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.