Tuesday, January 26, 2010

You want me to give you some design tips and let you use my name? OK but I gotta get paid in advance.

Dubai is trying to conjure up the old magic. Apparently the Ruler of Dubai has offered Victoria Beckham $25 million to give her name and her taste to a new hotel being built on a collection of islands in the shape of the world. Not a bad move for Dubai, it gets the financial crisis off the front page and if you already owe $80 billion what's $25 million more? Especially if it brings Posh Spice to town to fill up a few more hotel rooms. Personally $25 million sounds like a pretty good deal for Mrs. Beckham as well. If I were her though, I'd demand cash. Otherwise she might wind up with non-existent desert islands like the Nakheel II and Nakheel III sukuk holders, or else she might have to get in line behind the Japanese consortium that built the Dubai Metro. And under no circumstances whatsoever should she take shares of Damas.

Cloak and Dagger, Smoke and Mirrors

As you might imagine there are a lot of conspiracy theories floating around about the Dubai crisis. I want to talk about two in this post one implausible the other completely plausible.

The first theory that has been posted both as a comment and as an email to me is about the Abu Dhabi refusal to back Nakheel and the subsequent debt standstill by Dubai at the end of November. This touched off a global panic for a few days that was not as obvious in the US on account of the Thanksgiving holiday. More immediately it touched off a panic in the Nakheel Sukuk market. The bonds traded down to $0.44 on the dollar, slowly drifted back up to around $0.65. Then in late December Abu Dhabi rode to the rescue and paid off in full.

The theory is that the Abu Dhabi and Dubai planned the whole thing so that they could knock down the price of the bonds and then buy them back more cheaply and then pay them off and avoid default. I think there is zero chance that this is what happened. For one thing, if they were really serious about that then they could have used much harsher rhetoric and threatened an actual default rather than requesting a standstill agreement and that would have driven the bonds much lower. Also if they were so interested in buying back as many bonds as they could get their hands on why did they halt trading on the DIFX? All they did was force the trading to go on in London where, as it turned out, it was easy for hedge funds to get at them. Additionally the increased borrowing costs for all the other Dubai entities that have resulted from the Abu Dhabi bail-out two step are sure to dwarf whatever could have been saved with this clever sleight of hand. No, I don’t think that’s what happened.

No I think what happened was more along the lines of the official narrative. Abu Dhabi got skittish about rescuing the more farfetched of the Dubai property ventures and drew a ring around the things it would save. Nakheel was outside that ring. Abu Dhabi miscalculated however because the very next Nakheel Sukuk to come due had a clause which enabled the bondholders to go after the international assets of Dubai World in event of default. This would have involved massive public humiliation for all involved and so Abu Dhabi paid off.

The other conspiracy theory that has been both posted as a comment and emailed to me, anonymously in both cases but I did some sleuthing and I think the person might actually be connected to one of the parties involved. It has to do with my favourite topic: the Damas heist.

I wrote in an earlier blog post about a curious “unauthorized transaction” in which Damas lent $80 million to a private equity vehicle by the name of Dubai Ventures. Dubai ventures never paid interest on the loan which then accrued to something like $84 million at which point the loan was converted to equity. When the PWC forensic accountants going through the “unauthorized transactions” came upon this vehicle they inquired as to what was in the holding company and were told that what was in the fund were $20 million shares of Damas itself. This is really a mystery and in my original article I theorized that someone must have made off with the missing $64 million, perhaps to buy yachts or Ferraris with it.

Readers of this blog have posited a different and to their eyes a more benign theory. Their theory is that when the book building process was underway for Damas during it’s IPO there was not enough interest to make the offer a success. The Abdullah brothers who control Damas made a call to someone friendly at Dubai Holding who agreed that its private equity subsidiary Dubai Ventures would make a substantial subscription to the IPO on condition that Damas make Dubai Ventures whole. The “loan” and its conversion to equity were Damas keeping up their end of the bargain. The fact that a mere $20 million worth of shares remain in the vehicle is accounted for by the fact that Damas shares have declined substantially since the IPO, not because the funds were stolen outright.

This theory has the ring of truth to me. In the summer of 2008, as the global financial crisis gathered steam it was important for Dubai to not have a failed IPO in the DIFC. The Abdullah brothers were connected and well known and for their IPO to fail would have been particularly difficult. The powers that be probably thought that Dubai Ventures would be able to sell the shares in the aftermarket for a small profit and no one would be the wiser. Unfortunately Damas shares began to sink almost immediately and so there was never a chance for Dubai Ventures to get out but not to worry because the Abdullah brothers made them whole with the money of the other Damas shareholders. Ultimately they rode the shares all the way down until they got their call from PWC.

So what do you think? Was this not a fraud but rather an honest attempt to avoid embarrassment for the brothers Abdullah and more generally the DIFC and Dubai? Their hearts were pure when they put the transaction together but things did not work out as planned and as a result the shareholders are out $60 million? Not to worry though the Abdullah brothers plan to sell a yacht or two and pay it all back. No harm, no foul?

You know my answer to this. The issue is not whether their intentions were noble or not, what matters is whether or not they broke the law. Is there a law against this sort of thing in the DIFC? There sure as hell is. This plan was meant to conceal from the other investors that there was not enough interest in the IPO to justify the price being paid by the non-Dubai Ventures Shareholders. This scheme, if it took place, violated the DIFC Markets Law in several ways. Specifically The DIFC Markets Law, Part 8: Prevention of Market Misconduct, Chapter 1: Market Misconduct: Section 36(a): “contributing a misleading appearance of trading in or price for a security,” Section 38: “engaging in conduct relating to investments that is misleading” and Section 41: “a person in the DIFC shall not induce a person to deal by concealing material facts.”

So what is being done about this? Nothing. The DFSA is monitoring the situation but not conducting its own inquiry. The big international shareholders in Damas are emerging market mutual funds who claim to their investors that they have market knowledge in frontier markets so they will not bring a case because it would undermine their claims to know what they are doing. The inaction of the DIFC and the DFSA is not costless to Dubai. By undermining the integrity of the DIFC, the venue not only for this $80 million fraud but for the $80 billion restructuring of Dubai Inc. Their inaction puts Dubai as a whole at risk in order to spare the Abdullah Brothers and Dubai Holding some embarrassment.

Sunday, January 24, 2010

Dubai on Lake Michigan: The Emirate of Chicago, Sheikh Richard M. bin Richard J. Al Daley Ruler

Ever since I established an email address (ken@wallstwtf.com) connected to this blog I have been getting all kinds of email. Some have emailed me suggestions for things to write about and other have suggested things I should stop writing about altogether. Some have encouraged me and others have suggested my talents may lie elsewhere. These emails I take in their stride. Then there are some that concern me, one recent commenter suggested that I am an ex-DIFC insider who was terminated and is taking my revenge. This is untrue but it gets at the question of motive. I have tried to address that before but I have thought of a better way to make that point.

I am originally from the City of Chicago which I think has a lot in common with Dubai. Both are the commercial centers for their regions, and aspire to be truly global cities. They are similar generally and there are many specific things they share as well. Both are ruled by absolute monarchs who derive their power from their fathers. These men are at their core honest champions of their cities but both are surrounded by questionable people and are often given bad advice. Both have political machines that reward the friends and punish the enemies not of the City but of the machine. The ruler though himself clean decides who among his associates can get rich, and just how rich.

I have written about Naser Nabulsi who fired the head of the DFSA for not playing ball with him politically. In Chicago we have the Cook County Board President firing the political supporters of his rivals. Chicago's problems are so deep that it seems we need watchdogs to watch the watchdogs.

I have written about Dr. Omar appropriating for himself wealth that should belong to the DIFC bondholders and ultimately to Dubai itself. In Chicago we have a state representative who has stolen art from a public university to adorn her office and refuses to return it. We have City Employees setting up a fake charity, compelling thier subordinates to donate to it, and paying themselves the money.

I have written extensively about the Dubai financial crisis at the level of municipal finances. Chicago faces its own fiscal problems. I have suggested Dubai equitize assets, Chicago faces the same tough choices of privatizing city services and infrastructure.

Similarly in the same way that Dubai looks to Sheikh Khalifa to save it Chicago looks to Barak Obama to deliver federal support to the city.

So you see, fiscal irresponsibiity, dishonest politicians, patronage, cronyism, self dealing none of these things are unique to the Dubai experiance or the Arab experience or even the emerging market experience.

They are part of the human experience.

There are two important differences between Chicago and Dubai. One is that in Chicago there is almost always a US attorney who, if he throws enough Chicago politicans in jail, can become a Senator. Thus the feds are always out there hunting the Chicago politicians. The feds are usually a few steps behind and usually require something like a bitter ex wife as a star prosecution witness to get anything done but the crooks in government have to sleep with one eye open.

The other is that Chicago has a realtively free press. Not entirely, the City and the State Government do initimidate the press to some extent and the press sometimes tries to play kingmaker by glossing over the problems of one candidate and focusing on those of another. But now and again there have been true heroes who have emerged like Mike Royko who point out when the Emperor has no clothes. Though his columns were sarcastic you could tell how deeply he cared about Chicago.

Though I am no Royko to be sure, I care deeply about both Dubai and Chicago. One is my home and the other a place where I spent some of my most productive years. Both are a complex mix of deep flaws and great potential . The potential of each can only be realized if the flaws are identified and addressed. Dubai has a generational opportunity inside this crisis. There is an opportunity for Dubai to save itself if Sheikh Mohammed can only convince himself to limit his own power and make everyone, including himself, equal before the law. If Sheikh Mohammed can save Dubai and reassure foreign investors by instituting a more limited monarchy, that model can be followed by other monarchs in the region to benefit not only investors but the Arab world writ large. I think that bloggers in the region have a part to play aiding the reformers by pointing out the errors of the current system.

I know it makes some people unhappy to read my criticism but in the face of the present crisis, which threatens both Chicago and Dubai, the silence of reasonable people is far more destructive than my or any words can ever be.

Thursday, January 21, 2010

David Jackson: casualty of hubris... though not only his own.

Back in September of 2006 I went to the IMF meeting in Singapore. You can think of the IMF meetings as part Model UN part speed dating. They’re like model UN in that most of the sessions I went to had a bunch of guys trying to explain the massive American fiscal and current account imbalances and why they had been so persistent. No one really understood it but you can’t go to the IMF meeting and get up on stage and say “I really have no idea” so they looked like a lot of high school kids pretending as though they knew what the stance of Sudan would be on refugees in Bosnia. It was charming and made me feel good about the education I had received.

The IMF meeting is also a lot like speed dating. I know it sounds strange to say that about a gathering of the worlds central bankers, who wants to hang out with those guys? Easy the world’s financial institutions because central banks are where the money is. Trouble is, there are so many clients and so many rivals and so many potential clients and rivals, that you only get a little time with each one. Most financial institutions throw parties each night of the conference in an attempt to woo the clients. If you’re a young freebooter like me you check out the parties of the other firms and then work the room at your own so the boss can see you pressing the flesh.

So that night back in 2006 I hit the Saudi party, there were a lot of interesting people there and the most money but, sad to say, no drinks. The Qatari party was truly outstanding. They had all the martinis you wanted, seven different kinds of buffets and I want to say Cirque de Soleil or something there for entertainment, my memory of it is a little fuzzy. The QFC may not have had too much game as a financial center but they threw a mean bash. Then I headed back to my own party. After the riot of the Qatari party my own was pretty lame. I was pigeonholed by some really dull guy from the accounting department or something. He was an important person to cultivate but really not what I had in mind. As I was trying to figure out how to change the conversation to something more interesting than the Venetian discovery of double entry bookkeeping from the Arabs a group of men behind me burst into absolutely uproarious laughter.

As I turned around and as I did I caught the eye of the man at the center of the group, a large and boisterous African American. “Let’s ask him!” The man said, pointing at me. “Ask me what?” I replied. “Well, today we have been playing a game with all our bankers. People have been pitching us deals all day. We have provided them each with a simple test and whoever can pass it wins our next deal. Do you think you can pass?” I wasn’t sure, “I’m not sure, try me” says I. “OK, here goes: I’m going to sing a verse from a song and you have to tell me the name of the song and the artist. OK?” This was really odd but it beat the history of accounting so I told him to shoot. Then the enormous African American began to sing:

“I got in town a month ago, I’ve seen a lot of girls since then”
“If I could meet ‘em I could get ‘em”
“But as yet, I haven’t met ‘em”
“That’s why I’m in the shape I’m in.”

I knew it instantly: “Another Saturday Night, by Sam Cooke from... I think... 1963.” (BTW, that song is quite the theme song for non-Muslim males in Dubai)

Explosive Guffaws, from all the men in the circle but one, our salesman Imran. Imran just stared daggers at me. The man put his arm around Imran with his huge paw coming to rest on Imran’s shoulder. “You see, Imran you should have brought this guy along. Then you would have gotten your trade done. Heh heh heh.”

Then he looked at me, “So, Mr. Soul Man, what is it that you are trying to sell here in Singapore?” As it happened I was there to lobby support among some western finance ministers for a clandestine financing project related to the reconstruction of Lebanon after the recent war, so I told him that I wasn’t selling anything. “That can’t be!” He bellowed, I had been out of the US long enough for the loudness of other Americans to be noticeable. “Why I’ll bet you spent half an hour to get that dimple in your tie exactly perfect this morning. No one who isn’t selling something would go to that length to look so dapper.” It made me a little uncomfortable how right he was. “OK, OK, so you’re selling something but not right now, and not to me. Fine, you get a rain check. One free deal with Istithmar.” The man stretched out his hand to me, “My name’s David Jackson. What’s yours?”

You may recognize that name because David Jackson was the CEO of Istithmar the private equity wing of Dubai World who was forced out yesterday.

I tell this story to give you a sense of the kind of guy that he was. I joined up with David Jackson and crew that night and party hopped the IMF meeting with them, he was a fun guy. Back in 2006 the memory of his time slaving away at an investment bank was still fresh. He has been on the other side of the table pitching deal after deal to sceptical clients. Now he was on the fun side of the table, with a big pile of money and all his former bosses hoping that a few words in the right key some of it would rub off on them. So he had fun with them. He would make them jump through hoops like asking his Arab coverage people to name soul tunes. Or winding them up over their dimple tied ties. He was having fun with it, and why not. He felt he had earned it.

In a lot of ways he had. I think that over time it is possible that he fell under the spell of Dubai Sorcery, and the power of the Dubai Sorcery for expats is that it makes them fall under their own spell. David Jackson was probably a better than average investment banker in New York where he worked for ten years before coming to Dubai. Once in Dubai however, he was a rock star. As the head of a major private equity firm with “middle eastern money” (borrowed in his case) behind him people were lined up around the block trying to pitch him investments. The trouble is, when people are lined up around the block telling you how smart and important you are you start to believe them.

During the depths of the financial crisis Jackson gave a talk where he said that Istithmar was patient capital and that they were putting money to work while everyone else was selling assets. I’m sure that Mr. Jackson had access to the balance sheet and income statements so he must have known this to not be true. Still, I think he believed it. He believed it because he had begun to believe the stories his admirers told him and then he began to admire himself and that can be fatal. But David Jackson was not undone by his own hubris, he was undone long before that.

A lot of life is more about knowing the game than playing it well. David Jackson was a bright guy. Perhaps not so bright that he would have done as well in New York as he did in Dubai but bright nonetheless. He knew the game. He knew that the people who hired him wanted to be on the front page. They did not want to own 20 million shares of Costco, they wanted to own Barneys. They didn’t want to own six dozen holiday inns in the Midwest, they wanted to own the W Union Square in New York. They didn’t want to own 3% of Federated Investors they wanted to own Perella Weinberg and GLG. For the powers that be in Dubai making levered investments into high profile companies was part of building “Brand Dubai.” If higher volatility and lower returns were the result they would make it back in hotel bookings back in Dubai. In the beginning as I have told you he took it lightly, later on he took it seriously. David Jackson understood the game and David Jackson delivered.

The hubris that has destroyed the career of David Jackson was the hubris of the people who hired him. They hired him because he was outgoing and flamboyant and bright. They set up a game in which he had every incentive to buy trophy assets and he delivered in spades. They did this in the belief that the more widely the name of Dubai was known, the better it would be for Dubai. The trouble is buying trophy assets with massive leverage on the eve of a massive credit contraction is a spectacularly bad trade to make. So now the people who have set up the game have taken David Jackson off the board. Now the creditors and Abu Dhabi are the most important pieces. The players change. The game goes on.

Tuesday, January 19, 2010

If you care about Dubai email this man and request that he enforce the law.

In my previous post I mentioned a real estate investor who was suing Damac in DIFC court. I think he has no shot because there is a good argument to be made that he has no standing in the DIFC. I’ll tell you what though, there is a group of people who sure as hell do have standing to sue in DIFC court: the Damas Shareholders.

There has been quite a lot of news out about Damas and the Abdullah Brothers. It seems that Damas is close to negotiating a standstill agreement with its creditors. An informal agreement has been in place for some time and the company and its creditors are working to formalize it. Damas needs to do this because its balance sheet was obliterated by a series of “unauthorized transactions” executed by its majority owners. These transactions consisted of the 51% owners withdrawing funds from the company and purchasing assets with them in their own name. This constitutes an outright theft from the shareholders.

There are three Abdullah Brothers. One of them was the CEO and on his resignation one of the other Abdullah brothers became the MD. Then the former CEO negotiated a repayment plan with the current MD, that is to say that the Abdullah brothers agreed with themselves how they would repay the money. What they came up with is this: the Abdullah brothers will pay the company back the missing $165 million over the next 18 months otherwise the brothers will hand over 35% of the company (worth around $70 million) back to the company. Of course this is not really possible because so many other Emiratis have (wisely) sold out of their Damas shares that the company would then be effectively owned by non-Emiratis in contravention of the UAE companies law. The plan was never put to a vote of shareholders, the Abdullah Brothers agreed it with themselves. Then there are articles about how they have now sold a hotel and that this is a good sign that the company is moving past all this unpleasantness.

There is an lengthy and quite good article in the National about how the Abdullah Brothers stand to lose control of the company founded by their grandfather as a single storefront long before Dubai became what it is today. There is much discussion of what a tragedy this is for the Brothers Abdullah and how difficult this must be for them, and I’m sure it is. They’re a close family living in a compound in Jumeriah and go on traditional fishing trips on the weekends. This has come as quite a blow to the family. Apparently the brothers have put one of their three yachts up for sale. This is a noble gesture to be sure but they have three, why not sell them all? Why are they even deciding which yachts to sell? Why is there not a receiver or liquidator hitting bids all over Dubai with the personal property of the Abdullah Brothers in order to pay back the shareholders who have been defrauded and lost nearly $200 million between them? Where are all the shareholders yachts?

The investing public are cautioned against being prejudicial. Public ownership of family companies is new to the region and this requires a period of adjustment. “The Damas case, and a number of recent cases involving regional families and businessmen, highlight some of the challenges that regional business leaders face as they tap capital markets, which demand a higher degree of transparency and accountability,” said Nasser Saidi, an economist and the executive director of the Hawkamah Institute for Corporate Governance. (from the article in the National.) How quaint. “some of the challenges.” Like not appropriating the money the shareholders gave you in return for equity in the company to your own personal account? Is that a challenge? I beg to differ, I think they knew perfectly well what they were doing.

Let me posit a hypothetical. Let’s say that instead of selling a stake to international investors the Brothers Abdullah sold $270 million worth of equity in their company to Sheikh Mohammed the Ruler of Dubai. What are the chances that they would then withdraw Sheikh Mohammed’s money and deposit it in their own accounts and invest it in Turkish shopping malls and London hospitals in their own name? The chance of that would be zero because if they robbed Sheikh Mohammed blind they would be in prison or worse. No, they know all about what it means to do right by your shareholders if those shareholders have the power to put you in prison. But the poor suckers who bought shares in the Damas IPO don’t have the power of Sheikh Mohammed, they have the DFSA to look after their interests. And what do the Brothers Abdullah think of the DFSA? Well, they’re there’s no independent DFSA inquiry, no legal action, they get to decide which yachts they sell, and walk around Dubai as if they did not steal $200 million from unsuspecting foreigners. What does it look like to you?

So what is the DFSA doing? According to the article and the DFSA website they are “closely monitoring the investigation at Damas to find ways to improve corporate governance, especially at family-owned companies that issue shares to the public.” They’re closely monitoring the investigation at Damas? The Damas investigation is trying to locate the missing funds and value the assets purchased with them, not determine whether the funds are missing. It is known and admitted that they are missing and that they were withdrawn by the Abdullah Brothers. So, the DFSA is looking to improve corporate governance especially at family owned companies that issue shares to the public. I have an idea. HOW ABOUT ENFORCING YOUR OWN LAWS AND BRINGING CHARGES AGAINST THE ABDULLAH BROTHERS!?!

Don’t get me wrong. I know the people at the DIFC and the DFSA. They’re not bad guys. I can even tell you why they appear to be doing nothing. The Abdullah Brothers are a powerful merchant family in Dubai. From the DIFC perspective the Abdullah brothers supported the DIFC by conducting their IPO in the center. Given the prominence of the Abdullah family in Dubai I am sure that the powers that be in the DIFC consider this a political issue. The DFSA has not a single Emirati in its senior ranks and therefore they view their decision as standing aloof from a “political” issue.

I cannot tell you how many times I have met with European technocrats in the Arab world who when you describe how some terrible thing is about to happen will say something along the lines of “well that’s a political issue” and then go on to say “I view my role here as providing technical expertise, I’m trying to stay above the politics.” In the Arab world whenever a person says “I try to stay above the politics” what he is really saying is “I intend to achieve nothing.” The Arab world is a world in which you cannot always rely on the law. As a result everything gets done on the basis of personal trust built up over time, on relationships, on triangulating interests, in short on politics. To say you are above the politics is to say you are not in the game at all. Dubai desperately needs the DFSA to be in the game. They created the DFSA for precisely this reason.

The best hope for Dubai now is some kind of standstill agreement from the banks that will allow it to conduct an orderly liquidation of its assets in order to repay the creditors and avoid a default. To do this the international investors need to have confidence that if push comes to shove their disputes will be adjudicated fairly in an environment in which foreigners will have equal protection with locals. To that end Sheikh Mohammed established a tribunal inside the DIFC to adjudicate any insolvency or other litigation between Dubai World and its creditors. The Damas scandal, by standing aside from a $200 million fraud is shaking the confidence of investors that they will get a fair shake for their $20 billion. Indeed, lenders are already giving up before the game even begins and seeking to offload their loans which will the be bought at a huge discount by vultures like the Nakheel Sukuk and drive a tougher bargain with Dubai which as with Nakheel can lead to disaster.

I have been inspired by Martin Luther King Day yesterday, enough cursing the darkness. Let’s light a candle. If you are an Emirati or you care about the success of Dubai in any way. If you want to see the country remain as a commercial hub and emerge more strongly from this crisis, If you have any interest in a positive outcome for Dubai I ask you to join me and tak action. There is no way for Dubai or the entire Arab world for that matter to move forward without confidence in the rule of law. I ask you to do more than read my blog and hope for the best.

Email the CEO of the DFSA, Paul Koster and ask him to not rely on the deal the Abdullah Brothers have made with themselves but to conduct an independent investigation and if the brothers Abdullah have in fact misappropriated corporate funds to bring charges against them in DIFC court. If not then at least someone other than the Abdullah Brothers will have looked into this whole thing. As readers of my blog there are only a few hundred of you but you are disproportionately influential. Let’s see if you can make a difference or at least get a response. According to the DFSA website you can reach Paul Koster at info@dfsa.ae

News from Dubai

So there has been a tidal wave of news out from Dubai. The most interesting thing to me is that Abu Dhabi has clarified that when it said it was bailing out Dubai with another $10 billion the night before the Nakheel Sukuk was due what it really meant was that it was just adding $5 billion to the $5 billion that had been lent by Abu Dhabi banks on the day that Dubai asked for a debt standstill and touched off a global selloff. I’m not sure what to make of this. It seems to me that this is kind of an important reversal but though Dubai debt has traded off today people are not thinking this represents a major change in policy for Abu Dhabi and the markets still seem to think that AB will be there when Dubai runs out of cash again in May.

Bourse Dubai announced that it will roll its debt another year. I’m not sure if this is mandatory on the banks or not. Bourse Dubai, as mentioned in an earlier post, borrowed the money near the peak of last cycle to buy shares of the London Stock Exchange and NASDAQ OMX both of which have been roughly cut in half. It’s not clear to me whether it is mandatory for the banks to roll the debt or not. It may not turn out to be a big deal anyway. A lot of the debt is held by UAE banks which are subject to political pressure and can lend money against the DFM state of Bourse Dubai which is more than enough to cover the loan.

To me the most interesting story is about a “VIP Investor” by the name of Lothar Hardt who is suing Damac, a Dubai real estate developer, for not actually building the real estate he bought off. Allegedly Mr. Hardt was duped into parting with almost $10 million by Damac to buy apartments that had not yet been built in developments that had not been registered on land that Damac did not own. Oh boy.

Personally I have no sympathy whatsoever for Mr. Hardt. Interestingly the non-existence of these non-registered developments on unowned land did not stop Mr. Hardt from signing agreements to rent them out to third parties so presumably he is also liable. I think it’s pretty likely that he has flipped more than one off plan apartment before. He knew the game and the game was million dollar game of musical chairs. You had to flip your non-existent, non-registered apartments built on land you did not own before the global liquidity music stopped. When the music stopped Mr. Hardt did not have a chair and now he also does not have his millions. I’m sure many investors are aware that the reasons you get better return in emerging markets is that the chances that your money vanishes altogether are much higher. Sorry big man. You pays your money you takes your chance.

There are a lot of people in Mr. Hardts position but most of them are taking it like a man. Mr. Hardt is taking it like an American and he is going to court, and this is where it gets interesting. Hardt has decided to sue in the DIFC rather than the UAE proper. Damac has a finance company registered in the DIFC and the DIFC has is a UK common law based jurisdiction as opposed to the Sharia based UAE. Clearly he hopes that he will get a better deal in this jurisdiction than he would in the UAE proper and if the DIFC courts agree to hear the case he almost certainly will. Clearly it would be a fiasco for Dubai if Mr. Hardt were to win this case as there would then be a deluge of similar cases but my guess is that the contracts he signed contain a lot of boilerplate disclaimers which would crush him in either jurisdiction. I think he is using the need for the DIFC to be seen as a reasonable jurisdiction for the Dubai World tribunal to get a quick settlement. The trouble for Mr. Hardt is that there is a pretty good case to be made that his contracts were all signed in the UAE proper with UAE based agents so my guess is that the DIFC courts will remand his case back to the UAE proper where he will get nothing and like it.

I’ll tell you what though, there is a group of people who sure as hell have standing to sue in the DIFC and so far have not. If you have been reading my blog you know who they are: the Damas Shareholders.

This is a partial post, I'll put the rest up when I finish it.

Monday, January 18, 2010

Today is Martin Luther King Day in the United States

The hope of a secure and livable world lies with disciplined nonconformists who are dedicated to justice, peace and brotherhood. -MLK

He who passively accepts evil is as much involved in it as he who helps to perpetrate it. He who accepts evil without protesting against it is really cooperating with it. -MLK

The means by which we live have outdistanced the ends for which we live. Our scientific power has outrun our spiritual power. We have guided missiles and misguided men. -MLK

Change does not roll in on the wheels of inevitability, but comes through continuous struggle. And so we must straighten our backs and work for our freedom. A man can't ride you unless your back is bent. -MLK

I believe that unarmed truth and unconditional love will have the final word in reality. This is why right, temporarily defeated, is stronger than evil triumphant. -MLK

We must accept finite disappointment, but never lose infinite hope. -MLK

"Careless seems the great Avenger; history's pages but record
One death-grapple in the darkness 'twixt old systems and the Word;
Truth forever on the scaffold, Wrong forever on the throne,—
Yet that scaffold sways the future, and, behind the dim unknown,
Standeth God within the shadow, keeping watch above his own."

-James Russell Lowell, often quoted by MLK in his sermons

Sunday, January 17, 2010

Let me in! Let me in! I gotta get my welfare check! I mean my IPO allocation! Get outta the way!

In my previous post I wrote about the difficulties involved for Dubai to sell equity in its businesses in order to raise funds to pay down its’ debts. I have discussed already the psychology of Dubai and the reality that the level of indebtedness may exceed the amount of money that can be raised in equity. I would still argue that the strategic sale of equity is the best way for Dubai to manage the unwind of its’ debts. In this article I will address the most serious obstacle: the structure of the Emirati capital markets.

In order to explain the equity capital raising process it might be best to give an example of how it works in America. For that, I’d like to take the reader back to 1995 and the Netscape IPO. If you are too young to remember the early days of the internet Netscape was the first commercially available web browser. By August of 1995 virtually Netscape 80% of people using the internet were using Netscape to do so, so it had the best name recognition of any internet company. At the time people did not understand the commercial implications of the internet other than to know they were huge and so a lot of money poured into the field, initially from venture capitalists. The Netscape IPO was one of the first chances for the public at large to invest in the internet. Boy, did they ever.

The way that IPOs work in the US is that the company hires an investment banking advisor who does an initial valuation and gives a range. Then the company and their advisor go on a roadshow to pitch the company to potential investors and gauge their interest. Then a book building process is held which is kind of like a slow motion auction in which the investment bank collects orders from investors for the companies’ shares. When all the bids are in and the final price is decided the bankers go through and using their discretion to allocate the shares among the various investors. Usually they try to choose investors that are not likely to sell right away and occasionally “friends of the firm.”

What made the Netscape IPO so amazing was the investor demand for the shares. Netscape gave its product away and so it had little in the way of revenues as a result it was hard to value. Investors however gave the company the benefit of the doubt and bid the shares to the moon. Netscape offered to sell up to 5 million shares or about 10% of the company at a range of between $12-$14 dollars. During the roadshow it became clear that the demand was much greater so they upped the offer price to $28 dollars valuing the company at over a billion dollars. Even at this price there were over 100 million shares bid for meaning that the offer was oversubscribed 20 times with investors bidding for $2.8 billion. On the day the company went public the shares traded as high as $75 before closing at $58 and change. A home run for anyone lucky enough to get an allocation. Because of the massive oversubscription, many investors received no allocation and all those that did receive one got only a few thousand shares. MSAM the asset management wing of the lead bookrunner got only 6,000. Tom Brokaw got 28,000. Yep, people were mad about that. This massive initial valuation for an IPO touched off the internet boom in the United States that ultimately came to grief in 2000.

Just as Netscape kicked off my career the Dana Gas IPO kicked off my Middle Eastern career. Dana Gas, a start up gas company conducted an IPO on the Abu Dhabi Securities Market in October of 2005 in order to fund a massive expansion. The company solicited 300 “founders” (the equivalent of venture backers) who purchased 65% of the equity in the company. The remaining 35% was offered to the public. The IPO was ultimately 140 times oversubscribed with investors submitting 288 billion AED ($78 billion) in bids. The IPO price was 1AED and the stock opened at 5.48 AED a huge increase though like the internet boom Dana Gas has also come to grief with the shares closing at .98 AED today in Dubai.

So here we have two stories of two IPOs massively oversubscribed and massively successful on their first day of trading. Both were start ups, venture backed and were the tocsins of their eras. But what is important about them are not their similarities but their differences.

The first, and most obvious, difference is scale. The Netscape IPO doubled on its debut, Dana Gas more than quintupled. The oversubscriptions are very different, Netscape 20 times and Dana Gas 140 times. To say that one was 20 times and the other 140 times doesn’t go far enough to describe the difference. Not only was the Dana Gas oversubscription massive relative to the size of the offer, it was massive relative to the size of Dubai’s entire economy. In 2005 the total GDP of Dubai was 140 billion AED, so the amount bid for the Dana Gas IPO was greater than the value of all the goods and services produced in Dubai over the course of a year!!! How can that be!?! Imagine an IPO in the US generating $25 trillion in interest!! You might be thinking, surely you’re joking. No, I’m totally serious. Clearly this merits a closer examination.

The mystery behind this is that the IPO process in the UAE is very different from the process in the US. The most obvious way in which they differ is in the allocation process. As I have mentioned in America the IPO allocations are done in a discretionary process by the bankers. In the UAE the allocations are done formulaically and in two tranches. There is a retail tranche which is open to UAE or GCC nationals only. For the Dana retail tranche 700 million shares were set aside and divided evenly among all those who applied. For Dana that was about 400,000 people so each person got 1750 shares, thus each person made about 8000 AED on day one. Because of this allocation methodology the retail tranche can’t really be oversubscribed. What really happened was that the institutional tranche was 222 times oversubscribed, more than ten times Nestscape. That’s where the magic was.

While the retail tranche allocation is divided by the number of subscribers, the institutional tranche is divided by the value of each investors bid. If I bid for $1 million worth, and you bid for $10 million worth you get ten times as much as I do. This is novel and you could argue that it makes more sense than the American way of doing it where a handful of guys decide who gets what. In the UAE if you want more, you bid for more, you get more.

The banks add an interesting wrinkle to this: they’ll lend you the money to gross up your bid. HSBC was to lever some of their clients up to 5 times. So now, you put up one million, they lend you five million, now you’re in there bidding for $6 million and you’ll get a much bigger allocation. Many clients got significantly better leverage than five to one. I think the legal limit was 12 to one and some clients got even more than that. So why would the banks do this?

Well another difference in the UAE is that you have to actually put up the money at the time you subscribe for the IPO. As you don’t find out your allocation and get your refund for 30 days you have to pay interest on your loan for those 30 days. That’s how the bank makes money. It seems like a minimal risk to the bank, they’re lending you money to buy shares which have yet to be issued. If they lever you 10 to one and the issue is 20 to one oversubscribed they never even have to take a pledge of your shares because they get all their money back and you even get back some of your deposit. In the interim, your pledged money plus their loan to you go to the company which turns around and deposits it in the receiving bank until it’s refunded after the 30 days, so the money never actually leaves the bank.

Wait a minute, did you say the money goes to the company? Yes, the company gets to earn interest for 30 days on the amount of money bid for the IPO. So in the case of Dana Gas they got to earn interest on the GDP for Dubai for 30 days. I think the total proceeds to them were something like 1 billion AED, almost as much as they raised in the IPO itself. I’m not making this up. You’re probably thinking to yourself that something is missing here. What is the weak link in the whole argument? Well, there’s a big one.

This entire system is predicated two assumptions: 1.) there will be a massive increase in the shares on day one, and thus 2.) the issue will be massively oversubscribed. Imagine for a moment that the banks levered the subscribers 5 to 1 but the issue was only covered, not oversubscribed. Now the banks have essentially made margin loans to all their clients on a 5 to one basis at the IPO price. Unless the shares trade up a lot the bank is going to have to issue margin calls the instant that trading begins. If the shares decline then the bank is in very serious trouble indeed. Despite these risks banks and investors were willing to risk the entire GDP of the country on the fact that the Dana Gas IPO would be significantly underpriced and thus significantly oversubscribed. With a risk that big you would have to assume that it was a sure thing. So is it a sure thing that the IPOs in the UAE are systematically underpriced? Yes it is.

As I mentioned earlier in this article in the US the IPO price is determined by a process called book building where investors submit bids at varying levels beginning with an indication given by the bankers. This is done to try to arrive at a level which does not leave too much on the table for the sellers and at the same time leaves upside for the buyers. Who decides what the IPO prices should be in the Emirates? The government.

What happens is that the issuer and the advisors submit a request to ESCA, the Emirati Securities and Commodities Authority and ESCA has to approve the valuation. The ESCA valuations are always on the conservative side. There are several reasons for this. One is that ESCA, like the SEC has a mandate for investor protection. If you told the SEC to decide the value of all IPOs in the US it would probably make them cheap as well. Two, a failed IPO would look bad and the UAE will spend billions to not look bad. Most importantly is a philosophical reason and that is that the authorities look at the IPO process as a form of wealth redistribution. I have had government officials throughout the Gulf tell me this in person. The theory is that if you are running a successful commercial enterprise in the Gulf you probably had significant help from the state (not an unreasonable theory.) Therefore might it not be reasonable to expect the owners to take a hit on their IPO and share their good fortune with the regular folk by low balling the IPO price? ESCA thinks so and that's what matters.

So what are the implications for this? The most important one is that if you have a valuable business you would have to have a hole in your head to sell your business this way. Sure you might recoup some of the ESCA discount through the float on the oversubscriptions but the amount of that will be correlated to the size of the discount, the ease of subscription and the level of interest rates not the value of your business. As a result most of the businesses that have done IPOs were start-ups like Dana, government companies like the DFM or companies owned and managed by people who were subject to political pressure from the powers that be in the Emirates like Arabtec. It’s hard to see this by looking the the list of shares on the DFM, you have to look instead at the fact that the most successful businesses in Dubai would never ever consider doing an IPO.

To bring this back to my original point about the equitization of the debts of Dubai something it desperately needs to do. Local IPOs pose significant risks for Dubai. ESCA is a federal regulator in the UAE and therefore is controlled by Abu Dhabi. For Dubai to begin listing its crown jewels it would be subject to Abu Dhabi for valuations which would almost certainly be lower than it would get if a true auction were held. Gosh if only there were someplace that Dubai could sell equity where it would not be subject to the ESCA approval process and instead could do a book built IPO, wouldn’t that be a great idea. Well there is such a place it’s called the DIFC and it will be the subject of my next post.

Saturday, January 16, 2010

"Whom the Gods would destroy, they first make mad with power." -Euripides. Dubai considers something different, they're going to sell their power.

It came out yesterday that DEWA the Dubai Electricity and Water Authority was considering a potential privatization. This is very interesting for a number of reasons. The stated purpose of this is to increase service quality and the overall competitiveness of the industry. As with so many things in Dubai these days there is probably another reason behind the one given. At this point it is not a secret that the Dubai Government is facing a severe cash crunch. So far what talk there has been of asset sales has been at the subsidiaries Dubai World and ICD. DEWA is a public utility, yes it has debt but it is not an investment vehicle of the Dubai government but a basic municipal service. Perhaps if a successful privatization can be done at DEWA maybe something can also be done with the Dubai Metro to help raise funds to pay the Japanese contractors who built it. If nothing else this is a sign that the powers that be in Dubai though still capable of flights of fancy are coming to terms with the real issues at stake.

The thing that strikes me about this is that what the idea of privatizing DEWA really is, is the equitization of the debts of Dubai. That is to say Dubai is willing to give up some ownership in order to pay down debt. It is becoming increasingly clear that the debt burden of Dubai is so great that this is going to happen regardless of what Dubai does. There is just too much debt coming due relative to the ready cash that the Emirate has. One way or another Dubai is going to lose ownership in many of its assets. This can happen in one of three ways.

1.) Default and repossession— this is the messiest for all involved. Not only is the insolvency code in the UAE not up to the job, neither are the judges who would adjudicate them. There are also many assets in many jurisdictions and in the end the entire process would humiliate everyone involved and enrich only the lawyers. So far both Dubai and Abu Dhabi have bent over backwards to prevent this outcome.
2.) Stealth Equitization to Abu Dhabi—So far this has been the method of choice. The bonds in the Dubai Financial Support Fund carry a low rate of interest and do not contain any covenants or warrants or anything that even resembles equity or a claim on Dubai. Though that may be how things are on paper I think it is a dead certainty that the money does come with strings attached. Dubai may not fully recognize this as yet but I think the renaming of the Burj Dubai/Khalifa and the recent take-under of the largest private construction company in Dubai are signs that there is a new sheriff in town. This is a transfer of equity in fact if not in name. The difficulty for Sheikh Mohammed in this kind of opaque equitization is that he does not know where it ends. Today they want Arabtec, tomorrow Emaar? Emirates Airlines? And for how big a discount? The trouble with unwritten contracts is that they mean whatever the more powerful guy says they do.
3.) Formal Public Equitization—in theory Dubai could manage its own equitization through a combination of trade sales like the one envisioned in a DEWA privatization or through the issuance of public equity. The only time Dubai has done this was back in 2007 when it sold 20% of Dubai Ports World in an IPO on the DIFX.

This last idea whereby Dubai would sell equity in its various entities to outside investors and then take the proceeds and pay down debt is probably the best way forward for Dubai. It would allow Dubai to avoid default and it would also allow Dubai to emerge from the crisis without being completely beholden to Abu Dhabi.

Any attempt to formally equitize the debts of Dubai is going to run into three hurdles: psychology, reality, and the nature of the capital markets in the Emirates. Arabs in general and Dubai in particular are jealous of equity, they do not like to share it. This is generally understandable, who wants to surrender control of something, even partially, if there is any alternative. This recent announcement about a potential privatization of a basic service in Dubai I think is a realization by the government of Dubai that their debt is going be equitized no matter what and it will probably be better for them if they do it rather than have it done to them by their creditors or by Abu Dhabi.

The next hurdle is reality. It will only be possible for Dubai to equitize its debt if the markets believe that the discounted future cash flows of all the businesses that Dubai owns are greater than the value of the debt outstanding. It would seem that within quite a few of the Dubai entities this is very much in doubt, particularly in the Dubai real estate markets. In others such as DPW or Emirates Airlines the markets seem to think that there are pretty good prospects. So, ideally what Dubai would do is issue partial equity in the assets which are viewed favourably and use those funds to rescue those which are not. Given that this is going to be a close run thing it is very important for Dubai to get the best possible prices for the assets it has. To get the best possible price you need to have the widest possible auction and the ideal venue for that would be a public offer of shares in the larger Dubai entities.

This is where Dubai will face it’s greatest hurdle: the capital markets of the UAE simply do not function. The way in which they malfunction will be the topic of my next blog post.

Thursday, January 14, 2010

Dubai to UN: can we interest you in some islands in the shape of the world?

Dubai today invited the United Nations to relocate to the Emirate from New York. I think there are a lot of things to reccomend such a move. Firstly the climate is better than New York, at least it is during the diplomatic season. There is plenty of avaliable real estate both residential and commercial as well as a lot of empty hotel rooms and conference space. They're not wrong that there really are world class international airline connections to Dubai it is a pretty central location for a larger number of the member countries, centrally located near the center of the Euraisan/Afrian landmass.

There are a few issues though, and I'm not going to mention the regional ones such as being within missile range of certain nations upon which it may impose sanctions. Large sections of the UN Websites have been blocked including sections of the UNHCR and Human Rights groups. The screen you would get would say that these sites had been blocked because they conflicted with the moral and cultural values of the UAE but I think it might have more to do with certain critical comments made. These sites may have become unblocked since I left the Emirates but I don't know. Regardless it might be hard for those sections to do their work without access to the internet.

Another issue that will arise is SALIC, the speeding monitoring devices in Dubai. UN diplomats are used to ignoring fines and petty debts to their hosts here in New York City. Anybody who bounces a check to SALIC though may well see the inside of a jail cell in Dubai.

The most interesting part of this story though is how I found it. One of my favorite Bloomberg functions is NI ODD . This is Bloomberg's "news of the weird," their collection of ridiclous stories gathered from around the web. The number two story today is about a group of unsuccessful and apparently unlucky dieters who had the floor buckle beneath them at a weight watchers clinic. The number one story was Dubai Invites UN to move from New York. This should serve as a wake up call to the people who run Dubai about where their credibility is in the world now. Three years ago that story might have made the TOP function with some soul searching by Western analysts about the rise of emerging markets. Now its in the comedy section with other stories about people from whom the floor has fallen out.

I'm a surrealist and I used to love the Dubai real estate section, now I just read the court reporters. You can't make this stuff up.

It has been rough sledding for the DIFC lately. First NASDAQ abandoned the DIFX project to the DFM. This reduced NASDAQ from a partner in the development of Dubai as a financial center to a passive and very minor shareholder in the DFM. Bourse Dubai still owns substantial stakes in the NASDAQ and the LSE but may be forced to sell them if it can’t roll its’ debt in February. Not much has changed functionally, NASDAQ did not contribute much aside from the brand and the management and though the exchange has launched derivatives they have not realized their potential but symbolically its’ a blow.

Then came the news that Dubai Ports World, the star listing of the DIFX would seek a dual listing in London. It had been a major triumph that the DIFX had been able to play host to the DPW IPO as a single listing. At the time, back in 2007 DPW was the largest IPO in the history of the Gulf States and was also the first privatization for Dubai which, had it been followed by others, might have alleviated or perhaps prevented altogether much of the suffering that is about to befall Dubai. The fact that DPW is also seeking a London listing is a sign of the desperation of Dubai to raise the equity value as well as a sign of the failure of the DIFC.

As tragic as these things are, readers of my blog will know that these issues are not what I consider to be the main issue of within the DIFC, but more on that in a moment.

The DIFC is not standing by, it's cutting fees to attract more business. It is actively engaged in the issues on which Dubai is most focused. It is the jurisdiction of choice for the special tribunal that will oversee any issues relating to the insolvency of Dubai World or any of its subsidiaries. This was an absolutely essential step because behind the uncertainty around the ability of Dubai Inc. to pay its’ creditors and the willingness of Abu Dhabi to support Dubai if it cannot lies the greater uncertainty of what happens in the event of Default. The default regime of the UAE proper is extremely uncertain. The default regime of the DIFC is untried but the legal principles involved will be more familiar to western creditors and more comforting for all involved.

Though I make light of it in a previous post I think it is important that Dubai is playing host to a conference of insolvency lawyers. I think it shows at the very least that the powers that be in Dubai “get it.” Their capacity to roll the debts they have against their more solid companies will depend largely on the faith that the creditors will have in their capacity to take control in the event of an insolvency. This is important because in contrast to 2005, in 2009 creditors are less concerned with the return _on_ their money than the return _of_ their money. If the Dubai Insolvency Conference can help to ease the fears of investors then the rough ride ahead will be a little bit smoother.

I do however think that with all this focus on what precisely the laws say and imply that Dubai and the Emirates generally are missing the forest for the trees. The main concern with the international community is less with the quality of the law than their equality before the law. Generally I think the best job to have on the staff of any Middle Eastern newspaper is the court reporter as long as you have a taste for the surreal. Just in the past week or so we have had the story of a UK woman who was sexually assaulted then then arrested for drinking and engaging in illegal sexual activity with her fiancée. The case of an Afghan grain merchant being tortured by a member of the Abu Dhabi royal family. The Emirati was released though all this accomplices (non-Emiratis) were jailed. There is also case of Mr. Hassan which I have documented elsewhere. Emiratis have to remember that the rest of the world can read the whole paper, not just the business section and what the rest of the paper says is that if you go to court against an Emirati in the Emirates you lose regardless of the facts. This creates quite a sense of unease among foreign investors.

This was why the DIFC was established in the first place. To give investors confidence that financial transactions they undertook inside the center would provide some legal certainty. Then you have the stunning example of the DFSA standing aside while the Abdullah brothers loot Damas of $160 million. One Abdullah brother resigns and then negotiates with another Abdullah brother the pledge of shares worth a fraction of the amount stolen cash. The DFSA stands by while this all happens. No investigation, no legal action, no filing, no reprimand. These actions by the Abdullah Brothers break DIFC law, make no mistake about it. A crime has been committed but nothing has been done. Nothing. Why? It would seem because the Abdullah Brothers are Emiratis and the shareholders are not. The DIFC and the DFSA are proving themselves to be paper tigers, and just an extension of business as usual in the Emirates. Is it any wonder that DPW trades as a discount with this as its only jurisdiction?

This is fine for people who know and take those risks. Abu Dhabi can still play that game. There is money to be made there and there are ways to do business in a place where the legal and regulatory deck is stacked against you: only deal with people you know and trust personally and take the time to find out who they are. For Dubai that ship has sailed. It’s all well and good for the Abdullah Brothers to steal $150 million or so that’s a lot of Ferraris and houses on the Rivera but its not the end of the world. Now Dubai is trying to convince the rest of the world that it can fairly adjudicate $80 billion in debt there if need be in order to convince them to roll that debt. $80 billion is enough to sink Dubai and a lot of money to bet on something as flimsy as the DFSA. Will the international financial system take the bait? Wait and see.

Tuesday, January 12, 2010

Outstanding! And not a moment too soon!

Some blog entries write themselves.

Alas, they don't really. My apologies comrades/readers. I have been writing reccomendations for my young friends and former colleagues who have been cast out of the finance game for the time being and are thus hitting the career reset button and applying to grad school. Though Harvard as mercifully limited me to a mere 250 words per question many others ask for more and so my literary talents, such as they are, were devoted eslewhere. Patience friend reader, there is more to come.

Monday, January 11, 2010

Wishful Thinking

As I write this the top article on Bloomberg on the Web is about a foreclosure case in Dubai. The article says that this establishes a precedent that may open the floodgates to more foreclosures within the Emirate.

There are a few problems with that conclusion:
1.) Barclays refuses to release any information about the case other than it won. If this was a forclosure against a foreign national who had left the Emirates and not turned up to defend his rights to prevent enforcement, which are extensive in the UAE, then the verdict has little meaning.

and more to the point:

2.) The concept of precedent does not exist in Emirati courts so no single judgement is capable of "opening the floodgates." Indeed records of previous judgements are not even kept in Dubai which is probably why Barclays published the verdict itself.

Just more wishful thinking by Dubai creditors.

Dear passengers once we land there will be a slight delay as we taxi the plane into the bank accounts of the firms who built the Dubai Metro.

Bloomberg Today reported that CMA Datavision is now publishing quotes for CDS on Emirates Airlines. This is an interesting story not so much for the fact of it but for the timing. It’s no secret that lately Dubai has been struggling with debts. Dubai Ports World CDS have been trading as a proxy for all things Dubai especially as DPW was part of Dubai World. Dubai world of course is the parent company of Nakheel, the center of a dramatic cliffhanger after it asked for a debt standstill agreement and was subsequently bailed out by Abu Dhabi.

Emirates Airlines however is owned by ICD. Generally the asset quality inside ICD is better than that inside Dubai World or Dubai Holding for that matter. Why the sudden interest in Emirates Airlines CDS? After all, Emirates Airlines is doing relatively well despite the issues in Dubai itself and has been consistently profitable. ICD is doing relatively well compared to Dubai Holding and Dubai World. Well, the owner of ICD is the government of Dubai and that may be where the problem is and with it the next chapter of the Dubai saga.

It seems that the Dubai government has gotten itself into trouble with some Japanese companies. A while back, when Dr. Omar was right and the only real problem in Dubai was the traffic the government of Dubai decided to build a mass transit rail system. It put out a tender for it and requested that the bidders secure 90% funding. The Bin Laden Group, a massive Saudi construction firm (as opposed to the small Pakistani destruction firm of the same name,) secured Chinese funding and looked to win the bid. My guess is the Dubai government was loathe to grant the contract to a Saudi company so they withdrew the requirement and promised to pay themselves. As a result they awarded the contract to a consortium of Japanese companies.

Fast forward today and as is well known the Dubai government is... well.... a little strapped for cash. As a result they’re a little behind on paying the Japanese. It seems like the shots are increasingly being called in Abu Dhabi and the Japanese are probably getting nervous about their money. There isn’t a lot they can do about the work they have already done, it’s done and it’s in another country. They have stopped work on the rest but there is a lot done already and they are short something like $7.5 billion.

So what is the next stop for the Dubai Metro? Litigation Central. My guess is that the Japanese contractors have taken a page from the QVT play book and are going to sue the government of Dubai outside the UAE for recovery of what they are owed. Just like with QVT and Dubai World the thing to look for is what international assets does the government of Dubai have? Well, there are the international assets of Dubai World which I discussed at length during the Nakheel adventure which consist mostly of maritime infrastructure, real estate, and private equity holdings: nothing particularly liquid but nonetheless valuable. How about ICD? Well, most of its assets actually are in Dubai proper and therefore hard to get at with a judgement from an international court. Then there is Emirates Airlines.

Emirates Airlines is headquartered in Dubai but of course at any given time its assets are to be found outside the country: it’s planes. The Japanese Consortium could seek a judgement against Dubai in an international court and then seek to attach and arrest the planes belonging to Emirates Airlines. This is vastly simpler than repossessing the real estate assets of Dubai world would be, and the secondary market in commercial aircraft is far more liquid than that for real estate (especially now) or ports. Emirates does lease some of its planes but most it owns outright and about half of those that it leases it leases from other entities also owned by the Dubai government. It will probably also scare the hell out of Dubai and maybe Abu Dhabi to have repo men coming after their beloved A380s all over the world. As with the Nakheel Sukuk holders maybe they'll just pay off to avoid the embarassment.

This is all very bad news for you if you are a creditor of Emirates Airlines. The nature of the business requires that the primary assets be constantly flying outside the UAE to countries that are likely to enforce judgements obtained in UK, US or Japanese courts. If the planes are kept inside the Gulf where they are not likely to be seized by creditors of Dubai it can’t earn the income necessary to pay you. You might want to call up your friendly neighbourhood CDS dealer and hedge out your risk, and that is what I think is happening. Watch this space.

But sir, we LOST money on Arabtec! If we give back the losses like the Abdullah brothers plan to give back their gains can we also go free?

The DFM is conducting an investigation into “abnormal price movements” in the shares of Arabtec. It seems that the rumor about the Arabtec deal got out and traders took the stock higher, some 25% higher in three days. Aabar denied the rumors and Arabtec said they had no idea what was driving the stock. As it turned out sure enough the rumors were true as I’m sure the people who were buying the shares knew. Unfortunately for them they assumed that the takeover would happen as is customary: at a substantial premium to the current price. Instead, it came in at a substantial discount so anyone who bought shares in Arabtec on knowledge of the Aabar acquisition actually lost money. D’oh!

This is particularly interesting in light of the treatment of the Abdullah brothers who in a series of "unauthorized transactions" took over a hundred million dollars from the shareholders of Damas and invested it in their own names in Dubai real estate. This massive fraud has provoked nothing more than “close monitoring” from the appropriate regulatory authority. And now, since the brothers Abdullah have agreed to give back their gains (someday) or else give over shares (which the current holders cannot receive) there seems to be no further effort on the part of the authorities to pursue actions against the fraudsters. Perhaps if the Arabtec inside traders agree to give back their losses they can also escape regulatory scrutiny.

Saturday, January 9, 2010

Abu Dhabi to Arabtec shareholders: "O Plato o Plomo?" Lead or Silver?

Abu Dhabi has made its first offer that Dubai cannot refuse.

On Friday, the weekend in Dubai it was announced that Aabar, an Abu Dhabi government investment vehicle, had agreed with Arabtec to purchase mandatory convertibles for 6.4B AED which, when converted, will give Aabar 70% of the share capital of Arabtec. The conversion ratio implies a price of 2.3AED per share a 20% discount to where the shares closed on Thursday afternoon implying that Aaabar has acquired well more than complete control of the company for a discount from the current owners. Ordinarily current shareholders demand a premium to relinquish control. As a person who specialized in trading options around takeovers this is what in Wall Street merger-arbitrage parlance we call a “take-under.” At least that is how it looks at first glance but as with so much in Dubai one has to look a little deeper to see what substance for the shadow.

Firstly it is important to know what Arabtec is. Arabtec is a construction company in Dubai that was founded in 1975 by Riad Kamal, a London educated engineer and very enterprising Palestinian who founded the company when what we know as Dubai was merely a glimmer in the eye of Sheikh Mohammed. Arabtec became a highly competent subcontractor for the industrial and real estate development projects in Dubai. Take the Burj Dubai/Khalifa for example. Emaar announces a major project raises money through equity, debt, and forward sales of off plan real estate. It then takes that money and hires Arabtec to actually do the building. Emaar is a marketing and development company, the building gets done by Arabtec, and they did a lot of it. Arabtec built such Dubai mega-projects including such wonders familiar to Dubai visitors as Terminal 1 at DXB and the Burj Al Arab, (not to mention such questionable micro projects as the elevators in my old office in the DIFC Gate Village.)

In theory the debt financing is done at the real estate company level and the construction subcontractor should be largely immune to the woes of the large Dubai developers such as Nakheel especially considering the efforts that Arabtec has made to diversify away from Dubai into Saudi Arabia and Russia. Remember however that Mr. Kamal is a non-Emirati like Mr. Shetty. The political economy of Dubai being what it is, sometimes if you are a non-Emirati sometimes you have to take one for the Emirati team. And so as time went on Arabtec extended more and more trade credit to Dubai developers. Eventually its accounts receivable grew to almost twice the value of it’s equity. That is to say that in the event of the insolvency of the major developers in Dubai the equity holders of Arabtec would be wiped out. As a result the shares of Arabtec closely tracked the fate of Nakheel. It’s shares were cut in half when Abu Dhabi announced that not all Dubai entities were equally worth saving and seemed to put Nakheel outside the ring. Since the Abu Dhabi rescue of the Nakheel Sukuk holders Arabtec shares have almost fully recovered to where they were before the November crisis. So you have to ask, with things looking up why the take under?

The new deal is according to the CEO “dilutive to shareholders.” At first glance saying that this deal is “dilutive” to shareholders is like saying that the Titanic striking an iceberg was “moisturizing” to passengers. They begin by owning 100% of the company and end by surrendering 70% of the company at a valuation that implies a 20% discount to where their shares closed on Thursday which was itself 20% below where the stock was trading in mid November. This deal has been agreed with blinding speed. Negotiations began on January 3rd and the transaction was agreed on the 7th and is intended to be implemented by the 13th but for the fact that 75% of the shareholders have to agree the transaction. Surely they’ll balk at this transparent theft of value, and the Dubai drama will increase.

Not so fast.

You have to ask yourself what is the value of Arabtec without the deal. Well, the largest itema on the asset side of the Arabtec balance sheet are accounts receivable from various Dubai real estate developers. If those receivables actually are received the equity is worth quite a bit more than it is today. If they are not, it is worth zero. Who will decide whether those receivables actually are received? Abu Dhabi. Who owns Aabar? Abu Dhabi. The logic of this from the Abu Dhabi perspective is perfect. Nakheel almost goes bankrupt because it owes money to its Sukuk holders and its trade creditors (Arabtec.) Abu Dhabi steps in and rescues Nakheel and pays off the bondholders, money out the door. But wait, if Abu Dhabi takes control of Arabtec it can pay the rest of the bailout money to Arabtec as a trade creditor, which it now owns and therefore Abu Dhbai is the end recipient of its own aid. Outstanding! And why pay full price because it can bankrupt Arabtec by refusing to pay trade creditors and keeping the money only for bondholders. Looked at that way a 20% discount seems rich.

This is similar to what the US government did with the large banks after the AIG bailout. The Treasury bailed out AIG and gave it a cash infusion that it then turned around and paid the banks. Then the Treasury forced the banks to sell it preferred shares plus warrants. When the stocks rallied after the financial system did not collapse partially on account of the AIG bailout and balance sheet enhancing preferred equity infusion the Feds started selling out thier warrants and making some of the bailout back. Abu Dhabi is doing the same thing only better. They're taking straight equity at a discount and they are in to stay.

So what’s next? Riad Kamal the CEO said that the money would go to fund a wave of acquisitions by Arabtec. On first glance that sounds a little outlandish given the position of Arabtec but from the perspective of Abu Dhabi it makes perfect sense. Now that Abu Dhabi controls both the capacity of Dubai World to pay off its trade creditors and an acquisition vehicle in Dubai it can consolidate all the other construction firms in Dubai to which Dubai World and eventually Dubai Holding owe money which is all of them.

Imagine you own a Dubai construction company. Let's say you are a struggling businessman from the subcontinent. One day you are reading the paper about how that fellow Shetty just bought the whole 100th floor of the Burj. You had been planning to buy the 101st floor until the bottom fell out of the real estate market and now you are up to your ears in IOUs from Nakheel and Limitless. Your Emirati landlord keeps threatening to bounce your post dated rent checks and throw you in jail which has you thinking about Mr. Hassan. Then your phone rings. It’s that friendly guy Abdulla Al Habibi from the business development department at Arabtec. He’d like to buy your company and asks you what you think it’s worth. Well, our market cap is X you tell him. Hmmmm... he says, how much of your balance sheet are receivables from Nakheel? Ahh 80% you say. I see, I see he says. I’ll tell you what, here’s the deal: you sell your company for 50% of X or else I make sure Nakheel pays you zero and wipes you out. What do you say?

Well, you have to think about that for a second. Let’s say you say no, and if Nakheel defaults you’re going to court. The court you’re going to is a special tribunal in the DIFC with judges hand picked by Sheikh Mohammed, the ultimate equity holder in Dubai World, to deal with the creditors of Dubai World and its subsidiaries. How are things going in the DIFC with regard to equity for stakeholders? Well if you are a connected Dubai merchant family like the Abdulla Brothers they’re going pretty well. If you’re a non-Emirati investor, things are looking a bit gloomier. The truth is Mr. Habibi can save you for 50% or wipe you out. Odds are you sell and Abu Dhabi can roll up control of the real estate and construction industry in Dubai in just this way.

While the analogy I am using in the title is the offer that Colombian drug lords make to the judiciary: plato o plomo: lead or sliver, bribes or bullets, that doesn’t necessarily make it a bad thing. This methodology was also used by John D. Rockefeller once he had consolidated the refining industry in the US. He would go to guys that owned oil wells and say “gee I think you should sell me this well.” If the guy said no, Standard Oil stopped buying oil coming from that well until the guy went bust then he bought it in foreclosure. Then he went to people who owned petroleum retailers and said “gee, you should sell me your store.” If the guy said no, Standard Oil stopped supplying them until they went bust and they bought them in a foreclosure. The great great grandchildren of people who sold out to Standard Oil for shares are rich to this very day. It’s not always bad having a gun put to your head, you just have to make the right choice.

Tuesday, January 5, 2010

Dubai a city that South Asians can set on fire... or vice versa.

On the day of the opening of the Burj Dubai/Khalifa there were two human interest pieces in The National, an excellent Abu Dhabi newspaper. The stories are about two men named Mohammed Hassan of Pakistan and Bavaguthu Shetty of India. Both men came to the Emirates like many other South Asians to seek their fortunes. For many in South Asia the Persian Gulf is today what America was in the nineteenth century to immigrants from Europe, a relatively free place to strike out on your own and try to build a better life for yourself. If anything the magnetism of the Gulf today is greater than America’s a hundred years ago. The per capita GDP of the UAE is $44,600 per year vs. $2,900 in India and at purchasing power parity, in nominal exchange rate terms it’s more like $1,000. The disparities between America and Europe were never that stark.

This is a point that is not really well understood by many people who look at labor markets in the Gulf and South Asia, especially from an American perspective. To pay an Indian laborer in Dubai $5,000 a year in US dollars is the equivalent of paying him five times the per capita income in India or would be similar to paying an American $225,000 per year. Imagine there was a country where Americans with no education whatsoever could go and earn $225,000 a year tax free to wash dishes and fold clothes or work construction. Do you think people would go? Hell yes. Detroit and West Virginia would be completely empty. Would they feel exploited? No they would feel like the people paying them were suckers. You could do it for five years and come home a millionaire buy a bar and a pickup truck and spend the rest of your life fishing. This is the deal South Asians get when they go to work in the gulf, scaled of course for the cost of living in India.

And so many ambitious people from South Asia who don’t see great opportunities for themselves in India or Pakistan come to places like Dubai and Abu Dhabi. Sometimes they come on their own with a little money to start a business like the North Europeans who settled the American upper Midwest. This is how Mr. Shetty came and started a one room pharmacy in Abu Dhabi. Sometimes they come as manual labourers with little education but energy like the Irish or the Chinese who were put to work in the mines or on the rail gangs. Or like Mr. Hassan who came as a driver for an Emirati family. The one thing they can’t do is stay and become Emiratis. This is also hard for Americans to understand. Being an American is not an ethnicity, it is ascribing to a set of shared beliefs (and agreeing to global taxation.) This is the exception not the norm. Frenchmen, Indians, and Emiratis are born not made. But for most South Asians who come to the Gulf the deal they get is the best on offer so they take it.

As in America sometimes things work out for the best as is the case for Mr. Shetty. Mr. Shetty is in the newspaper today because he bought the entire 100th floor of the Burj as well as several other apartments as high as the 148th. He was an enterprising man and grew is one room pharmacy into a hospital, and the hospital into a chain of hospitals. From the chain of hospitals he moved up the value chain to pharmaceutical manufacturing and then diversified into retail and financial services. He has made the papers before having won various business awards and being considered a pillar of the business community.

Things did not turn out quite so well for Mr. Hassan. He got into an argument with the teenage sons of his employers. In the course of the argument the boys beat Mr. Hassan unconscious with a 2 by 4. Either they were really mad or maybe they thought they had killed him and needed to get rid of the evidence because they then doused him in gasoline and lit him on fire, killing him. He’s in the news because his killers, who were originally sentenced to a three years in prison, were released today after time served (one year.) This was because they worked out an arrangement whereby they would pay “blood money” to Mr. Hassan’s family back in Pakistan. Personally the fact that they were released after time served is only slightly more distasteful than the fact that their initial sentence was three years.

So what’s the difference between these two men? Just by reading the stories it looks like a lot. Shetty had an education, he came to the Emirates as a pharmacist. He had enough money with him to start a business a small one, but something. Hassan on the other hand was probably brought over by a company that recruited in domestic workers or cab drivers. Usually these companies keep your passport and so you can’t leave though Mr. Hassan could probably not have afforded his flight home even if he had his passport. He probably did not have a lot of say in who he worked for and certainly could not do much about how they treated him. Another difference is that one of them is a Muslim and the other a Hindu. If you’re an American you may not be able to tell by their names but you also can’t tell from their outcomes. Mr. Hassan was the Muslim, Mr. Shetty the Hindu.

Though they came with different assets they also faced many of the same hurdles. As mentioned, neither of them can ever acquire Emirati nationality, nor can they ever have permanent residency. Whatever the statute they will never have equal standing in a court of law in a case involving an Emirati. For that matter Emiratis don’t always have equal standing against each other which is why they largely avoid the courts. As non-Emiratis they can have very long term leases or freehold condos but they can never own land.

Indeed, though he has made millions in the Emirates Shetty cannot ever own more than 49% of his companies unless they are incorporated in a free zone. That may help explain why he diversified into manufacturing and re-export because the free zones are designed to encourage those businesses. For his major enterprises I am sure he has structured them in such a way as he retains most of the profits and any major changes to the management or disposition of assets require a supermajority that would give him a veto but he can never be totally secure that he owns what he owns. So in the sense that they have minimal legal recourse against Emiratis the thing that unites them is more important than the wealth that divides them.

Some of the best business advice I have received was also some of the simplest. “If you want to be a player, learn the game.” Sounds simple but you’d be surprised how few people do it. The difference between Mr. Hassan and Mr. Shetty is that Mr. Shetty knew the rules of the Dubai NRI game and prospered Mr. Hassan broke one of the cardinal rules and was murdered and his killers are free.

Mr. Shetty by law could only own 49% of his business so he was forced to take on a partner when he started his pharmacy. He probably found the most influential Emirati he could to own the other 51%. In the beginning it probably wasn’t a very influential Emirati. Shetty may have been able to keep more than 49% of the profits but he made sure that the Emirati got paid. That way if things went badly for him or an Emirati threatened him or refused to pay, he would go to his partner who would work out the problem with the other Emirati as equals.

The 49/51 rule is sort of like a protection racket because the courts don’t really function and for a non-Emirati attempting redress against an Emirati they are truly dangerous. It’s also a sort of welfare for Emiratis. They have majority ownership in all the businesses in the Emirates that are run by foreigners but play little role in the day to day business, they’re political muscle. This arrangement is very common. American consular officers in Dubai are trained in this because often when Emiratis are applying for visas and they have to describe their profession many of them cannot even list all of the businesses they are in because they are partners in so many.

Once Shetty was successful he was enriching his Emirati partner and the Emirati brags to his friends. Now more people want to be partners with Shetty. He starts new businesses, more partners. All of them take a piece of the action and the cost to any particular Emirati of threatening Mr. Shetty goes higher and higher because now they are taking on more and more people who are benefitting from Mr. Shetty’s success. When he gets interviewed he talks about how great the business environment is, how wonderful the ruler is, and it’s true. He’s doing better in Abu Dhabi than he would have ever done in Andhra Pradesh.

The whole time he keeps making the payments because he knows that when the payments stop so does his protection. Indeed, he lives on a knife edge. If someone decides that Shetty is taking too much or one of his partners decides that he really needs what Shetty has, Shetty will lose everything and be on a boat back to India. An Emirati friend once told me “We let them make twenty, thirty million then we take everything else.” That is probably an exaggeration but occasionally they do, because they can.

The legal system is a precarious thing in Dubai and most other Gulf States. It is not particularly good at settling disputes between Emiratis which is why they rely on relationships and reputation more than the courts. For unscrupulous Emiratis the courts are positively a weapon in conflicts with foreigners. This is why the 51/49 rule is a blessing inside a curse, it enables foreigners to co-opt Emiratis into intervening on their behalf. But it makes the foreigners permanently insecure. They are richer than they would be back home in India or Pakistan but they can never be totally safe. If any South Asian ever needs to be reminded of this every few months there is a story about someone like Mr. Hassan who argued with an Emirati, was beaten unconscious, lit on fire by men who walk the streets of Dubai today as free men as if it never happened.

I am using the extreme examples of Mr. Hassan and Mr. Shetty to make a point. The acute phase of the Dubai Crisis is in the hands of the Al Maktoum and the Al Nahyan. The strategic fate of Dubai is in the hands of a million people with names like Khan and Patel from Pakistan and India who run the businesses and rent the apartments and on who Dubai will rely on if it is to recover. When the most recent round of funding from Abu Dhabi runs out in April the Dubai government will go to the wall again. Maybe they’ll get more help from Sheikh Khalifa.

If they don’t they’ll have suffer the humiliation of handing over the Dubai Inc. crown jewels to their creditors. Faced with that prospect the option of expropriating the foreign owned and run businesses in Dubai is going to become an extremely tempting. The government of Dubai has already stood by while the shareholders of Damas were robbed blind by a powerful merchant family. How much would it bother them for Indian and Pakistani businessmen finance the retention of their honor and their assets?

On the other hand this is a golden opportunity to cement the role of Dubai as the business hub of the middle east. If they make a point of ensuring property rights and rule of law they’ll draw more investment in from South Asia and recover faster. But the cost to them may be bankruptcy and scandal. Can they resist? The Dubai Crisis remains a cliffhanger.