Tuesday, December 22, 2009

We have the text of the standstill agreement just behind this sand dune, or maybe the next one.... by the way this is your collateral.



The first meeting of Dubai officials and the creditors of Dubai World was yesterday. The meeting was somewhat anti-climactic as Dubai has not yet hammered out a few details. Among them are what the standstill request is, the form of the restructuring that the standstill will enable, and nature and conditions of the aid from Abu Dhabi that will itself enable the restructuring and the standstill.

There have been a few humorous touches to this such as the emailed statement which said that further support funds were conditional on the parties reaching a standstill agreement. Message to creditors: unless you agree to not accept interest payments from us we can’t get the funds with which to pay you the interest you have already agreed not to receive.

The reasons that have been given for the delay are that the conditions around the aid are not fully agreed and that the financial structure of Dubai World is complex. Those are indeed true and valid reasons but I think this will be more complicated and take longer than the current creditors would like because of a subtle shift that has gone on in the relative power of the parties involved now that the 12/09 Nakheel Sukuk has been paid off in full.

The holders of that Sukuk were able to force Abu Dhabi to cough up the money for three reasons: 1.) their sukuks had a guarantee from the parent company Dubai World 2.) Dubai World has international assets in jurisdictions that were likely to honor a judgement form a UK court. and 3.) any change to the terms of the Sukuk would require approval of 75% of the Sukuk holders meaning that any person or group that acquired 25% of the bonds could kill any restructuring. That made the Nakheel Sukuk holders very powerful and they used that power to get Abu Dhabi to pay off in full.

The remaining creditors are not so lucky. To understand this it is important to understand the corporate structure of Dubai World. Dubai World is a holding company which has about $5.5 billion in debt and its’ assets are equity stakes in its subsidiaries. Relative to the value of those stakes and their earning power $5.5 billion is a high though not unreasonable level of debt. The subsidiaries themselves however vary widely in their levels of health and debt. Some of them such as DPW, the free zones and the drydocks are probably OK. Others such as Istithmar are in serious trouble and some like Nakheel may well be altogether insolvent depending on how one values non-existent islands in various shapes. I go through the subsidiaries in a previous post.

The trouble is that the only way for creditors of the troubled subsidiaries to get at the assets of the healthy ones is to push the default to the holding company level. The Sukuk that just got paid off had a parent company guarantee so it could do that. The remaining creditors at the subsidiary level don’t have the ability to escalate to the holding company level and thus go after the international assets. The best they can hope for is to make use of the new insolvency regime established in the DIFC Courts to wipe out the equity holders and take over the assets and sell them for what they can bring. Given the uncertainty around how all this would work the remaining creditors are really at the mercy of Dubai.

I think the optimal outcome for all involved would be to liquidate Nakheel and Istithmar pay off the creditors of those entities to the extent possible and then give whatever is left to Dubai World. I don't think that is what will happen however. I think the folks at Dubai World and their masters in the Dubai government don’t want to surrender any equity if they can avoid it. I think they are trying to figure out how to work this so they can force the creditors to take a haircut and leave their equity intact and I think they can do it.

This is because the most problematic subsidiary is Nakheel. Depending on what’s in the covenants they can probably have a look at Istithmar and if there are any other assets where the equity is underwater they can put the equity to the creditor and walk like a US homeowner who is under water mailing the keys to the bank. The assets that are not undewater Dubai keeps.

With regard to Nakheel Dubai World has the creditors right where it wants them. The remaining creditors have no recourse to the parent. The main underlying assets are all in the UAE proper and therefore any non-GCC nationals cannot take title to them anyway. Even if they set up an SPV with proportional equity ownership but 51% GCC national voting power they’re still disadvantaged by a liquidation.

From what I have read it seems to me that a not inconsequential portion of the Nakheel balance sheet is made up of non-existent islands and empty desert. A fire sale liquidation could be embarassing indeed both for Dubai and for the people who lent it the money. In order to prevent a real exploration of what exactly that desert is worth the creditors will take whatever haircut Dubai offers them as long as its more than they think they will get in a liquidation.

Therefore I think the Dubai will go to the wall against the Nakheel creditors... and win.

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