How Hindenburg Is Profiting From Adani's Downfall

The research firm isn't shorting stocks.

How is the 10-person New York-based research firm Hindenburg profiting from the decline they caused in the massive Indian conglomerate known as the Adani Group?

You probably know that if you think a company is going to do well and make a lot of money, then buying its stock is a way to potentially participate in that upside.

But how do you profit from a decline in a company’s fortunes?

Well, the classic way to do it—and the way Hindenburg does it most of the time—is by taking a short position in the company’s stock.

How shorting works is you borrow the stock from another investor and then you sell it immediately. Then when the stock goes down, you buy it back and return it to the investor you borrowed it from (with interest).

Since you bought the stock at a lower price than you sold it for, you make money.

Of course, things won’t always go your way. Instead of going down like you expect it to, a stock could go up—and it could go up a lot.

And in that case, you’d be forced to buy back the stock at a much higher price than you sold it for.

You might be thinking, “short selling sounds like it’s just the opposite of buying stocks the normal way.”

Well, it’s kind of like that but it’s actually much riskier.

With a normal “long” position in a stock, you know your downside—it’s zero. You own a stock; it could go to zero; that’s not great but your downside is capped.

With shorting, your downside if potentially limitless. If you short a stock at $50 per share, later that stock could go up to $500 per share—$5,000 per share, or more. And then you potentially wouldn’t even be able to afford the shares that you need to repay the person you borrowed them from.

As you can see, shorting is a high risk strategy that’s not appropriate for most investors.

But under the right circumstances, it can pay off. If you manage your short positions responsibly and you have some really good research and insights that tell you a stock is going to go down—like Hindenburg might have—then shorting can be a profitable way to bet against a company.

In fact, shorting doesn’t even necessarily have to involve stocks.

You could short other assets, like bonds, as well.

That’s what Hindenburg did in the case of Adani. They didn’t short Adani’s stocks, which they believe are being manipulated by the company. They shorted Adani’s bonds.

The concept is the same: you borrow the bonds from someone; sell them; and then hopefully buy them back at a lower price.

Bonds, which are debt of the company, tend to be less volatile than stocks. But they’re still really sensitive to the health of a company. If Adani struggles to make payments on its bonds, then their price could tumble. 

In addition to shorting— either stocks or bonds— another way to profit from a company’s misfortune is through derivatives.

Derivatives are financial contracts whose value is based on the performance of something else—often another asset (derivatives “derive” their value from this other “thing”).

You have stock options, whose value is based on the price of a stock. Or futures contracts, whose value is tied to the price of a commodity. Or credit default swaps (CDS), whose price is tied to the likelihood that a company will default on its debt.  

Some of these derivatives increase in value when a company struggles.

Put options and CDS tend to rise in value when a company is facing hard times, and so they are ways to profit if you think a company is going to face hard times.

In addition to shorting Adani’s bonds, Hindenburg mentioned that it has purchased derivative contracts as a part of its bet against the company.

In the coming year, we’ll see if Hindenburg is ultimately right about Adani and whether these bets pay off.