Adani, Le Maire & Hindenburg

...and how going around South America is a product of the short sale.

“Sabed que ha traçado la necessidad hazér deste negocio juego” 

(“Please note that this trade became a game out of necessity”)

-Joseph de la Vega, Confusíon de Confusíones, 1688

Hindenburg’s short report on Adani¹ is a very impressive piece of work that will undoubtedly work well for them but - in all likelihood - represents the beginning of an uphill battle from here for profits made shorting the stock of a company in bed with the government. Reflecting on this, I can’t help but recall the truism “You can’t arbitrage the government”.

Mostly, I’m reminded of the story of how the Cape Horn and the Hudson River were discovered.

I am certainly scatterbrained but I can assure you there’s a connection between the two.

If you aren’t aware of it, let me enlighten you - because while I have no view on Adani’s prospects, I do have a great story and piece of history to share…

Isaac Le Maire, Father of the Short Sale

This is where the long and painful story of shorting companies in bed with the government began, in 1602 with the IPO of the Dutch East India Company (the ‘VOC’). Here’s how one of the first instances of short selling on a public market (and likely the first instance of naked short selling, that is, without owning the shares before selling) indirectly was responsible for the discovery of Cape Horn - the route from the Atlantic to the Pacific around the southern tip of South America, the discovery of the Hudson River and (much more directly) the complete ruin of what could have been the richest men to ever live. 

Amsterdam, 1602. Isaac Le Maire, merchant and trader,  YOLO-s his NAV on voyages to the Indies that and generates a 400% ROI in about 6 months. Needless to say, Isaac is wildly bullish on globalization. Isaac amasses significant wealth on both his ventures, both on the goods and by selling vol on his own endeavor. By selling insurance on them to investors, then joining the voyages to ensure those claims won't pay out, he is paid double what his competitors make when he successfully completes a trip.

Soon, however, the government sees how much money these private voyages are making, and it has an idea.

Why not consolidate all of the trading companies going to the Pacific? Thus, the VOC - the 1st publicly traded company, the model for every multi-national conglomerate - is born. 

Isaac is bullish af on the VOC, after all, government backed monopolies are good investments. Not just that but VOC shares would be traded on the Dutch stock market, the most liquid in the world at the time.

Early trading on the Dutch Stock Exchange, aka EuroPrevious Amsterdam

He buys big into the newly formed VOC, purchasing shares pre-IPO roughly equivalent to $1 billion of today’s dollars. He’s the largest single shareholder in the Dutch East India company - arguably the most valuable single company that has ever existed on earth - at one point owning one quarter of all VOC shares outstanding. 

But there’s an issue, like many of our own time’s wealthy folks, he’s prone to clashing with regulators and executives. He is eventually ousted over a disagreement regarding his creative accounting of a voyage (probably an issue with receipts for expenses, classic) and forced into a non-compete agreement with the VOC. For a little bit, he satisfies himself by dominating the trade of grain along the European coast. He’s profitable, but not 400% ROI in 4-6 months kind of profitable. He keeps getting thwarted by the monopoly. The money he could be making in the Indies consistently haunts him. He wants a) that sweet, sweet East Indies money and b) revenge on the directors who banned him from it. He decides to take matters into his own hands using a lot of VOC shares, insider knowledge and his credibility on the exchange.

Under his non-compete his profits, quite frankly, suck compared to what's possible in the pacific. 

Derivatives of revenge

Because of the liquidity of the Dutch market, he realizes he can pull another one of his “double profit” moves. First, he uses the recent rally to unload all his stake in VOC, which begins pushing the price downward. He forms a syndicate to compete with the VOC, and rather than simply borrowing and selling, he takes advantage of the fact that the Dutch stock market at the time had a vast derivatives market and uses forward contracts to bet against the VOC. This way, he doesn’t need to alert the entire world to his plans by making repeated trips to the bookmaker. No share was transferred, and there was no need to pay anything at the time the contract was signed. None of this happened until the contract’s end date. And even then it was not necessary to transfer the share. Traders could opt for a cash settlement, in which case they would offset the price in the contract against the spot price at that moment—the price at which shares were changing hands on Nieuwe Brug.

Isaac had already been in talks with the King of France to set up a French East Indies company, and once he was satisfied with his short position, he used a network to leak out the rumors that the French were looking to compete. Spreading his remaining shares across a handful of henchman, he sends them out onto the stock exchange to raise a panic. To spread rumors that ships had sunk, that the new company was already operating etc. while selling shares to anyone who would buy, at steep discounts, to reinforce the downward momentum of prices. 

It worked. He successfully depressed the share price significantly by the time the first forwards expire, and the first foray into his revenge short is a success. 

But he wants more. Isaac Le Maire does not cover - not just yet. He comes back for more. 

His idea: there has to be another route to the Pacific, a new one that wouldn't be subject to the monopoly. You see, VOC didn’t actually have a monopoly on “all Pacific trade”. It had a monopoly on “all Pacific trade via the Cape of Good Hope & the Strait of Magellan”. 

Now, someone of-the-day might say there is no difference between the two. It’s like having a monopoly on breathing, but only because you have the rights to oxygen. There isn’t really much hope of success in doing it otherwise. Le Maire refuses to accept this is the case.

He funds an expedition headed by his son to find it, expecting the news to push VOC even lower. He would gain both by having the rights to this route by law and his short would profit since VOC would no longer have a monopoly over all routes to the pacific. He approaches the King of France with the idea. 

The “APE” of 1609

The VOC gets wind of this scheme and learns of the fact that Le Maire is the one behind the rumors and price declines. In response, they institute a dividend. Not just any dividend either, a fat dividend. Over the next 18 months, VOC shareholders receive 162.5% of their nominal share value in kind. “We’re doing great, come get some spices”. This creates a headache for Le Maire, because the derivatives market is kind of new and it hasn’t quite been worked out whether he’s on the hook for literal tons of mace and such. Additionally, to counter the rumors of the French company, they fund a new explorer by the name of Hudson. Yeah, that Hudson. He goes out and - predictably, given his namesake - discovers the Hudson river. 

Jacob LeMaire, Isaac’s son, sails for the southern tip of South America - known as Tierra del Fuego. In the early 1600s it was believed this was a continent that extended fully south. Jacob attempted to prove them wrong by discovering a way around it.

The voyage is successful in discovering a new route - Cape Horn - around the southern tip of South America. Jacob sails to the VOC outpost in Java, expecting a hero explorer’s welcome for having discovered this information which, quite literally, changed the world. Instead, upon arriving, he is arrested.  The VOC alleges Jacob has infringed on their patent trade to the spice islands. They refused to recognize and credit him with his discovery. Back home in Amsterdam, the VOC is busy petitioning their buddies in the Government and  the Dutch stock exchange to ban short selling.

Think of the widows and orphans!

The VOC directors explained in their petition to the States of Holland that a group of share traders had conspired to drive down the price of the shares by selling shares, despite having never owned them or borrowed them They had sold many times the value of the shares actually registered on their accounts in the company’s capital books. 

The VOC directors argued that these practices were objectionable; innocent investors had become the unsuspecting victims of the bear traders. Widows and orphans, they wrote, could be harmed by the low share prices – they would be unable to wait until the share price recovered if they were in sudden need of liquidity (an appeal to the Christian morality of the day). 

The directors further argued that the presence of bear traders could discourage people from investing money in the VOC, substantiating the damage done by claiming that one could forecast the well-being of the Dutch Republic using the share price of the VOC, and therefore suspected the involvement of competing foreign interests attempting to harm not just the company but the sovereign itself. If you’re not picking up what I’m putting down at this point, go on to Twitter, search “Adani” and see how many people/bots are equating the share price to the health of the Indian economy. 

Despite ledgers showing that VOC was the only company in which a significant amount of the shares outstanding were sold short, they tried to persuade the States of Holland to take measures, arguing that this was a problem that affected all participants of the market. 

The market participants of the time submitted competing petitions, making the claim that the decline in price had primarily been due to mismanagement and warning of the pitfalls of a short selling ban. In addition to these petitions, a memorandum on the state of the share trade and the VOC in general was sent to Johan van Oldebarnevelt, the most influential Dutch politician of the time. This memo, attributed to Isaac le Maire, is considered to be the first manifestation of shareholder activism in history. Despite all this, short selling was banned by the exchange in 1610. 

This development forced Isaac to cover, bankrupting the syndicate he had formed in order to short shares and fund the journey. Unfortunately, since Le Maire’s syndicate had not simply borrowed shares and sold them short (which meant he could return the borrowed shares at any time) and had rather used forward contracts with a fixed expiration date that neither party could exercise early, he was stuck wearing the entire decline. After short selling was banned, there simply was not enough liquidity for him to buy back his entire position or negotiate new forward contracts. He tried, but ultimately, shares of VOC hit new all time highs. 

It is worth noting here that one of the most famous speculative bubbles in history, the Dutch Tulip mania, peaked just 20 years after Holland banned short selling (although, of course, correlation does not equal causation).

The VOC ended up essentially rewriting history and ascribing the discovery to one of their explorers, Willem Schouten, and begins utilizing the route - increasing their profits even further. Jacob was sent home to Amsterdam empty handed, and unfortunately died during the voyage.

Over the course of about 6 weeks, Isaac Le Maire became the first person to execute a naked short sale on an exchange, the first person to get short squeezed and perhaps the first person to have his position wrecked by government intervention

Le Maire fought the decision of the Dutch government for the next 5 years, eventually securing a judgment in his favor allowing him to trade by the newly discovered route and publish his son’s diaries (therefore giving him credit for the discovery). By then, however, the new trade route had already been put into use by the Dutch West Indies Company and was essentially worthless.

Except my honor…

Le Maire died shortly thereafter. On his tombstone in Egmond aan den Hoef, it is written that he over 30 years he lost everything (except for his honor!) to the tune of 1,500,000 guilders.

A guilder was, in Le Maire’s time, equivalent to 10.6 grams of gold. This means that by Le Maire’s own estimation (presumably he wrote the epitaph) he lost a bit more than a billion US dollars in today’s money - putting him above George Soros’ S&P futures trade and directly below Toshihide Iguchi’s bond trade on the list of largest trading losses ever.

However, in terms of opportunity cost, Le Maire is so far above the likes of Bill Hwang it is astounding. Recall that, at his largest stake, Isaac owned a staggering 25% of the Dutch East Indies Co (the most valuable company of all time, with a humble dividend yield in 1610 of 162.6%). At the peak of its market cap, the VOC (in today’s dollars) was worth upwards of $7 trillion. 

Meaning that if Le Maire had simply done nothing, not challenged a company that was effectively the trading branch of the sovereign government, not sent out a voyage to South America, not been tempted by the superior profits of the Indies versus continental European maritime trade, his fortune would have been worth - just 13 years after his death - about $2 trillion in today’s money. 

But then, we also may not have discovered the Cape of Good Hope or the Hudson River until much later.

It’s easy to get angry at short sellers, but the fact remains that despite Adani’s shadiness being a very “open secret”, MSCI still had them in their index. Not just in their index, but 5% of their index. Won’t someone think of the widows and orphans who own INDA?

When they write-up on something you own, it’s reasonable your first instinct is “screw this guy”. But to that, I say: if you’re convinced by what they write, then you’re just paying a premium to the market to get out of your position with newfound information. If you’re not convinced, well, more fuel for the rally and better prices for you to buy at. Arguably, making the allegation that a company’s financials are fraudulent should have the highest bar for evidence in the short-selling game, because it’s an area where the claim is so severe. The financial statement is kind of a covenant between investors and companies, and to violate its sanctity is a cardinal sin. Throwing around accusations of fraud in financial reporting should absolutely require a preponderance of evidence and not be done off the cuff. Some of the more recent short reports I’ve read seem to think that it’s not a good report if they don’t accuse the company of fraud. Don’t get me wrong: if a company is fraudulent and you have evidence, you should short them, write a report about the fraud, and then release said report (preferably in that order). But you can also write a short report on a company based on things like their valuation, their balance sheet, the competition they face or the quality of their products. Throwing in an accusation of accounting irregularities or fraud just because is a bad look if it’s not very very well founded and really just makes the rest of the report look weak. That’s not the case with this report, and if you if you read Hindenburg’s evidence (and Adani’s odd, meandering 400+ page response) you’ll see that they respected the process and delivered. So the only question that remains is, is this Hindenburg’s VOC short? Are they taking on an entity too large to fail?

While I suspect that Hindenburg will have an equally difficult time being short Adani, due to their connections to government and obvious willingness to play dirty, if anyone deserves to profit from the common knowledge that the company is shady it’s them. They’ve made the proverbial trip around the horn, and they’re delivering the facts: you can go around South America. Whether they get arrested in Java for relaying those facts to us remains to be seen.

1. https://hindenburgresearch.com/adani/