailed analysis of six of the seven listed Adani firms, calling the conglomerate “deeply overleveraged" in this 16-page note. The note said, wrongly, that Adani Group had six listed companies. Adani Wilmar Ltd wasn’t included. 

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New York-headquartered CreditSights was founded in 2000 by two bankers. Fitch Group bought the research firm in January last year. It claims its independent, subscription-based market research is read by 20,000 investors and analysts. 

After the note was published, the seven listed Adani Group companies saw ₹94,000 crore eroded from the combined market cap.   

Subsequently, Adani Group’s chief financial officer, Jugeshinder Singh, Head of Corporate Finance, Anupam Misra and Head of Ratings, Rahul Kumar spoke with the CreditSights team. 

Then, on 7 September, CreditSights followed up the earlier note with a second one – to “reconcile" its calculations with those presented by the Adani Group. 

This note stated that CreditSights had erred in calculating the earnings before interest, tax, depreciation and appreciation (Ebitda) of Adani Transmission Ltd and the gross debt of Adani Power Ltd. Adani Transmission’s Ebitda should read as ₹5,200 crore as against ₹4,200 crore it had stated in the 23 August note. Adani Power’s gross debt was ₹48,900 crore, lower than the ₹58,200 crore it had said earlier. 

CreditSights did not explain what had led to these errors, not large discrepancies at any rate.  

Notably, the second note has two parallel sets of metrics, one attributed to Adani management while the other set of data ascribed to CreditSights’ calculations. These are important metrics used to evaluate the health of a company, such as gross debt, net debt, unrestricted cash, Ebitda and some other ratios. 

The research outfit’s decision to publish two sets of numbers instead of reconciling the differences between the in-house calculations and those of the Adani group raises important questions.  

First, is this the first instance where CreditSights has published two competing sets of numbers for key metrics after an interaction with the management? More importantly, why has a research house from the Fitch stable, no less, put out two sets of data, creating confusion, especially when investors expect research groups to do the analyses?  

Second, why couldn’t the calculations be reconciled?  

Third, why do global rating and research outfits think it fit to indulge in such practices in emerging market economies when they dare not do the same in advance economies?  

Since the decision was forced by the fact that the metrics—run-rate Ebitda, sponsor affiliate debt and waterfall structures for infrastructure borrowings—are treated differently by Adani management and CreditSights, the fourth question is: should these be standard, universal calculations? 

Finally, CreditSights’ decision could possibly set up a precedent where more companies would want their classification of financial metrics to take precedence over what is a standard definition. This would only make the job of investors, analysts (and journalists) arduous. The moot point: are investors any the wiser when it comes to understanding how leveraged is the Adani Group?  

​The differences in the calculation of Ebitda, a key measure of profitability, stem from Adani’s inclusion of interest income. In the management’s opinion, as it is in the infrastructure business, it needs to maintain certain cash reserves. Now, the money earned as interest on these reserves should be added back to the total Ebitda of each of the Adani companies. 

CreditSights argues that although interest income is typically added for infrastructure companies, the intention of calculating Ebitda is to understand the core profitability of business without any money earned on cash sitting with the group companies. The research arm said this was the standard approach it used for all the companies under its coverage. “EBITDA by definition is earnings before interest, both interest income and interest expense," it wrote. Why has it then departed from its standard practice and published an alternative calculation alongside its own in this case is a question that can be best answered by the Fitch Group entity. 

The other difference with regards to Ebitda is that Adani management believes a run-rate Ebitda is a better metric to understand each company’s ability to service the loans or debt; its argument is that not considering run-rate Ebitda understates the operating profit and overstates gross and net leverage. Put simply, due to an aggressive acquisition approach of the Adani Group, run-rate profitability is a better indicator of the health of each of the firms instead of considering the Ebitda for the last twelve months.   

CreditSights agrees that for growing companies following last year’s profitability tend to understate Ebitda and overstate leverage. But it argues that this is more conservative for yet-to-be earned income and also because it does not have much visibility into the investments made or planned by the companies. 

It agrees that for several Adani companies, and in particular Adani Green Energy Ltd, the investment strategy is aggressive, and expects this to be largely funded with debt that will not allow for its gross and net leverage to reduce. “From our perspective, Adani’s investment plan provides a visible path for debt to increase on the one hand, but a less transparent path for EBITDA to grow, particularly in the outer years, and, for analysts, this creates a greater dependency on management forecasts," CreditSights writes, explaining why it thinks this is unlike a one-off acquisition where future incomes may be used to reduce leverage. 

CreditSights' reasoning has merit. 

The Adani management also recommended “Sponsor Affiliate Debt" or loans made by promoter and family be excluded for the calculation of the gross and net debt of the individual Adani-owned firms. It told CreditSights that such loans should be treated as partly equity. The reason it gave is that these loans have no repayment period or defined interest and will be paid only after all loans to other lenders are cleared. 

Sponsor Affiliate Debt or promoter loans to Adani Enterprises Ltd were  ₹12,500 crore; ₹7,800 crore to Adani Green Energy Ltd; ₹7,300 crore to Adani Power Ltd and ₹2,300 crore to Adani Transmission Ltd. 

CreditSights, however, maintains that these are convoluted instruments. Most importantly, it considers precisely such promoter loans for the other companies under its coverage (e.g. Bharti Airtel, San Miguel Corp) as debt in its leverage calculations. 

The question then is: if CreditSights is sticking to its original position on all these objections from the Adani management, as it seems to be, going by the second note, then precisely what does CreditSights seek to convey by putting out a follow-up note? 

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