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.