Sunday, February 14, 2010

Dubai World Creditors: batten down the hatches, the storm approaches.

Zawya Dow Jones, the extremely capable MENA news bureau reported today on some rumoured details of the package that might be offered to the Dubai World creditors. The proposal, if true, would be an utter fiasco for the Dubai World creditors.

The details, unconfirmed, were that creditors would have their interest payments eliminated, the maturity extended by seven years and receive a 40% haircut meaning that they would recover only 60 cents for every dollar lent. This plan may come with an explicit Dubai government guarantee though I’m not sure what that is worth considering the credibility of the Dubai government. There was also a vague description of full recovery over a shorter time horizon though 40% of the recovery would be taken in equity in Nakheel. Given that the balance sheet of Nakheel includes undeveloped desert and non-existent islands in various shapes valued at billions of dollars this may well be economically the same thing as the $.60 on the dollar seven years out.

I think this will come as quite a shock to the markets. The Nakheel Sukuk that matures in May is currently trading at $0.65 on the dollar. If the creditors of the parent company, which owns desirable businesses and is thought to be in better shape in aggregate than Nakheel, are being offered $.60 on the dollar with zero interest the debts of Nakheel are trading much to richly. Dubai CDS have been bid up in recent days and from this it looks like they are set to go higher.

The most important reason however that this will shock the markets is what it says about the level of support that Dubai is getting from Abu Dhabi. After the full repayment of the ’09 Nahkheel Sukuk with the cash infusion from Abu Dhabi creditors felt as though they would all be rescued by intervention from the richer Emirate. Being asked to forgo all interest payments and take a 40% loss plus an extension out to 2017 is basically another repudiation of support for Dubai by Abu Dhabi. As a result the damage won’t stop at Dubai World but will be transmitted to Dubai Holding, ICD and DIFCI as investors gather that the support from Abu Dhabi is indeed limited.

So what happens next?

First there are the creditors of the parent company which are based in the UAE: the Abu Dhabi and Dubai based banks. I don’t think a lot needs to be said about this because they will accept whatever deal is on offer because they are effectively controlled by the governments which are making the offer. The central figures in the next act of this drama are the international banks who are creditors of Dubai World at the holding company level.

The international creditors are led by HSBC and RBS. The decision they have to make is whether the deal they are being offered is better or worse than declaring Dubai World in default. It’s hard to know what would happen in event of default. Ordinarily the equity holders would be wiped out and the debt holders would then own all the assets. In this case, given that the equity holder is the government of Dubai, that may not be possible. If Dubai denied their rights to the underlying assets of Dubai World then they would have to pursue their claims against the international assets of Dubai World. I’ve given a list of these assets in a previous entry.

There are also the actions of Dubai World and Abu Dhabi since the rescue in late December to consider. At the time Abu Dhabi announced a $10 billion contribution to the DFSF, which it later scaled back to $5 billion, or just a little more than was necessary to pay off the Sukuk holders. Dubai World has also put Istithmar holdings into slow motion liquidation, selling its stake in an Indian airline, putting Inchcape Holdings a shipping company up for sale and liquidating a private aviation company. DPW has solicited interest in someone buying some of their assets in Australia. Notice what these businesses have in common, they are assets located outside Dubai or are attachable physical assets which cannot generate revenue unless outside the UAE (ships and planes.) That is to say they are slowly off loading the assets the creditors would be able to pursue in the event of default.

More disturbingly a company formerly considered part of the Dubai World group, the Dubai Multi Commodities Center has declared its independence from the group on the basis that it was originally founded by an Emiri decree. It may well be that the company was founded by decree but it seems to have been largely funded and incubated by Dubai World with the funds of the creditors. For it to leave the group with no compensation being offered to the parent company is asset stripping so thinly veiled as to be haram.

The Dubai official quoted by Zawya said that the reason that no deal has yet been offered is that they wanted the international creditors to have enough time to properly analyse the business plan of Dubai World. It seems to me that the business plan is offloading the attachable international assets and stripping the productive domestic ones without compensation to the parent. Given that there has been no response from the creditors to the defection of DMCC it seems that there are no loan covenants barring divestiture. Thus this is a brilliant strategy on the part of Dubai World. The creditors at the parent company cannot put Dubai World into default until the loans come due in 2011. By that time Dubai World may have been able to sell all of its international assets and remove all the valuable UAE ones meaning that by the time the creditors began to sue Dubai World all the recoverable assets would be gone. That makes $0.60 on the dollar with a sovereign guarantee look pretty good.

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