Is there an investment opportunity in PSP Projects shares?

Adani’s journey this year is like a roller coaster ride. Before Hindenburg’s report, group’s market cap was more than Rs 19 lakh crore. Then came the short sellar’s bomb and it fell to Rs 6.8 lakh crore. Where Adani group was accused of stock manipulation, cooking its books and poor corporate governance. It led to investigations against the company by SEBI, Supreme Court. Now the proceeding of investigations has given a boost to share prices. Going ahead, the company needs to raise reputational capital for higher credibility in corporate governance and relations with different stakeholders.

Supreme court appointed a panel to look into the matter and no evidence was found of stock price manipulation. SEBI is investigating violations regarding offshore entities but no fruitful results have been yielded up to now. Besides this, Adani group is looking to raise capital by selling its non-core real estate assets. Amidst positive newflow, Adani stocks are on a roll and the group’s market cap increased to more than Rs 11 Lakh crore.

Business Model
Various businesses of Adani have a huge proportion of fixed assets (High operating leverage). This increases the volatility in profits and cash flows. The group has a presence in the infrastructure and construction business. These sectors have a long gestation period and require continuous investment in the initial stages before it becomes profitable. Adani group has also expanded its claws into cyclical businesses like cement and FMCG. These sectors are prone to volatility. To add the cherry on top, it also has high levels of debt (Rs 2.27 Lakh Crore at the end of FY23).

All these risks are measured by the Beta of a stock. Beta suggest change in stock price due to change in market. It is considered as an output of regressing share price on the market but underlying factors are cyclicality or high price elasticity of the sector, high operating leverage and high financial leverage.

This indicates that Adani would have a high risk on a fundamental level.

Let’s move to life cycle analysis. Some of the group companies have matured but some are at the infant stages of the corporate life cycle. So for a few years, if the external environment remains favorable for Adani then it will sail through as most of its business will mature and become stable. Till then there will be some risks regarding the business model.

At the same time, the group is looking to modernize itself. It has data centers, setting up AI labs and bought a 5g spectrum. All this would help in seamless coordination among different entities and transition of the group towards Industry 4.0.

Corporate Warfare
Adani’s rise has been stratospheric. This brought the company on global radar and it has become prone to another risk. Risk of corporate warfare. If a company has potential but not living up to it then there is a threat of hostile takeover but if the company keeps on growing then everyone tries to take byte from the pie. This has happened time and again in history with various businessmen across the world be it Ambani in the 1980s, or Carnegie and Rockefeller in the US. So being on the global radar has increased risk for Adani.

Adani Group is a holding firm and it should be seen as a portfolio of companies or different projects. Risk related to any new project should not be seen in isolation but on a marginal level, meaning how much it will increase the risk of the whole Adani group. After a certain level of risk, concerns start to emerge about the viability of the group. At that point creditors would be hesitant in giving capital, suppliers would ask for quicker payments and the company may find difficulty in winning bids or contracts for projects.

Adani has an image of efficient execution but for maintaining such execution it is important to manage risk and portray sound corporate governance.

As the company grows, corporate governance becomes more difficult because managing a huge diversified group is very complex. So Adani needs to focus on enhancing corporate governance credibility.

Reputational Capital
Basically, the company needs to increase its reputational capital. Reputational capital is the cumulative sum of a firm’s culture, brand value and relations with different stakeholders (including general public).

Adani is focusing on this but that can be further enhanced by adding credible names to its board. Like giving board seat to Aswath Damodran, raising capital from activist investors such as Carl Icahn or Bill Ackman and giving them seats in the board.

All this will give a huge boost to the company’s reputational capital. This will increase the threshold at which the group’s marginal project would become risky (Latest project that would question the viability of whole group portfolio). This will allow the company to raise capital, win projects more easily and continue to execute effectively.

Company risk regarding sectors and capital structure is measured by Beta. Risks pertaining to uncertainty in cash flows are measured by calculating the present value of cash flows under different scenarios. Some with favorable outcomes having high positive cash flows and others with non-favorable ones where cash flows might be very low or negative. Then probabilities are assigned to different scenarios and the expected present value is calculated.

Increasing reputational capital will increase the probabilities of high cash flow scenarios which will lead to higher expected present value for the company. Which in turn will increase the value of a group on a fundamental level.