Thursday, December 31, 2009

Happy New Year!



The year may have changed but human nature has not and therefore there will be plenty to write about in 2010 as well. Thanks you friend reader for your unseen but everfelt presence.

Tuesday, December 29, 2009

Remember when Dr. Omar had a garage full of Ferraris just for working for the government? Man this fraud decree blows.




Sheikh Mohammed bin Rashid Al Maktoum laid aside his title of Vice President of the United Arab Emirates and picked up his more familiar mantle as Ruler of Dubai today and issued a decree. This decree concerns the penalties for graft and how one might avoid them. I don’t have a copy of it myself as of yet so I have only the press release and the newspaper articles about it which seem to generally be a rewording of the press release.

The law increases the penalties for fraudulently seizing public or private funds to prison terms of between 5 and 20 years. Lest this seem a little too draconian the law also stipulates that anyone who gives back the money signs a “settlement agreement with their debtors,” (I’m sure they mean creditors but I wanted to get the quote correct.) At the same time Dubai announced a partnership with AT Kearney to create new policy tools to attract foreign direct investment. Unsurprisingly all the people who work for Sheikh Mohammed think its a great idea.

This is all very interesting. The press release says that this is designed to “eradicate all forms of fraud thus enhancing the Emirates position as a leading global business hub,” and also that it “facilitates the redemption of funds fraudulently seized from public or private money.” I think the latter goal may be more important than the former.

Back when I was trying to figure out how to legally invest in Saudi equities as a non-GCC national or institution one of the laws that got in the way was something called the anti-coverup rule. This was a law that essentially criminalized Saudi nationals assisting foreign investment into the kingdom by holding shares in their name as nominees for non-Saudis. The penalty when I first got to the Kingdom was 5 years in prison and a 500,000 SAR fine. Let me assure you, a five star hotel in Riyadh is no picnic, prison? Forget it.

The thing is, despite this draconian penalty people did this all the time and if you were say... running the middle eastern equity business for a large international bank it was really annoying. The clients would come in and say, “why can’t you guys help me invest in Saudi? Bank XYZ in Dubai does it, Bank ABC in Qatar does it. But I don’t like having to take the credit of banks ABC or XYZ, I want to take your credit.” Then I would have to patiently explain that as we were an international firm and governed by multiple regulators we were in fact, unlike our local competition, obliged to comply with the law and indeed our compliance with the law was what made us more creditworthy than ABC and XYZ in the first place.

Of course all kinds of foreign investment was going on in Saudi Arabia through these nominee accounts. The Saudi Authorities knew it, it’s impossible to keep secrets in that part of the world, but the legal and surveillance tools at their disposal were unequal to the task. Thus no one was ever prosecuted under the anti-coverup rule but in 2007 the penalty was increased from five to seven years in prison and the fine raised to 700,000 SAR. Why did they do this? They did it to raise the expected value of the cost of breaking the rule. They knew that the financial community knew that the probability of the rule being enforced was minimal so they raised the punishment. The increase in jail sentences for fraud in Dubai strikes me as a similar effort.

The increased sentences are not the interesting part of this decree. The interesting part is the amnesty for those who pay back the money or reach a “settlement agreement.” So basically you can go to prison for a mighty long time if you fraudulently assign yourself funds from “public or private sources,” but if you return the funds or agree to a partial return of the funds you are scott free. I think this implies two things. First is that it is likely that when the bankruptcy... errr... restructuring... experts started going over the books of Dubai Holding, Dubai World, ICD, and DIFC they found fairly striking discrepancies between the debts owed and the assets owned and probably also noticed that the CEOs kept showing up in Ferraris.

As I have written in my pieces on Dr. Omar and Naser Nabulsi a little self dealing was not uncommon in Dubai generally as long as it was not egregious. My guess is that if asset prices had continued to go skyward (pardon the pun) no one would be asking any questions about this. As it stands the discrepancies between the asset and liability sides of the balance sheets of Dubai Inc are highly inconvenient and probably substantial. Ordinarily Sheikh Mohammed would privately reprimand his lieutenants and move forward but now he has Abu Dhabi breathing down his neck, and _he needs the money_.

Trouble is Sheikh Mohammed’s lieutenants were no fools and a lot of that money has probably found its way into numbered accounts in Switzerland, Singapore and Lebanon where it will never be heard from again. Unless the account holders have a really good reason to bring it back. Or 20 years worth of good reasons. My guess is that this is a warning being issued to people who have taken a lot of money from Dubai Inc, many of whom probably thought they were entitled to do so at the time, that Sheikh Mohammed fully intends to get that money back so that he can pay off Abu Dhabi.

While this may be bad news for some of Sheikh Mohammed’s former lieutenants guess who it’s good news for: the brothers Abdullah. While it increases the penalties for fraudulent seizure of private funds it grants amnesty to anyone who signs a “settlement agreement.” The disgraced CEO of Damas Tawhid Abdullah signed just such an agreement with the management of Damas which pledged 350 million shares worth about $50 million in the event that he doesn’t pay back the $165 million he took from the company within 18 months. Why would the shareholders agree to such a settlement which potentially locks in a $110 million loss? Well they were represented by the MD Tawfiq Abduallah, the brother of disgraced CEO. That’s right folks, the man who perpetrated the fraud and the MD at the time of settlement agreement are brothers who both owned 17% of the shares. Outstanding.

If the brothers Abdullah are allowed to get away clean from looting Damas Dubai is going to need a lot more than a few million dollars worth of consulting from AT Kearny to recover from the blow to its' credibility.

Monday, December 28, 2009

Gentlemen, this stock exchange thing is the best idea we've had yet! Someone get Sheikh Mo on the phone and see if he wants one.




In the fall of 2005 I attended a financial services conference in Dubai. The most relevant session I attended had to do with the future of the exchange architecture in Dubai. There were representatives from the DIFX and the DFM, the regulators and some local and international firms. Each participant gave a short and glowing talk about the future of GCC exchanges and those in Dubai in particular. Then there was an opportunity for those in the audience to ask questions.

One of the first questioners was a British man in his 50s or 60s. I remember thinking that he looked like an ageing hippie. In my memory he is wearing a flannel shirt and overalls, has a long white beard and a bandana but that is almost certainly not the case because you would have to be out of your mind to walk around Dubai in flannel. As much as his clothing may have stood out from the general audience of besuited bankers and Arabs in national dress, his mindset differed even more. He asked the assembled panellists how they thought any exchange could succeed when everyone knew that successful financial markets require a middle class and that in Dubai there was no middle class whatsoever.

The way he asked the question you might guess that he was one of those perpetual, and at the time frustrated, Dubai naysayers who had already decided the outcome but needed to ask the question out loud in order to print it. There were a lot of people who when they went to Dubai and saw the way the Emiratis lived and then spent time with the Indian community and noted the discrepancies felt strongly about issues of social justice within Dubai. It seemed to me that this was the journalist grandstanding and speaking truth to power at least that was how he saw it.

The men on the dais saw it differently. Who was this man with his bushy white beard and ridiculous outfit to question the Dubai dream that was in the making? It was a little embarrassing for someone to have sneaked into the Madinat Jumeriah and try to rain on the parade of the international financial system with this reference to the uncomfortable subject of income inequality in the Arab world. Luckily it was not hard for the men on the dais to figure out what the script was. This was 2005 when the prospect of doing business with a Dubai government entity made you reach for your wallet rather than your gun and everyone knew what the Dubai Inc. answer to this was: “of course there is a vibrant middle class in Dubai and the great project of making Dubai a financial center on par with London and Singapore is moving forward at full speed.”

Sitting in the audience I thought the whole exchange was preposterous. While they disagreed over whether there was a vibrant middle class in Dubai, and here I think the balance of the evidence would weigh in favour of the journalist, they both agreed a false premise. They both assumed that a thriving middle class was necessary for the Emirati capital markets to develop. In my opinion they had it backwards, without developing the capital markets in Dubai there could be no middle class. Why is that? I’ll get to that but first a little history:

OK folks, pop quiz question one: What was the first IPO in history?

Answer: the first IPO was for the Dutch East India Company (known by its Dutch acronym VOC) in 1604. Voyages were so expensive and so risky that the risk had to be shared. The Dutch took this one step further by scaling up the financing from individual voyages to an entire company organized for the purpose and by offering the shares generally the risk was spread as widely as possible. That share sale led to the organization in Amsterdam of the first regular stock exchange in history. Incidentally this was one of the best trades in the history of the world. The VOC paid 18% dividends on average for 200 years.

Pop quiz question two: which country in 2008 had a similar income distribution to that of the Netherlands in 1604, Dubai or the United Kingdom?

Answer: Dubai.

In order to understand how important capital market development is to Dubai and the Arab world generally it’s important to understand how their economies function today. Most people assume that the concentration of wealth in the Arab world is the result of the fact that there is not too much distinction between the royal families and the state and so in most countries the royal family effectively controls the oil wealth and this makes them fabulously wealthy. This is true but it is only part of the story.

The other part of the story is the extent to which the remaining economy is often controlled by a handful of merchant families. In Saudi Arabia ten merchant families control 24% of the non-oil economy between them, the top 25 probably control well over half. There are many reasons for this.

The most obvious is that some families receive royal patronage which gives them an advantage over other families. You have to remember that being an Arab monarch is not the same thing as being a dictator in the western sense. Their power comes much more from balancing various power centers against one another within the country rather than from the barrel of a gun. They generally follow a divide and rule strategy playing the religious establishment off against the business elite and the business elites against one another.

This sort of thing went on in western Europe during the consolidation of monarchical power there as well. Remember Queen Elizabeth granted Sir Walter Raleigh a monopoly on the importation of wine, or vast tracts of land in the Americas. The same is true in the Arab world today. Arab monarchs often give gifts of land to favoured allies, this is why there are so few public parks in Arab cities, the kings tend to give the land away sometimes with disastrous consequences as in Jeddah recently. They can also grant or support monopolies on the importation of certain items. Awarding government contracts to favoured allies is also a source of wealth as is putting people in charge of government enterprises with opportunities for self enrichment. One need only look at the Byzantine structure of Dubai Inc. to see the hand of someone who wanted to reward many people with lucrative posts.

This is not to say that the only road to wealth is government favour. Ability is also a factor and the poor state of education in the Arab world means that a little education or a lot of ingenuity can go a long way because there is relatively little competition in local labor markets. The Bin Laden fortune was built on government contracts but the first contract was won with legitimate skill. The poor quality of general education in the Arab world perpetuates the concentration of wealth because it tends to stay in the hands of those who are wealthy and wise enough to send their children to school abroad or to the few quality international schools in the region.

The final reason for the concentration of wealth is access to capital. If you have a good idea for a business you need to have some way to fund it. Generally there are three ways to fund new business ventures: retained earnings, debt, and equity.

A great many of the businesses in the middle east are funded with retained earnings. This why you see so many family conglomerates. Aside from the fact that commercial ventures also serve to cement family bonds often a business produces more earnings that can profitably be reinvested in that business. Often when this happens the family will use those earnings to start another business venture sometimes in a similar line but often in a completely different field as a means of diversification. Of course who as access to retained earnings as a source of financing? Those who already own businesses! Thus this is another way in which the distribution of wealth is self reinforcing.

Another way in which one might fund a business is through debt, most commonly in the Arab world through bank loans. There are a few factors which conspire to make this not particularly effective. One is the nature of how decisions are made with bank loans, sure a lot of analysis is done to determine the creditworthiness of the borrower but at the end of the day the decision of whether to lend is made by one man or a at best a small committee. Those people can be influenced by the royal family or by long relationships with the potential borrowers so once again access to bank capital favors those who are already part of the system. There is another issue, peculiar to the Arab world, which makes it difficult to use bank capital to finance new ventures and that is that in Sharia courts it is not always so easy to take possession of collateral in the event of default. This means that a bank is unlikely to lend to someone that does not already have a reputation for paying back loans. Of course you can only have such a reputation if you are already in business so issues with recovery in insolvency also serve to sustain the concentration of wealth.

So that leaves equity markets as a source of capital for Arab entrepreneurs. In theory public and private equity markets together are an ideal source of capital especially in the Arab/Islamic world. Equity markets enable the investor to receive significant upside which gives a better return to the investor given the higher risks one faces in emerging markets that part of the world. Private equity is like a partnership and is therefore Sharia compliant in a way that many debt structures are not. As a result of these things the universe of private equity investors in the region is much greater than the number of potential bank lenders, not everyone can be a bank but anyone can invest in equity.

Thus you can think of equity markets as a sort of “democracy of capital.” At a bank a single loan officer can make a dictatorial decision as to whether to fund your idea o not and your connections and your collateral are as or more important to him than the viability of the idea. Additionally in most GCC countries you can count the number of banks on your fingers. The number of private equity investors number in the hundreds, or even thousands and the number of public equity investors in the millions. These investors become partners in the business and so are more concerned with the viability of the idea than the value of any collateral and they vote with their money. By aggregating up each individuals willingness to take risks and enabling them to share the risks equity markets should more efficiently channel money to the most productive enterprises. One can never completely eliminate the role of relationships and connections from the Arab world but equity markets, by their democratic nature minimize their influence and maximize the importance of the idea itself.

This is why effective equity markets are ABSOLUTELY ESSENTIAL to increasing productivity and employment and minimizing income inequality in the Arab and Muslim world. This is why I am so up in arms over the fraud at Damas. But the fraud at Damas is only one of many deep flaws in middle eastern equirty markets and I will illustrate more of them in subsequent posts. But I want to do more than simply curse the darkness, I want to look for what lights there are. There have been advances in recent years in Dubai, and in Saudi Arabia. Who knows what fruit the DIFX/DFM merger will bear. Perhaps the problems of debt and fraud in Dubai are beyond the powers of capital markets and reform to save them. But then again, perhaps not.

Sunday, December 27, 2009

Some Contact Info

There have been some requests for an email address at which people can contact me directly so here goes: ken@wallstwtf.com

Fire away.

Which side am I on?

The recent Dubai debt crisis has produced two distinct types of analysts: the Dubai Schadenfreude Corps as well as the Dubai Cheerleading Squad. I’d like to try to split the difference. I’d say that generally I think the Schadenfreude Corps is inclined to go a little overboard. Like it or not the borrowed money that cannot be repaid did go into building world class infrastructure that will be virtually impossible for international creditors to repossess and would be of dubious value even if they did. If you have been to Dubai and the other major GCC commercial centers there is a substantial qualitative difference between Dubai and the other cities.

At the same time the arguments of Dubai Cheerleading Squad are equally not compelling. True the infrastructure of Dubai is excellent but infrastructure is a capital intensive business and given that Dubai is likely to face a significant disadvantage with regard to the cost of capital vis a vis its’ GCC rivals for the foreseeable future this advantage is not sustainable. The other arguments about the entrepreneurial spirit of Dubai hold some water but overlook the fact that most of the entrepreneurial spirit that has not relied on the largesse of the Government of Dubai has been from foreigners. For foreign entrepreneurs to succeed in Dubai there needs to be access to capital and faith in the legal protections of the government or at least protection from outright expropriation. This is why I have, and will continue, to write so much on the theft from the Damas shareholders by an Emirati merchant family with zero action by the authorities. This fact, far more than the crushing debts, is what stands to undermine Dubai long term.

Looking back over what I have written thus far I think it might be a little too easy to paint me into the camp of the Schadenfreude Corps. I don’t consider myself that way. I am deeply saddened by the situation of Dubai. Love it or hate it Dubai was on a path to becoming the Arab New York: a place where people from all over the Arab world could come to seek their fortunes and reinvent themselves. The Arab world is in desperate need of this sort of thing and if Dubai truly is crushed under the weight of this crisis the Arab world as a whole will suffer. Abu Dhabi or Doha may well succeed Dubai as the financial/cosmopolitan capital of the GCC (I'd say Mecca has a lock on the cultural capital and Riyadh the political capital) but this is not yet certain and if Dubai does come apart there will be a lag before somewhere else is able to be what Dubai is.

In my opinion for Dubai to survive the current crisis and recover the area on which it must focus is efficiency of its’ financial system and the Rule of Law. My next few posts will focus on these topics interspersed with analysis of the ongoing crisis.

Damas Jewellery would like to announce our most recent creation, we call it "The Foreign Investor"



In honor of the perfection of thier share pledge, Damas announced today that it was issuing a limited issue luxury item: a human skull encrusted with 10,000 cubic zirconia.

How much would you expect to pay for this? $500 million? $1 billion? No! This outstanding offer is avaliable to all foreign investors for a mere $270 million contribution to the Abdullah Brothers Dubai Real Estate Support Fund (formerly known as shares of Damas.) This outstanding combination of shares and skull today has a retail value (on NasdaqDubai) of $43 million for a loss of only 84%!!

But wait! There's more! As of today, with the perfection of the Abduallah Brothers share pledge you can recieve 350million shares back in the event that the company cannot recover the $165 million that has gone missing from company funds. Those shares have a value of $56 million!! Bringing your loss to only 63%!

But that's not all, once the Abduallah brothers have turned over their 35% ownership in the company back to the Treasury your ownership stake will go from 47% to over 70%. Since foreign investors are only allowed to own 49% of an Emirati company, this is a violation of Emirati Law. Thus you will also get a guided tour of the Emirati legal system. This is sure to be fascinating and lengthy!! Outstanding!!

And you thought you were just financing a jewellery company!

Congratualtions! Tell your friends! Dubai has tens of billions of debt that it needs to equitize, so there's plenty more where this came from!

Thursday, December 24, 2009

Wednesday, December 23, 2009

Dear foreign shareholders, I'd like to present you with these additional shares in Damas, they entitle you to hand over its assets to the bondholders.




Damas released today the share of local and foreign ownership and it turns out that except for the 51% owned by the brothers Abdulla virtually the entire company is owned by non-Emirati nationals. This makes the pledge of the shares of the Brothers Abdullah representing 35% of the outstanding shares impractical. This pledge was made in the event that the brothers Abduallah were unable to repay the $165 million that has found its way into the brothers' Dubai real estate portfolio. If they are given back to the company the reduction of the shares outstanding would put the foreign ownership above 49% and violate the laws of the UAE. It is interesting to note that the folks who got shafted in this were all international investors. Gentlemen, this is why it's called an emerging market.

The company itself requires a debt standstill and restructuring which may or may not be forthcoming. Looks like we may get a test of a DIFC insolvency being enforced in the UAE courts well before Dubai World comes to a head.

Still no action on the part of the authorities.

Well not exactly, the Dubai police did jail a Philipino man for stealing $1000 from a charity box. He should have aimed higher.

The Times they are Exchangin'

Today it was announced that the DFM the Dubai local stock market will acquire NASDAQ Dubai (which for convenience and nostalgia I will call by its former name the DIFX) for $121 million. The current owners of the DIFX are NASDAQ OMX (33.3%) and Bourse Dubai (66.7%) bourse Dubai is also the parent of the DFM of which it owns 80%. So in essence Bourse Dubai is consolidating its’ Dubai subsidiaries into a single entity and instead of owning 33% of the DIFX, NASDAQ now owns 1% of the DFM. The valuation of $121 million is only slightly below the $150 million valuation implied when it paid $50 million in cash for its 33% back in 2007. So NASDAQ does take a small write down. Interestingly the transaction is structured such that the portion that goes to NASDAQ is all shares and to Bourse Dubai is all cash.

So what is this all about? Does it bring the DFM and the DIFX closer together? Well today both the DFM and the DIFX are controlled by the same holding company Bourse Dubai which owns 80% of the DFM and 66.6% of the DIFX. Who is the CEO of Bourse Dubai? Essa Kazim. Who is the Chairman of the DFM? Essa Kazim. So both before and after the transaction both the DFM and the DIFX are owned by Dubai entities whose leadership not only share the same goals but in fact are the same person. All that is really happening from the Dubai perspective is that Bourse Dubai is consolidating its’ Dubai assets in a single subsidiary rather in two separate ones though they both continue to have separate trading platforms operational structures and operate in different jurisdictions.

It might be better to think of this as NASDAQ selling rather than as the DFM buying. The DIFX, though it pains me to say it, has not been a success. Rebranding it as NASDAQ Dubai has not helped. Listing derivatives has not helped. These days, being associated with a Dubai Government Related Entity is a liability, not an asset. This transaction enables NASDAQ to go from being a 33% partner in the DIFX to a 1% passive shareholder in the DFM. It has to take a trivial writedown to get it. The terms of the deal enable the DIFX to continue to use the NASDAQ Dubai brand, my guess is that this is not a permanent state of affairs. If NASDAQ Dubai is able to retract its’ brand it will be able to draw to a close an extremely successful set of transactions with Dubai Inc.

At this point it is helpful to remember how we got into this position. In the first half of this decade cross border exchange mergers were all the rage. Several European exchanges joined together to form the Euronext which then merged with the New York Stock Exchange in 2006. Once the NYSE had done the Euronext deal NASDAQ did not want to be left behind and started looking for a European partner. In so doing it made a strategic mistake and took a run at the London Stock Exchange and failed. This left it with a 33% stake in the LSE that it could neither convert into control nor could it sell as it was simply too large to dispose of without crushing the price. At the same time Bourse Dubai was buying up shares in the OMX, a Swedish exchange and more importantly a technology provider to a great many exchanges. Qatar was, as usual, reading day old copies of Gulf News to come up with it’s strategic plan and was also buying up shares in OMX. NASDAQ was also interested and it looked as though a tough bidding war could erupt.

Instead what happened was a complex deal between NASDAQ and Bourse Dubai. Bourse Dubai bought OMX for $4.1 billion in cash and then sold it to NASDAQ for $1.7 billion in cash plus a 28% stake in NASDAQ. Bourse Dubai also agreed to buy the 28% of the LSE from NASDAQ LSE for 14.4GBP per share or about $2.2 billion. NASDAQ also agreed to pay $50 investment for 33% of the DIFX. When the Dubai officials who had negotiated this returned to Dubai there was a sense of triumph among them. Dubai was now a major shareholder in both NASDAQ and the LSE. The NASDAQ had validated the Dubai brand by lending its own name to the DIFX. Emiratis would be represented on the boards of some of the oldest stock exchanges in the world and the QIA were left with their day old copies of Gulf News to plan their next moves. (Which they did by taking a stake in the LSE.)

Well how did it all work out? Well, sure enough NASDAQ is selling out of its $50 million investment in the DIFX for $40 million in shares of the DFM, a $10 million loss. On the other hand it did acquire OMX in its entirety and thereby gained a foothold in Europe and an important exchange technology supplier. It also was able to unload its’ entire LSE stake it used the money to pay down debt and buy back shares which improved its position for the shocks to come in 2008. Gentlemen, high fives all around!!

How did it work out for Bourse Dubai? Well, their 28% stake in NASDAQ which cost them $2.4 billion ($4.1 billion for the OMX shares less $1.7 they got in cash from NASDAQ) is now worth $1.2 billion, a loss of $1.2 billion. Of their LSE stake they have sold 7% leaving them with 21% that would have cost them $1.6 billion is now worth about $700 million, a loss of $900 million. After the deal was announced, LSE shares rallied for some time eventually getting to around 20GBP. Lets assume that when they sold the other 7% they did a good job and earned an additional $100 million meaning their total loss on the LSE stake was $800 million. So on these transactions with NASDAQ Bourse Dubai has lost a total of $2 billion. Ummm... Let's just say it looks like a great trade for the NASDAQ and leave it at that.

So where did Dubai get all the money they needed to finance their entry into the world of international exchange ownership? Where they get all their money: they borrowed it. The next question to ask is how much and when is it due? Hmmmm... According to Morgan Stanley, they borrowed $2.5 billion and its’ due in February of 2010. Whoa! Hold on a second, so back when they borrowed this money their stake in NASDAQ was worth $2.4 billion and their stake in the LSE was worth $1.6 billion or $4 billion. Now, however, those stakes are worth $1.2 billion and $700 million respectively for a combined $1.9 billion. Uh, oh. $1.9 billion is less than the $2.5 billion they borrowed. Sounds like it might be hard to roll that loan forward. Gentlemen, it is time to put on the thinking caps.

What about other assets? Bourse Dubai owns 80% of the DFM, that’s worth $3.2 billion right there, why not pledge that as collateral to extend the loan. Hmmm.... good thought but there are a few problems with that. You can’t enforce a pledge over shares in the UAE and in any case, I’m not sure if you’ve noticed but there have been some articles lately in the press about the dangers of lending money to Dubai Government Related Entities secured by assets inside Dubai....

But wait, what about all that cash on the DFM balance sheet? There’s gotta be $800 million there at least. Yes, but if we pay it out as a dividend we have to share it with the 20% of people who are not the parent company. We’ll probably have to do something like that sooner or later, but it would be better if we could just move the cash straight upward.

Wait a minute, doesn’t the parent company own the DIFX? Why don’t we offer to buy that? It was last valued around $150 million, lets’ call it $120 million so that its’ not egregious. Let’s structure it in such a way that we can pay shares to NASDAQ and cash to the parent. Dubai still controls the whole show, Essa Kazim is still in charge but now we have shipped $80 million in cash upstairs and have avoided having to share any of the transferred cash with the other shareholders. Bingo, we have a winner.

Sound familiar? That’s the deal they struck today.

Most of the above is speculation. I don’t know whether NASDAQ is seeking to minimize its exposure to Dubai though it would be rational. I don’t know whether the financial position of Bourse Dubai would justify this method of sending cash to the parent around the shareholders. I know the losses are real but don’t know whether Bourse Dubai can call on the parent company or DFSF for funds and so this was unnecessary. Though they are speculations I think they are plausible explanations for today’s events. I think that in reality, this is not really about NASDAQ, and it’s not really about the debt issues at Bourse Dubai. It’s about the victory of one political faction over another within in Dubai, and potentially the rebirth of the city, but that is a story for another day.

Tuesday, December 22, 2009

DFM takes NASDAQ Dubai out for $121 million in cash and stock.

Oh boy, where to begin...

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.

Saturday, December 19, 2009

Transparency in Dubai, Part II. The Great Dubai Jewellery Heist of 2009



I apologize dear readers for the suspense in which I have been keeping you these past few days. I hope this post makes up for it at least a little. If you’re just logging in you might want to read the backstory. I would also like to apologize for the length.

As I was saying a story has come out that deals a blow, perhaps a lethal one, to the idea that the rule of law has any writ whatsoever inside the DIFC and therefore the creditors of Dubai World may not be able to sleep that easily despite Abu Dhabi’s billions which will keep Nakheel afloat until May.

Our story begins in the summer of 2008. In July of that year a Dubai based jewellery retailer called Damas conducted an IPO on the DIFX which has since been rebranded NASDAQ Dubai. Damas is a well known company in the region and you can see their stores in many of the malls in the region. Started as a family business in 1907, it had spread throughout the Gulf and was expanding into new jewellery markets as well. As you might imagine jewellery is a good business in the gulf and the competition for this IPO was fierce and my firm was in that competition. Ultimately we lost out to Credit Suisse, which as we will see, was probably for the best.

The IPO was for 270,000,000 shares representing 27% of the company for $1 apiece raising $235 million for the company and $35 million for a selling shareholder. Damas was a UAE company and therefore subject to a limitation on foreign ownership of a maximum of 49%. This was solved with a trust structure, the fact that only 27% of the company was being sold and the fact that three brothers from the original founding family would retain 17% each of the outstanding shares or 51%.

In a lot of ways this transaction is emblematic of the reasons the DIFX was created. A business owned by a local merchant family was able to avoid the local stock market where IPO valuations were determined by the government rather than an auction process (the subject for yet another post.) They were able to tap both local and international capital markets at the same time. In addition to local investors the Damas shareholder register includes names like Morgan Stanley Asset Management, T. Rowe Price, ING Bank, that is real money accounts from the West. The IPO enabled an outside investor to exit thus encouraging other private equity investments in the region and it supplied capital to Damas to finance its’ expansion and therefore create private sector employment in the region. It seems as though the DIFC and the DIFX are providing a valuable service to both Dubai and the wider region.

As with all offerings the prospectus described the use of proceeds and those were: “to fund its store network expansion, make further investments in its manufacturing platform, repay indebtedness, fund its ordinary working capital requirements, and for general corporate purposes.” So subscribers to the IPO believe they are financing the expansion of retail jewellery manufacture and distribution as well as everyone in Dubai’s favourite activity: debt reduction. Well, sadly, it was not to be.

On October 13th of this year the CEO of Damas Tawhid Abdullah stepped down. The reason given to the press was that he had been involved in some unauthorized transactions. Abduallah denied he had been involved but did not provide any further explanation as to his removal. Unauthorized transactions? Hmmm... and what might those have been? Well the first story to come out was that Damas was concerned about the effects on jewellery demand of higher gold prices and decided to diversify away from its core business. Sounds kind of reasonable, what were these investments. Well, a full list isn’t really available to the public or the shareholders but it would seem the investments were made into Dubai real estate and hotels as well as a shopping mall in Turkey.

Ahhh.... so how big were these investments and how are they doing? These transactions amount to $165 million or well over half the IPO proceeds and as mentioned it’s not known precisely what they are but the ones that are known seem to have declined in value. Not good news for the shareholders. They thought they were buying shares in a going concern but instead seem to have bought the top of the Dubai real estate market.

Well this is the DIFC not Dubai proper so what happened when this was announced? Well, as mentioned Tawhid Abdullah was removed as CEO, all well and good. He was replaced by the deputy CEO Hisham Ashour who retained PWC to look into the unauthorized transactions and announced that he was shutting down some unprofitable subsidiaries. A gentleman by the name of Tawfique Abduallah was made Managing Director responsible for day to day operations. All for the best, some suspicious transactions go on that seem to harm the shareholders and the CEO is removed. Sounds like perhaps a step forward for corporate governance in the region.

But wait a minute, it’s kind of funny how similar the names of the old CEO and the new MD are. Tawhid Abdullah and Tawfique Abdullah? Well they should be similar... they’re brothers. So $165 million of IPO proceeds are misspent and the CEO is removed but replaced by his brother? Yep.

Then to reassure the investors the company signs an agreement with the brothers to repay the $165 million by liquidating the assets and paying the company back. In the event that the brothers fail in their pledge they will hand over 350 million shares of the company. Not exactly international best practice but perhaps no harm no foul?

Hmmm... wait a minute! Hold the phone! If these assets were purchased with company funds doesn’t the company already own the assets? Why would the company need to sign an agreement with the brothers at all? Could it be that these asset purchases were made with company funds but in the name of the brothers Abdullah? This is a complicated matter but it can be described in very simple terms familiar to the general reader: “outright theft.”

But don’t worry shareholders the Abdullah brothers will pay you back. And if they don’t get you back your $165 million they’ve pledged to surrender 350 million shares of stock to you. Hmmm.... what are those shares worth? Well at Thursday’s closing price: $52 million so in the event that you are not paid back the brothers Abdullah will get away with a mere $113 million of your money. But wait a minute, is it even possible for international investors to take possession of 35% more of the company given that it has to be owned 51% by Emirati nationals? Time will tell.

Had I not worked tirelessly for years working on building up the DIFC I would think the story up to now was completely hilarious but it gets better. A lot better.

One of the investments made by Damas was an $80 million loan to a private equity firm named Dubai Ventures at a rate of 6%. Dubai Ventures never actually paid any of this interest it just added the interest to the principal so that Damas was owed $84 million. Over the summer Damas converted this loan into equity stake a Dubai Ventures investment vehicle over which Dubai Ventures had discretionary management powers. Once Mr. Abdullah resigned as CEO and Mr. Abdullah took over as MD, PWC made a phone call to Dubai Ventures and asked into what precisely they had invested their $84 million. The answer is quite a surprise.

I can only imagine this phone call would have sounded like a cross between an Abbot and Costello Routine and an automated voice mail.
DV: “Hello, Dubai Ventures.”
PWC: “Hello, I’m from PWC calling on behalf of Damas.”
DV: “Great, you guys are a big investor and a valued client. How can I help you?”
PWC: “Well it seems that we have $84 million in an investment vehicle that you guys manage and I’m calling to find out in what precisely we are invested in.”
DV: “Damas”
PWC: “Yes, I represent Damas. But what are we invested in.”
DV: “Damas.”
PWC: “Exactly but what are we invested in?”
DV: “I told you, Damas.”
PWC: “No, that’s who I am but what am I invested in?”
DV: “Damas is what you’re invested in.”
PWC: “I’m invested in Damas? But I am Damas.”
DV: “Exactly.”
PWC: “Wait a minute, what is the whole point of diversifying away from our main business by investing in private equity which then turns around and invests in my own publicly traded shares?”
DV: “Isn’t it obvious? If not, I think it’s a question for the brothers Abdullah.”
PWC: “Oh I see, I think we have a lot of questions for them. So in any case can you give me a valuation on the shares?”
DV: “Sure, let me check..... ah here it is: $20 million.”
PWC: “I’m sure there must be some mistake. We invested $84 million with you.”
DV: “That may be but what’s in your account is $20 million dollars worth of your own shares.”
PWC: “Surely there is some mistake, what else can you tell me?”
DV: “No further information is available.”
PWC: “Seriously? There has to be something, we’re talking about a serious amount of money here.”
DV: “No further information is available.”
PWC: “Are you f**cking kidding me? Where’s the rest of my $64 million?”
DV: click..... dial tone.

Yep. It’s true. Damas invested $84 million in a vehicle which seems to have invested in its own shares but at a 400% premium to their actual value. Or you could look at it another way and it seems as though the brothers Abdullah and Dubai Ventures have conspired to defraud the Damas shareholders of another $64 million.

At this point let's take a step back and ask ourselves who are these guys and what are the implications more generally for Dubai? Perhaps the brothers Abdullah are bit players in Dubai, small time grifters who just happened to have caught a few foreigners in their net this time. And how about these Dubai Ventures guys? Is that just some Bahraini shell company set up to facilitate the fraud?

Would that it were so. The brothers Abdullah are pillars of the Dubai financial community. Sheikh Mohammed himself awarded Tawhid Abdullah the best entrepreneurial mentor award at the Young Business Leaders Awards. He was named Businessman of the Year in 2006 at the Arabian Business Awards. Gosh if he was awarded Arabian Businessman of the year in 2006 what possible award could he win this year, the year in which he has almost certainly done his best or at least most creative work?

And how about Dubai Ventures? Is that some shell company? No. Quite the opposite. Dubai Ventures was a subsidiary of Dubai Group and has since been reorganized but is a subsidiary of Dubai Holding. Dubai Holding is personally owned by Sheikh Mohammed bin Rashid Al Maktoum the Ruler of Dubai.

Wait a minute! Does that mean that this is an outright theft from shareholders in a publicly listed company perpetrated by a prominent Dubai merchant family abetted by a private equity fund ultimately owned by Sheikh Mohammed himself? I'm not saying that but what does it look like to you?

Clearly if ever there were a time to show that the transparency and regulatory regime of the DIFC has teeth this is it. This fraud is a black eye for Dubai, the DIFC, the DFSA, and through Dubai Ventures, Dubai Group, and Dubai Holding for the ruler himself. Surely all the forces at the command of the DFSA are swinging into action, prosecutors are working around the clock building the case, the Dubai Police are kicking in the doors of the brothers Abdullah at 3AM, shaking them out of bed and searching their homes for the missing hundreds of millions. For this scandal that strikes into the heart of Dubai as a place to invest and do business. It threatens the very credibility of the state and the ruler. Surely the state will defend itself with all its’ resources so that Dubai can eventually recover from its’ current travails.

Well let’s have a look at the DFSA website. What do they have to say on the matter? Not much I’m afraid. All we have from them is a release dated October 13th saying: “The DFSA has been closely monitoring the situation and trading in the market. It has been proactive in ensuring that it discharges its role to maintain the integrity of the market.” I'm not sure what they mean by "being proactive" but their definition and mine I think are quite different.

Thus far no enforcement actions have been initiated in either Dubai or the DIFC. No official investigation. Nothing. Damas says that it is contemplating legal action against Dubai Ventures but as it is ultimately owned by the Ruler it is likely to struggle. Good luck.

So what does all this mean in the context of the wider struggle of Dubai under its’ massive debt burden? Well this actually says quite a lot to the creditors of Dubai World. The crown jewel of Dubai World, DPW is listed on the same exchange and is subject to the same regulatory regime as Damas. The same legal system that is engaged in the non-enforcement of its’ own laws, and non-investigation of this fraud with its’ links to the Dubai Holding is now responsible for adjudicating any suits against Dubai World or its’ subsidiaries which are ultimately owned by the government of Dubai.

It sounds to me that the creditors of Dubai World are in for more excitement when Abu Dhabi’s $10 billion runs out in April. If I were such a creditor I would be reaching for my stack of sell tickets. If I were an employee of the DFSA I would be either rolling up my sleeves or packing my bags and if I were the Ruler of Dubai I would be raining down fire and brimstone on all involved.

As it turns out I'm just me and unless some serious enforcement action gets going on this I'm probably going to have to pay off my friend Abdullah Al Gravedancer on our 1AED bet that that the DIFC was just another real estate play. I should point out that Abdullah is an observant Muslim and when we made the bet I mentioned that it was not Shariah compliant for him to gamble. He said, "This is no gamble, that the DIFC is a fraud is a sure thing." Its' not too late for Dubai to turn it around but the clock is ticking.

Friday, December 18, 2009

Transparency, Dubai style. That's the DIFC there on the upper right. Under the....um.... cloud.



So this piece is a difficult one for me to write for a number of reasons. One is that I worked very hard and very long and believed passionately in some of the institutions that are made ridiculous by the story. It is also hard for me to write because it largely proves a friend of mine correct in an argument we have been having for several years.

Our argument was about the DIFC, the financial free zone in Dubai that was in the news on Monday. In addition to giving Dubai World $10 billion in order to give Dubai World and its creditors time to negotiate Abu Dhabi and Dubai also agreed to establish an insolvency process for Dubai World in the event that things don’t work out. That process makes the DIFC courts the jurisdiction of any suits against Dubai World and establishes a tribunal made up largely of DIFC judges to hear all disputes and adjudicate an insolvency if it becomes necessary. Naturally if you are going to have any confidence in that process you have confidence in the DIFC, the regulator the DFSA, and the DIFC court system and this is what my argument was about.

The DIFC is a special legal zone within Dubai that adjudicates commercial disputes according to laws based on those in the UK with judges brought in from UK common law jurisdictions. This makes legal outcomes and contract enforcement much more certain than they are in a Sharia court for reasons that will require another post altogether. The DIFC also has a regulator, the DFSA, which is responsible for supervising the financial activities within the zone and the DFSA was intended to operate to a higher standard than other regulators in the region. There was also the DIFX an exchange built to international standards which, on account of the superior legal and regulatory framework (and a great effort of one of the DIFX members) was able to connect to Euroclear and through that to the international financial system.

My theory was that the DIFC was a major advance for the region and would have quite a few healthy effects on the region as other countries sought to import its innovations. This would in turn make it easier to raise capital to start businesses and might breathe some life into the non-oil, non-real estate sectors of the gulf and offer more meaningful employment.

My friend had another theory. His theory was that the entire legal and regulatory structure was a sham designed to rent office space and sell apartments. He thought of the whole thing as kind of a gimmick, like say, building an island in the shape of a palm tree in order to sell villas.

One thing you need to know if you are going to get in an argument with an Arab guy is that they are relentless. My friend, let’s call him Abdullah Al Gravedancer, would make this point to me whenever he could. There we were at the Caribou Coffee in the DIFC and he would pound the table and say “The DIFC is a fraud.” I would be in the office in London he would ring me up and tell me “The DIFC is a fraud.” I’d be with my family back in the US on Thanksgiving I would get a text message saying “The DIFC is a fraud.” The peak was when I was at the IMF meeting in Singapore and Abdullah was on his honeymoon, he called me and told me “the DIFC is a fraud.” It got to the point where I was afraid to lift the lid on my garbage cans for fear he would pop out of them yelling “the DIFC is a fraud!”

The thing you need to know about American is that we can be argumentative as well and I fought Abdullah whenever this topic came up. Also as Americans we are pragmatic people so I took it further and tried to make my theory that the DIFC was about reality not realty by working on improving it. I worked with the DIFC legislative body on the laws, I worked with the DFSA on their enforcement, I worked with the DIFX on everything under the sun. I levered my firm into the region and marshalled all the resources of a major investment bank to support the DIFC in theory and practice. To my mind not only was the DIFC not a fraud but it was the best chance I would get to try to make life better for people in the middle east by improving their financial system.

Then a few days ago I saw a news story posted on facebook that, once I had investigated it, made me fear that perhaps the DIFC is a fraud.

To be continued...

Wednesday, December 16, 2009

We Own Citibank from Where?



A colleague once asked me to come with him to pitch a client in Abu Dhabi. I was working in the Gulf and had had some recent successes so he wanted me along to demonstrate our commitment to the region. We drove the hour or so from Dubai to Abu Dhabi, met the friend and pitched our idea. The guy let us talk about it for about forty five minutes then asked us some pertinent questions and then thanked us. “So how about it?” My colleague asked.

“Well, it looks like a great opportunity but I don’t think we can swing it.” Says the guy.
“Why not?” We ask.
“Well, you’re not really on our list of preferred banks.” He says. Keep in mind we were the largest bank in one of the largest countries in Europe. My colleague was undaunted.
“Surely this transaction can get us onto that list.” He says.
“Well, not exactly. We have a list of banks waiting to get on our preferred list. You’re not on that list. Then we have a list of banks waiting to get on the list of banks waiting to get on our preferred bank list. You’re not on that list either. But after today I can put you on the list to get on the list to get on the list.”

It was humiliating. We were being kept behind some kind of investment banking velvet rope. We weren’t on the list, or even the waiting list to get on the waiting list. I felt like I did when I waited in line for an hour and a half at the Ministry of Sound only to be turned away for not wearing “glamorous clubwear.” I remember trying to decide what would be more embarrassing: getting turned out of the Ministry of Sound or actually wearing what passed as “glamorous clubwear” in 1995.

The name of the client was ADIA the Sovereign Wealth Fund (SWF) of Abu Dhabi. At the time they had something like $800 billion under management which made them one of the largest investors in the world. SWFs were created by the Arab states to manage their current account surpluses and to put something away for a rainy day. They are generally competently managed and usually have multiple advisors that they play against each other in order to sift the best ideas.

As you can see from our story financial intermediaries are lined up around the block pitching investment ideas to them because a few words in the right key could put you in touch with a truly massive amount of money. With $800 billion there is almost nothing you can’t buy and transactions that are of massive importance to the seller are a trivial proportion of the total assets of ADIA.

And so it was that in the fall of 2007 the worlds banks converged on ADIA seeking to recapitalize their firms after having the stuffing knocked out of them during the subprime crisis that began in that summer. There were many deals done that year with sovereign wealth funds one of them was done between Citibank and ADIA.

In the deal ADIA put up $7.5 billion and got preferred shares that would pay an 11% coupon until 2010 at which point the preferred shares would convert to common equity at a conversion ratio that would imply a price of $30-$37 dollars. Citibank shares closed today at $3.45. Looks like someone is going to be taking a mark to market P&L hit when that conversion happens. A big one. Like $6.7 billion dollars big.

Before one bursts out laughing it is important to remember when this deal was made. It was made in November of 2007. At the time the severity of the subprime crisis was just coming to light and not fully appreciated. Nonetheless Citibank shares had been cut in half while the wider market was only down a few percent from all time highs set in October. So ADIA was getting a chance to get an 11% coupon from what at the time was a AA rated entity and buy the shares of the largest bank in America at 50% discount.

Reading about the deal at the time and wondering what must be going on at Citibank that a AA rated bank holding company was paying 11% for funds. Remember a year later in the midst of the financial crisis Warren Buffet only got 10% on his Goldman preferred AFTER the Lehman collapse. I remember thinking either Citibank management was panicking or did not deserve its AA rating but in either case ADIA seemed to be getting a great deal. It is also possible that the fact that their stake in Citibank would give them a larger stake in the firm the most famous Arab investor who practically made his name in it may also have influenced them.

The rest, as they say, is history. Citibank share have dropped from $30 to $3 with quite a lot of excitement along the way and now ADIA is looking at a 90% loss. Well someone at ADIA seems to have had the idea that maybe history might be negotiable. It seems that someone from ADIA called up Citibank and asked if it might be possible to change the conversion ratio so that ADIA’s effective purchase price would be something more in line with where the stock was today.

It probably seemed reasonable to them. They are the largest investor in the world. Citibank has a thriving business in the Emirates and probably a lot of Al Nahyan money in its private bank. It had been courting the Arab world since it fled Saudi Arabia in haste in 2001 they probably felt the relationship factors worked in their favour. It might have also been embarrassing that lately some other SWFs had sold their Citibank shares at a profit partially because they got in later and partially because they insisted on structures that protected their downside risk. Also this sort of negotiation is not uncommon between big financial players when one side has experienced a large unexpected loss. Sometimes there is a little give and take in order to preserve a longer term relationship.

It might have done them some good to take a break from obsessing about the collapse of Dubai and read an American newspaper or two. Or to check who they would be joining on the shareholder register of Citibank. They would have noticed that the last thing on the minds of the people who run Citibank is their relationship with ADIA. Like most people in the financial services industry, including myself, their primary concern is with their bonuses. Now the trouble with working at Citibank right now is that there is a guy in Washington who decides what your bonus is without reference to the shareholders. The US Treasury is also the largest single shareholder of Citibank. The trouble is that both the guy in Washington and the Treasury work for this group of people known as “the voters.” The trouble with “the voters” is that they, on average, make about $45,000 per year which is damn good for a per capita GDP figure but is pretty light as a bonus. And these characters, “the voters” seem to get a lot of satisfaction out of lightening the Citibank bonus pool.

As a result the number one priority for Citibank executives is to get rid of their relationship with “the voters.” This is a major problem for the guys who run Citibank. In order to pay back the TARP money, they have to raise equity and sell shares. The trouble is, who wants to buy shares of something they know the government owns a ton of and wants to sell? Tricky. So Citibank was in the middle of negotiating all this with the appointed representative of “the voters.” When they got their call to renegotiate from ADIA. ADIA probably wanted this to be done quietly but that isn't what Citibank wanted. ADIA played into the hands of the Citibank executives because now they could tell the government that they had ADIA threatening to back out of the deal and to do it publicly so the government should back away from its’ pledge to sell.

Indeed as of the close of business today “the voters” are reconsidering thier plan to sell their shares and Citibank has sold equity and raised the money.

Tuesday, December 15, 2009

Schadenfreude Pandemic Averted (for now)




Back in October of 2000 I was having a martini with a friend of mine at Bar 42 and we were reminiscing about the end of the internet boom. We had been to a launch party at the bar, so named for the 42 different kinds of martinis it served, for some new internet company a year before in the fall of 1999. The party had been massive and lavish. The new shareholders of whatever company had just done its IPO had spared no expense to entertain the youngsters who with hope and html were going to make them rich beyond the dreams of Croesus. A year later the bar was deserted and we couldn’t remember the name of the company that had entertained us the year before.

As it happened it took more than hope and html to pay the rent and the salaries let alone leave anything for the shareholders. So the internet bubble popped and my friend and I were drinking to its demise. At one point my friend turned to me and said, “You know Ken, I’m sooo happy the Internet Bubble is over?”

“Why’s that?” I asked, a little surprised. I, for one, missed the parties.

“I’ll tell you why. For years I had been going out in New York and as an investment banker (my friend was a media analyst at a bulge bracket firm) I was the top of the dating food chain. Lawyers and accountants were well off but boring and the media and advertising guys were interesting but gay or poor. I’d go into any bar and I’d have my pick of the ladies. It was excellent.”

“Then the internet guys show up. Not only are they interesting, reinventing the whole economy yada yada yada, they’re making more money than God and investment bankers put together. If I had a dime for every time some girl walked away when I told her I worked at an I-bank, or I got that dead fish stare when I told them I didn’t have any pre-IPO shares I could probably bring back the boom myself. Well, now that the internet has destroyed all those guys and they’re back in their tiny apartments in some outer borough we rule the roost again and all is right with the world.”

Schadenfreude. Glee at anothers’ misfortune. It was thick among the junior folks at investment banks back at the tail end of the internet boom and before the recession really got underway in 2001-2002. It wsa short lived though. As I pointed out to my friend that night we in the financial industry had been living off that internet boom for some time. Who did he think was behind the high salaries paid to media analysts? People who were interested in media and the internet that’s who and sure enough my friend lost his job shortly thereafter and moved to what he would have called a flyover state, America’s outer boroughs.

Why do I tell this story? I tell this story because it is similar to a lot of stories and thinking by people connected to Dubai. While sure enough there were plenty of creditors on the edge of their seats or trembling in fear at the prospect of squaring off against Sheikh Mo in Dubai or UK courts there was also a fair number of people who were quietly cheerleading the fall of Dubai. Why might this be?

You have to remember what it was like to live in Dubai from 2005-2009. Like New York and the Bay Area from 1998-2001 a lot of people got very rich very fast for doing things that seemed not very smart. Those people made life miserable. There you were every day, turning your cog in the great Dubai money machine. Turning those cogs was not a bad job, tax free for non-Americans, the pay was generally better than you would get in London and the work was generally easier. You could show up at 9AM and still be the first guy in, none of this 7AM meeting business people put up with in New York and London. Plus there was no minimum wage and there was a huge supply of cheap labor so for $5000 a year someone would live in your house, cook and clean for you. And it was sunny every day. Ahh yes, you were the envy of everyone back in rainy London or grimy New York. That’s the life.

But then, in every office, there was the “Off-Plan Real Estate Baron” to throw a wrench into your self-satisfaction. The Baron might have been sent to the Dubai office after some embarrassing failure in London. When he arrived he KNEW he would not be going back any time soon. So the Baron buys an apartment for $300,000 and tries to make the best of life in Dubai such as it is. Then, before his furniture even arrives, someone offers him $400,000 for it. Hello! $100,000 for just standing around? That kind of thing never happens, so he sells and buys a new apartment for $300,000 and then tries to figure out what to do with the $100,000. That’s when he discovers the magic of Dubai off plan real estate.

“Off Plan” real estate is a phrase for apartments or villas that have yet to be built. In order to finance them the real estate companies sell them forward on an instalment basis. You put down a deposit and then over time as the construction proceeds you pay in instalments and are fully paid up by the time you take delivery. Of course as the thing doesn’t exist yet and may not actually be built the deposits can be quite small which means the leverage can be quite large. So once he discovers this The Baron is on his way. He puts down $100,000 for an off plan apartment worth $1,500,000. A few months later a real estate agent calls up and says “hello Mr. Baron, I have a Russian gentleman who would like to buy your rights to that apartment for $1.7 million. He’ll take over your instalment payments and replace your $100k deposit and pay you $200k in cash, what do you say?"

What do you think he says? He says "HELL YES!!!" He takes his $300,000 and buys three more off plan apartments and is off to the races. You can see where this is heading. The Baron works in the same office as you. Makes the same salary and bonus as you working for your company and is probably not as good at his job as you are. Behind that is making a huge fortune in Dubai real estate. This is when you start to notice things about him you don’t like that might not have occurred to you otherwise. He’s socially awkward. He has poor taste in clothes. He’d never survive in London, not like you would anyway.

That may be but he sure seems to be making it in Dubai. Dubai was an outstanding place for conspicuous consumption. You have a housekeeper he has a gardner, a cook, a driver, a maid and if he’s got children he’s got a nanny for each child and a manager to manage them. You live in a nice villa, he has a huge one or a massive apartment overlooking the Palm. You’re taking a cab to work because you don’t want to deal with the traffic, he’s driving his Ferrari because... he can. If you’re single you can’t get a date to save your life aside from the occasional low hanging tourist and he’s going home every night with a different Russian girl so attractive that if you met her in London you could never go out with her not because she wouldn’t give you her number (which she wouldn’t) or because you can’t get into the clubs she goes to (which you can’t) but because you are not hip or rich enough even to know where those clubs are.

But you have one thing on him and that is the certainty that sooner or later it will all end in tears. For Dubai, maybe for the Middle East, but sure as hell for The Baron. You’ve probably even told him this yourself. Some late night over drinks at Sho Cho’s you were reminding him that 450,000 luxury apartments were under construction at that very moment for a city that had 1.3 million residents 800,000 of whom were migrant labourers from the subcontinent and therefore unlikely to be in a position to pay the offer for a luxe 2 bedroom with a view of Dubai Marina. You might have reminded him that every year Dubai was adding as much office space as there was in the whole of San Francisco and the vacancy rates were high and already climbing. You would be sure to remind him of the open secret that Dubai had no oil and the whole thing was built on a mountain of debt that would sooner or later come crashing down on him and everyone else who was caught long Dubai real estate.

Depending on what kind of guy he was he might take up the gauntlet. He might make a bunch of arguments about the Dubai miracle. He might tell you that there would be 60,000 investment bankers working in the DIFC, about how 2 million retirees from the UK would move there, about how the price of oil was going to $1500 a barrel, or about how Abu Dhabi would never let anything bad happen. It would sound a lot like the kinds of things you might have heard in New York around Q1 of 2000. Or he might not be that kind of guy. He might just finish his martini and apologize that he could not offer you a ride home in his Lamborghini because there was a lovely young lady at the end of the bar he wanted to talk to but he would see you in the office tomorrow. You would take a cab home a little deflated. You may or may not be right, but he sure as hell was rich.

What was true on an individual level for Dubai expats was true on a national level for the other Gulf states. Abu Dhabi and Saudi Arabia were completely bewildered by Dubai and at the same time strangely attracted to it. Here they were, daily making hundreds of millions in cash money providing the world with very important hydrocarbons and no one wanted to talk about them. It was always Dubai this, Dubai that. Kuwait and Bahrain felt the same, each had been the cultural or financial center of the Gulf in its turn and wondered how it had happened that Dubai had leapfrogged them, especially when it did not have a fraction of their actual resources. If imitation is the sincerest form of flattery then Qatar was Dubai’s most sincere flatterer. It often seemed as if the strategic vision of Qatar was to be found in day old copies of the Dubai paper Gulf News. Despite the disdain in which most of the nationals of other Gulf States held Dubai I always found them eager to make an excuse to go to Dubai. It repelled and fascinated them.

Then the financial crisis hit the world and the worm began to turn in Dubai. Real estate prices came in, the off plan game was up. That said the Dubai optimism was irrepressible. This was a small bump on the road to the realization of all the great potential of Dubai. It’s region was stronger, it was not the same as the subprime crisis, Abu Dhabi was there et cetera et cetera. Then came the Abu Dhabi walk-away and the debt standstill request. Suddenly the collapse of Dubai had a timeline. December 14th followed by December 28th and the whole thing would come crashing down.

A schadenfreude pandemic seemed imminent. Finally everyone who had been right instead of rich would remain right and those who had gotten rich would be crushed under the collapse of Dubai. You could see it best in the UK press which, after drinking the Dubai cool-aid for years suddenly was indignant that such craziness could have gone on as long as it had. They called for Sheikh Mohammed to resign and whether he did or not he was about to receive his comeuppance from those other villains that the press loves to hate, the hedge funds. It was most easily seen in the press but it was everywhere, just below the surface. Glee at anothers misfortune.

But it was not to be. At the eleventh hour Abu Dhabi did step in like all the optimists said it would and saved Dubai the public humiliation of having to put Dubai World into liquidation or else abrogate judgements against it made in UK court. Dubai lives to fight and build for another day or at least until May 2010. At least as far as Dubai World is concerned. Everything else is on a case by case basis.

Personally, I wouldn’t recommend buying any off plan real estate there any time soon, but I've been wrong on that before.

Monday, December 14, 2009

Look up in the sky, is it a bird? Is it a plane? No! It's SuperNahyan bringing money and legal certainty for DW creditors!!



Readers of this blog will know by now that Abu Dhabi has stepped in with a $10 billion contribution to the Dubai Financial Support Fund. Counter to previous statements this money will be used to support Dubai world and cover its debts, interest payments, and trade creditors until the end of April 2010. At the same time, the Ruler of Dubai has issued a decree establishing a clearer course of action should the insolvency or liquidation of Dubai World itself or any subsidiary become necessary.

This may seen as a victory for Dubai and it certainly is one for the folks who stepped in and bought the Sukuk and sought to intimidate the Emirati government into paying off in full as well as a catastrophe for those who put their faith in Dubai and then sold when Abu Dhabi seemed to step back. Fortune it seems has favoured the bold.

In some ways it should also be read with a note of caution. Abu Dhabi has now committed $5 billion more than it initially planned to the Dubai Financial Support Fund. The fact that Dubai World needs a cash infusion of $10 billion in order to keep it alive for six more months is a sign that things are Dubai World are worse than many of the more pessimistic assumptions and certainly mine and give the lie to the idea that a restructuring on its own was even remotely possible. There can be no doubt that had Abu Dhabi not stepped in there would have been a catastrophic default.

The fact that Abu Dhabi restored its support after its’ earlier decision to revoke it restores the solvency of Dubai but leaves the credibility of the Emirates in doubt. There remain serious problems at Dubai Holding and ICD. Investors will now assume that Abu Dhabi will support those as well and will be less inclined to believe Abu Dhabi will let those fall despite the comments that other Dubai entities would be supported on a case by case basis. Additionally the outside world will have no insight into the discussions between Abu Dhabi and Dubai that led to this.

Dubai has taken the positive step of trying to provide legal certainty around the potential insolvency of Dubai World by establishing a tribunal of DIFC judges and giving them jurisdiction over it and applying the DIFC insolvency law (which is close to UK law) to all actions taken against Dubai World. Interestingly the text of the announcement says that Dubai courts _may_ enforce judgements of the tribunal. It would be more helpful if that read that the Dubai courts _will_ enforce the judgements. Nonetheless, it should give creditors some comfort.

My personal view is that this is a helpful but only a partial reform. Why make a law specifically for Dubai World? Why not extend it to ICD and Dubai Holding? Or for that matter the whole of Dubai? Though off the hook for now, Dubai’s access to capital is likely to remain constrained for some time. It would very much serve the Emirate to establish legal certainty over commercial transactions in Dubai. I would argue that the whole of the Arab and Muslim world could benefit as well, this will have to be a subject for another post.

الخطر الأخلاقي Means Moral Hazard in Arabic

QVT, the t-shirts you ordered have arrived.



Wow, what an extraordinary series of events have unfolded in the United Arab Emirates today. Many in Dubai will consider this a victory for the Emriate as it has avoided default and humiliation at the hands of its international creditors. At the same time, it has shown that Dubai can by no means stand on its' own and requires the charity of its' stronger neighbor. Though it will come out of this chapter still solvent the credibility of the Emirate and the Ruler have been severly undermined. Not only in the eyes of the international financial community but also in the eyes of the many sukuk investors who would have sold in panic to the international vulture funds who successfully stonewalled the debt standstill request and intimidated the UAE into a full payment.

This is by no means the end of the game. This is chess not rock scissors paper. If Dubai is to recover from this it will not be on the back of grand plans and outlandish schemes but rather on the back of a pragmatic approach to winding up the various GREs that remain in trouble and through forthright dealings with creditors. The new decree proposed today is a step in that direction but it is only a step and the path will yet be long and hard, with more painful admissions ahead.

Sunday, December 13, 2009

The Cavalry has arrived to scatter the vulture funds!! Or rather to pay them off in full!



Abu Dhabi has agreed to support Dubai and Dubai world with $10 billion and will pay off the Nakheel sukuk in full as well as the trade creditors. Dubai will implement a new restructuring law in the event that it is not able to recover from this and winds up putting other entities into liquidation. World markets are rebounding and Dubai credit is loosening. It seems that the salesmen who pitched the Dubai GRE debts as safe because they would be made whole by Abu Dhabi were right after all though after a harrowing two weeks.


The whole thing does kind of make you wonder what that whole two week head fake thing was all about but unless your last name is either Maktoum or Nahyan you'll never know. The announcement says that Dubai World is considered strategic and the other Dubai GREs will be dealt with on a case by case basis. The plot thickens as it thins.

I'll have to think more about the long term implications of this but if it does result in a more robust commercial legal system in the Emirates it will be a long term positive. In any case, high fives all around at the Vulture Funds and Dubai can take a deep breath.

“OK mateys, now that we’ve sold assets and paid off the creditors the good ship Dubai World is ready to raise anchor and set sail!”



OK, this is a long post so I'll summarize:

1.) I do a VERY sloppy estimate of what the Dubai World liquidation would yield to the Dubai World Creditors

2.) My conclusion is that unless the Nakheel real estate assets are more than 50% overvalued on the balance sheet (admittedly a possibility) there are enough assets to make the creditors whole.

3.) There are significant assets outside the UAE that international creditors could pursue in the event that they felt they were being treated unfairly.

4.) Those assets outside the UAE are large enough to satisfy the sukuk holders but not all the creditors.

5.) My best guess is that Nakheel will be put into default as will Dubai World but once at that stage it will be in the insterests of all involved to negotiate as each will be able to credibly threaten each other with substantially negative outcomes.

6.) I think Dubai is over estimating its ability to insulate it's healthy subsidiaries from the restructuring as its equity in those are its most transparent if not most valuable assets. It is also underestimating the asset sales that will be necessary. Istithmar World for example will probably have to be liquidated entirely.

Well, it’s 6PM in New York City and therefore 2AM in Dubai. The moment of truth is hours away there. Notwithstanding the rebuke given to wallstwtf by investors in Dubai levitating their stock market in anticipation of deal with creditors I think it is important to think about what a liquidation of Dubai World might look like.

This is important even if the government of Dubai does make an offer because whether or not it is accepted by 75% of the Sukuk holders will be determined by what their next best alternative is. That alternative is going to be a liquidation or other form of work out of Dubai World.

So what will happen in the event that Nakheel cannot pay the Sukuk by the end of its grace period on December 28th? The amount due is $4.1 billion because in addition to the $3.5 billion in principal the last interest payment plus an equity kicker are also due as there has not been a Nakheel IPO. Well the trustee, in this case Deutsche Bank, will take actions to acquire the Sukuk Trust Assets. As described in an earlier post these consist undeveloped desert and a non-existent island. As these assets are unlikely to be valued at the $4.1 billion which is due a dissolution event will have occurred and the trustee will activate the Dubai World Guarantee. At which point the Nakheel Sukuk holders will become parri passu creditors of Dubai World with the syndicate of banks with which Dubai World is already negotiating.

At the holding company level Dubai World today has $5.5 billion in debt, this will then be joined by the Nakheel Sukuk holders to make $9.6 billion at the holding company level. Some of the $5.5 billion are revolvers which may not be fully drawn down but given the current state of Dubai World finances I think that’s unlikely. So Dubai World has $9.6 billion in debt a little over half of that is held by six banks one of which it controls, one of which is controlled by the Abu Dhabi Royals and four international banks. The Sukuk holders are a combination of Islamic investors and western institutional investors including some vulture hedge funds. I am not sure what the relative power of the creditors are at the holding company level or whether the 75% approval percentage continues to apply once the Nakheel Sukuk holders become creditors of Dubai World. I’m not sure what the implications of this are but any creditor that feels sufficiently left out of the negotiations can sue the others internationally or sue Dubai World for recovery of their assets so I don’t think any of the creditors can run over any of the others.

First I’ll look at what’s there and then address how likely the bondholders are to recover those assets.

There is a very important distinction between the creditors which are owned by GCC nationals and those which are not in the sense that GCC nationals can own land in the UAE and non-GCC nationals cannot. Given that many of Dubai Worlds subsidiaries are UAE based real estate companies this is an important distinction but only in the case of a disorganized liquidation and a hand over of the assets to the bondholders as some could take ownership and others could not. My assumption is that any local real estate assets that would have to be disposed of would be auctioned off and then the proceeds divided among the creditors.

The more important distinction is between assets which are inside the UAE and those which are abroad as any litigation inside the UAE is not likely to go well for the creditors though they stand a far better chance internationally.

First let’s have a look at the assets of Dubai World starting with those organizations which are most easily attachable in international courts.

Dubai Ports World. DW owns 80% DPW a publicly traded equity on NASDAQ Dubai. As of Friday that stake was worth $5 billion.

Istithmar World. Istithmar World functions as a private equity firm and owns assets all over the world. It is actually somewhat difficult to determine what the value of the equity in Istithmar world is worth. The WSJ reported that it started with $3 billion in equity and using leverage like a PE fund purchased assets worth $20 billion. That would imply that a decline in asset prices of 15% would wipe out the equity. The assets were purchased from 2004-2007 and I think it is not at all unreasonable to assume that the average asset price has declined 15% since then.

This is where the debt structure comes into play. It would seem that none of the debt is held at the holding company level. This means that the debt is all secured by the assets themselves. Depending on what debt covenants there are, DW could theoretically put Istithmar into liquidation and in cases where the asset is worth less than the debt against it you could hand the asset over to the creditors. Where the asset is worth more you can sell it and hand the proceeds over to the parent company. Therefore the value of Istithmar World probably is greater than zero, let’s call it $500 million recognizing that there is probably significant variance associated with that number.

Leisurecorp. This is a developer of golf courses, ski mountains, and marinas as well as a golf course management company and a company that develops golf applications for GPS devices. This company has some assets in Dubai but a great many outside of Dubai and therefore attachable. It seems to not have any debt at the holding company level but it is impossible to know what debt secures individual assets. I have no idea whether this is worth anything. Let’s call it $100 million.

Dubai Energy Resources World. This is a new venture investing in oil and gas exploration in Russia and Nigeria. I’m going to assume a value of $0.

That’s pretty much it for international assets. Let’s see what they have in Dubai.

Dubai Maritime City. This is a project under construction to create a zone focused on the international maritime shipping business as a complement to the role of DPW in global port management. Personally I think this is a good idea but the crisis hit before the project really got off the ground. I think we have to value this at $0.

Drydocks World, this company has $1.2 billion in debt and is described as on a “firm financial footing.” That said it is also in talks with its creditors so it’s not clear what value to assign any value to its’ equity. That said it is probably non-zero. If we assume a debt to equity level of 1:1 we can call it $1.2 billion but let’s haircut that to $600 million.

Limitless. This is a real estate development company with projects in Dubai, Russia, Jordan, Saudi Arabia, Malaysia and Vietnam. It also has $1.2 billion in debt at the holding company level and an unknowable amount at the project level. With real estate assets that are partially completed, given that additional financing will be required to complete them I think the equity value can be assumed to be near zero.

Economic Zones World. This group owns the JAFZA or the Jebel Ali Free Zone, and this undoubtedly is worth something but it also has $2 billion in debt. Given that this is a real estate project lets assume a 5:1 debt to equity ratio to get $400 million and then haircut that to $200 million.

Dubai Multi Commodities Center. This is a commodity trading infrastructure company, that is it runs trading platforms for commodities trading including the DGCX which traded $10 billion notional in November. It once also had a substantial real estate arm that was merged with Nakheel. DMCC has $60 million worth of debt outstanding. My guess is this is marginally profitable let’s call it worth $25 million but it could be worth well more than that as the growth rates are substantial though it’s hard to say how sustainable.

That leaves Nakheel the entity that got us into this mess. If we assume that the Sukuk’s disappear it still has $4 billion in bank loans to the parent company and another $1 billion in a facility to finance the Atlantis on the Palm. There are real assets in there, actual fully developed real estate projects in Dubai as well as two large malls. As of June 30th 2009 it valued its assets at $40 billion and has liabilities of inclusive of the loans and exclusive of the Sukuk of $15 billion. Sounds like $25 billion of equity if we assume the assets are held on the books of Nakheel are marked to market. Given the valuations assumed for man made islands we have to assume that the true number is substantially lower. That’s where the mystery is.

But let’s remember why we are asking this question: can Dubai World pay back its creditors. If the valuations, admittedly sloppily done, are approximate, then to make the creditors whole we only need $3.2 billion more to cover the hole, to do that the $40 billion would have to have a marketable value of $19 billion or so or half of the value at which they are carried on the books. I don’t think that’s unreasonable.