Adani Hindenburg row: Aswath Damodaran, a valuation expert, noted in his most recent blog post that the Adani Group has three times as much debt as it should, indicating that the organisation is overleveraged. He clarified, though, that this is just poor business practise and not a scam. He contends that unless someone subsidises the debt, such as the government, careless bankers, or green bondholders, Adani’s use of debt does not benefit or add value. He explained that lowering the debt load would lower both the cost of capital and the risk of failure.
An Expert’s Perspective
As a member of a family-run organisation, Adani Enterprises Ltd., the higher debt of one Adani company might be offset by lower debt at another. In his blog post, Damodaran—who teaches corporate finance and valuation at NYU’s Stern School of Business—explained the benefits and drawbacks of borrowing as well as the ideal financing mix.
What Aswath Damodaran Explains
According to Damodaran, borrowing money won’t be able to change a company’s operating risk, which is derived from its assets, either current assets or investments made for future growth. By increasing the volatility of the residual claim, or earnings, the borrowing will increase the risk for equity investors. He stated that because failure to make interest or principal payments can lead to bankruptcy and a real loss of equity, the contractual claim that comes with debt can create truncation risk.
Operating Risk vs. Equity Risk
Damodaran emphasised that lowering interest rates on borrowing money cannot, by itself, change the total cost of funding because that cost is based on the risk of the assets. Unless a finger is placed on the scale, giving one source special benefits, the advantages of borrowing at a lower rate will always be counterbalanced by a higher cost for equity investors, leaving the cost of funding unchanged.
The Role of Tax Benefit and Operating Cash Flows in Debt Ratio
Some businesses borrow money for questionable reasons, and “some seem intent on using these questionable reasons,” according to Damodaran. According to him, tax benefits are the main justification for borrowing, and the ideal debt to income ratio rises with the marginal tax rate. He pointed out that operating cash flows are used to pay off debt, so businesses with higher operating cash flows relative to their market value can afford to take on more debt.
The Risky Business of Borrowing
In their zeal for power, Damodaran noted that the insiders, founders, and families of the Adani Group make dysfunctional decisions, borrowing being one of them. He claimed that when control becomes the dominant prerogative for those in charge of the company, they may decide to borrow money rather than issue shares to the public and run the risk of having their control of the company reduced, even if doing so raises funding costs and increases truncation risk.
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