Tuesday, July 27, 2010

Here's the plan: we liquidate Dubai World in slow motion and hand out the money starting to my left, if the creditors agree they can sit between us...

Last week there were some seemingly minor developments in the Dubai World saga. These were the Nakheel restructuring plan and the presentation of the Dubai World restructuring plan to the general lending community outside the Lenders Committee which had blessed the proposal back in May. On the surface of it this presentation carries with it no new news, the proposal is more or less identical to what the big lenders agreed.

I’ve written about this before at length, but to summarize, the lenders will be asked to roll their loans out into tranches of five and eight years. There will be no haircut on principal but the interest rates will be cut to 1% on the 5 year tranche and between 1-3.5% on the eight year tranche. Apparently the 8 year tranche will have several choices for the lenders on repayment type and the degree to which there is a “shortfall guarantee.” Presumably the more risk the lender takes the higher the rate. It seems kind of a Hobson’s Choice to me because even 3.5% is substantially below a market price for that risk and the word is that there is some question as to whether the guarantees would be enforceable in UK courts.

So what is different about this announcement than the one that was made in May? Well, several things. One is that the lenders are not in a position to negotiate the terms, it is a take it or leave it deal. The big banks had an opportunity to challenge Dubai on the nature and structure of the deal back in May but they were more concerned about not taking too big an immediate loss. They successfully blocked Dubai’s opening gambit of a partial write down of principal but conceded on the structure of the deal and on concessionary interest rates. By doing this they basically enabled the government of Dubai to drain the DFSF, channel the vast majority of the funds to Nakheel, and through Nakheel to the Sukuk holders and the local contractors which had trade claims against Nakheel. The Nakheel creditors, who are also mostly local are getting a much better deal than the creditors of the parent company. Well that’s what happens when you put immediate loss avoidance ahead of your long term strategic interests but considering that this decision was made by western banks it should come as no surprise.

Interestingly the new sources of repayment seem to acknowledge that Nakheel is doomed and the DFSF transfer was mostly to rescue local firms rather than actually revitalize Nakheel. Back in May there was talk about how the cash injection into Nakheel would enable it to finish it’s projects and contribute to the repayment of the Dubai World parent company creditors. In the new proposal there is a lot more discussion of asset sales, it seems that Infinity and Istithmar will be liquidated entirely and that some of the holders of the Dubai 10 year tranche will be repaid with the sale of “strategic” assets which can only mean Dubai Ports World. There is also some talk of the creditors in the 10 year tranche being paid off “in kind” whether this means shares of DPW or non-existent crescent shaped islands I do not know. My guess is most banks other than perhaps NBD-Emirates would avoid that option.

It also sounds like the tone was a bit more aggressive. The package was delivered as an ultimatum: “Take this or take your chances with a liquidation.” To add insult to injury it has been insinuated that the DFSF may take precedence to the original creditors in the event of liquidation. Additionally the procedure would be executed in the DIFC under a special tribunal established for the purpose rather than the original jurisdiction of the contracts. This is a point made in an interesting interview of the former head of the DFSA. Before the Damas fiasco I would have said they were better off in front of a DIFC panel but given the impunity with which the Abdullah Brothers have gotten to skip out on their payment plan without having to either actually pay their fine or even disclose that plan I think the creditors are quite right to be fearful of what would happen in the event of default.

The question on everyone’s lips seems to be whether the creditors will accept the proposal or not. Personally I think it is a near certainty that they will take it because at this stage they have no other option. Nakheel had already taken its’ cash infusion and divided it among the largely Emirati Sukuk holders and the trade creditors there’s no more help from Abu Dhabi on the way. While it’s questionable that DFSF might be in front of the creditors it’s a good thing that Dubai is swapping its own debt for equity and getting behind the creditors. So what in essence is happening is the DFSF is jumping to the front of the creditor queue and Dubai is getting in back with the banks in the middle. My guess is that this was forced on Dubai by Abu Dhabi: pay us off first, then the foreigners so the UAE saves face, then whatever’s left you can have.

In strategic terms the creditors have no interest in forcing a liquidation because, if you assume that Nakheel will not recover within 8 years, most of the repayments are going to be funded by the liquidation of the Istithmar, Infinity and the eventual sale of DPW and other “strategic” assets. You can think of the restructuring as a slow motion liquidation. A slow motion liquidation is probably much better than a liquidation adjudicated by an authority which is ultimately under the control of the wounded former equity holder. As an added bonus, the slow motion liquidation will be masterminded by Abu Dhabi which has every incentive that it come off because it, is in front of the creditor queue. The bank creditors probably prefer this because Abu Dhabi has more power over Dubai than they do.

The interesting question to me is just how much are the assets that are for sale going to bring in. What will Dubai be left as the equity holder of? My guess is they would be happy if they could pay everyone off with all the international assets and keep JAFZA and Nakheel. It’s still an open question though. This is something that won’t be known for many years. I think the banks mostly did not push harder because most of the people making the decisions know they will be elsewhere when the falcon comes come to roost.

Sunday, July 25, 2010

Is a muscular indepedent judiciary coming to a self-legislating financial free zone near you? Inshallah.

In my last post I suggested that Bisher Barazi get out of town because the DIFCI counter-claim reads more like a vendetta than a defence against his lawsuit to recover his severance pay. It looks like he agrees and according to The National, a respected paper in Abu Dhabi, he has sent his family home to Syria and has himself asked the judge to lift the travel ban on him so that he can defend himself from the comfort and relative safety of Damascus. The judge said no dice. This is a little interesting to me because the judge in this case seems to be adjudicating remotely as well as he conducted the hearing from London by video link. This is of particular interest because the DIFC is qualified to hear commercial disputes only. It can only fine and censure its members, it has no criminal authority and therefore cannot imprison Bisher. It can however refer criminal cases to the Dubai courts for adjudication and enforcement. We may be seeing a preview of coming attractions in the DIFC court’s refusal to allow him to leave, which is of course all the more reason for him to do so.

Additionally he has been asked to detail all his assets and sources of income in the UAE. Still more interesting he is required to demonstrate that he actually owned the villa he just sold. This seems a little odd because presumably the buyer would have also checked that he was buying the villa from the actual owner before handing over the cash no? I think I know what the judge is after in this case. When I was in Dubai I heard a lot of rumors about expat civil servants being paid under the table by the various organizations that employed them with certain high value gifts like villas, cars, and everyone’s favourite: off plan real estate. I imagine that in Dubai proper this is not a big deal but given how much emphasis is being placed on “unlawful compensation” on the former management of the DIFC I think this policy, if indeed it took place, is going to get a lot of scrutiny. If Bisher did receive extra undocumented compensation from the DIFC he is almost certainly not the only person to have done so. It will be a cliff-hanger for everyone else living in gift homes as well. My guess is that more than a few people will be watching the Barazi-DIFC litigation with their real estate agent on hold and their travel agent on speed dial.

Most importantly of all, they will get to watch it. The DIFC Court ruled against a request from both parties to close the hearing to the public. Having had my hopes for the DIFC dashed repeatedly I am wary of reading too much into this but I think it might be significant. Firstly, as a point of journalistic honor I have to concede that as with the ESCA ruling on Aabar, I have perhaps taken too dim a view of the DIFC courts and described them as a tool of Sheikh Mohammed in his quest to punish Dr. O and Bisher. But now the DIFC courts have denied two requests from the government: 1.) that the trial be conducted in secret, and 2.) that they cripple Bisher’s capacity to fund his defence by demanding a 500,000 AED deposit. It may not be a first but having a court in the GCC deny a request of an agent of The Ruler is pretty unusual. Is it possible that we are seeing the creation of a independent judiciary in the DIFC? This will indeed be an interesting court case to watch.

Inshallah the Abdullah Brothers will get their day in court as well if the DFSA ever musters the thrasos to take them on.

Thursday, July 22, 2010

In the Emirates, as in life, if you mess with the bull, you get the horns. Maybe moreso.

In this post I put forth a theory as to why Dr. Omar and Bisher Barazi are in so much trouble. Check here for the previous article.

Sometime in late 2006 or early 2007 I sat in a conference room in the DIFC, the one with the imperial view of the massive construction site which composed the vast majority of the Gate District at the time. I was at a meeting with the representatives of the other investment banks and the then CFO of the DIFC Bisher Barazi. Bisher had a voice both nasal and high pitched, kind of like beaker on the Muppets but with a severe head cold. When he became excited he seemed to be out of breath and on the verge of sneezing at the same time. At this particular meeting he was certainly excited.

We were discussing the proposed IPO of Dubai Ports World. It was being proposed that DPW execute a dual listing on the DIFX in Dubai and the LSE in London and we were hoping to convince them to do a DIFX only listing. This was going to be the biggest thing to happen in the DIFC and would prove to Sheikh Mohammed that the guys who were running the Center had not merely snookered a bunch of foreigners into renting expensive real estate but had actually created a functioning financial center. Nothing makes people nervous like scrutiny and, as we now know, the guys who ran the DIFC were not used to scrutiny. So there we were in our meeting with a nervous, and therefore excited, Bisher Barazi.

Bisher had good reason to be nervous. The international banking community had been drinking the DIFC cool-aid for over a year but so far we had little to show for it. My firm in particular, Deutsche Bank, was massively committed. We had moved aggressively into the center and has helped build much of the legal and technical infrastructure that enabled the DIFX to launch on time in September 2006. We intended to use our first mover advantage to establish a dominant position in the center. If you wanted to trade, clear or settle on the DIFX odds were that somewhere along the line you were going to have to pay us. We stood to benefit massively if the DIFC worked out and the DIFX became a major exchange. That said, at the time there was precious little business going on and we in the region were starting to have a hard time explaining to our Lords and Masters in London why we were devoting so much time and effort to the project.

I had seen this before when I worked on an exchange start up in the US. The exchange had an 80% cost advantage over its rivals and still took 18 months to gain market traction against entrenched rivals so I wasn’t too worried. The difference however was that we owned equity in that exchange and made a substantial windfall on its IPO and subsequent trade sale. The DIFC had steadfastly refused to grant us equity in the DIFX which would have helped us justify the efforts we were putting forth. This being the Arab world, with its’ penchant for retaining control, we were continually told no dice. I had confidence that it would work out eventually but it was getting hard for me to keep co-opting the folks back in London and the other DB support centers to continue to pour resources into the project.

So as nervous as Bisher was, it was pretty frustrating to have him pace back and forth and harangue us in his high pitched squeaky voice about all the work that was going to have to get done in order for the DPW IPO to come to the DIFX and for it to come off without a hitch. We need a retail offering, we need DMA access to Europe, we need... we need... as he got more excited he spent more and more time looking at me and his tone switched from “we need to..” to “you need to..” “You need to connect us to Saudi, you need to provide connections to the exchange for UAE brokers, you need to...” I had already been thinking of all the things I was going to have to do to muster the resources within DB to do all these things. I would have to call in favors, I would have to fly to Amsterdam to rally the troops in GTB, I’d have to go through multiple New Product Approval procedures and I would have to go all over the firm making presentations about the bright future of DB in the MENA region. I had practically emptied my account and would now have to blow my own personal credit bubble at the DB favour bank.

Then all at once it hit me that it was entirely possible that all this would be for nothing and I would be holding the bag. So I interrupted the lecture, pointed accusingly at Bisher and said, “Listen here, I don’t work for the DIFC. I’d like nothing more than to build out this infrastructure but you have denied us the opportunity to take equity in the DIFX or any other upside in the success of the DIFC. Nonetheless you continue to demand millions of dollars in infrastructure investment and millions more in free consulting. You have to understand that I work for the shareholders of Deutsche Bank not the DIFC stakeholders and it’s going to be the DB shareholders who decide whether this gets done, not you.” (I really did say that, I was a great believer in the cult of the shareholders)

I’ll admit, I felt pretty clever. I thought that this might open the door a crack and make them cough up some equity in the DIFX so we could really see some upside when the rest of the world joined us in drinking the DIFC cool-ade. Not for the last time in the region did it turn out that I thought myself a good deal cleverer than I was, for Bisher Barazi had a plan.

Unbeknownst to me, DIFCI and my management at Deutsche Bank had been in negotiations for DIFCI to become a massive shareholder of Deutsche Bank. By June of 2007 they had acquired 2.2% of the company and became our fifth largest shareholder. And let me tell you, as far as the DIFX was concerned, Bisher’s plan worked like a charm. No more wisecracking from Ken Monahan about how the DB shareholders would decide the fate of the DIFC, the DIFC was the shareholder. It was worse than that. I had to give Bisher my cell phone number. And whenever it rang no matter the time zone or circumstances in which I found myself I would have to answer it. For the next six months at random I would get phone calls from Bisher demanding status updates, did I do this, did I do that, was it really possible that we would deliver on time and in full? Did I understand how important this was? Where was I? What was I doing? Why was I doing whatever I was doing instead of working on this? Mercifully he did not call all that often but when he did, it was not awesome.

And wherever I was at whatever time and however sober I had to reassure Bisher in as soothing a voice as I could muster that indeed at this very hour an army of people in London, Amsterdam, Dubai, Hong Kong and Bangalore were working night and day to ensure that we delivered on time and in full. And we did. We executed, with a single listing on the DIFX, the largest IPO in the history of the GCC with a simultaneous retail offer in the UAE and an international book build. We created a link to Euroclear so that international investors could buy the shares in their existing accounts and we connected clients in dozens of countries to the DIFX all over DB infrastructure. Yep, as far as the DP World IPO went, the DB investment was a stroke of genius.

Yep, a stroke of genius except for one small detail. DIFCI completed its’ purchase of DB shares in June of 2007, the all time high for the stock. At the time of the announcement the stake was worth $1.8 billion. Then fate took a hand and the financial crisis got underway decimating the values of financial institutions the world over, even companies like DB which took no government money. Today DIFCI’s $1.8 billion investment is worth $720 million and $1.1 billion has been sacrificed to the trading gods. So while from the tactical perspective it was a stroke of genius, from a strategic investment perspective it was a complete fiasco. Add to this the $2 billion loss that Bourse Dubai took on its NASDAQ and LSE shares, a transaction on which the DIFC advised, and it doesn’t look like the guys doing the investing in financial services firms did Dubai any favors. I’ll bet they wish they just let us invest in the DIFX like we asked.

This brings us back to the present, there’s nothing like losing a cool 3 billion of Sheikh Mohammed’s money, or rather money Sheikh Mohammed has borrowed, to put you in the crosshairs of the UAE and the DIFC legal systems. Perhaps Sheikh Mohammed cannot imagine that so much money could disappear without some kind of malfeasance. After all it did take outright theft in order for $165 million to vanish from Damas, surely $3 billion can’t vanish without some fancy footwork by some light fingered subordinates. From my perspective $3 billion did get lost but it got lost the old fashioned way, bad decision making, not fraud.

But there’s a difference between robbing a bunch of international investors and legitimately losing a bunch of Sheikh Mohammed’s money. If you’re an international shareholder you’re forced to rely on the law which is why you get nothing but laughter and forgetting from the Brothers Abdullah. Sheikh Mohammed IS the law so no matter how legitimate your poor decision making if you lose his money you are in serious trouble. No laughter. No forgetting. He doesn't have to rely on the DFSA, he can just throw you in jail until you pay him what he thinks you owe. Don't like it? Too bad. You mess with the bull you get the horns. This is no longer about $544,000 in back pay for Bisher Barazi, it is about Sheikh Mohammed getting some payback. Bisher Barazi had better call up that guy with the submarines and leave town because he is going to get a lot more than $122,000 in emotional damage from Sheikh Mohammed.

Wednesday, July 21, 2010

How the DIFIC Counter-Claim against Bisher Barazi could drag Dubai back into the debt morass from which it most recently emerged.

So I have decided to have a closer look at the “Fraud Sweep” going on in the DIFC. I’ve written once already on the Dr. Omar aspect which, despite his payoff and release, remains an open question. It will actually be difficult to assess where the Dr. O case is because it is going on in Dubai Courts to the extent that it is being done within a legal system at all.

Then there is the drama of Bisher Barazi. It’s being played out in the DIFC courts with and unusual level of transparency. Both Bisher’s complaint and the response of the DIFCI are viewable by the public. Just go to the DIFC Courts website and click on “anonymous login,” search DIFIC, double click on the case and the documents come right up. They make for interesting reading.

I think Barazi’s complaint is kind of funny. Once Dr. O had been thrown out the new sheriff in town decided to clean house and basically told Barazi to go home. Barazi says that when the DIFCI told him to pack his things they said they were acting on the orders of the Financial Control Department, the organization looking into what happened to all the money that has gone missing from DIFCI. Barazi considered himself to have been terminated and according to his contract he had three months paid leave coming to him. The DIFC didn’t pay him. The new governor told him he would look into it. Nothing happened. He spoke with the guys from Finance Control and they told him he was not under investigation and that they had not ordered his suspension. He had a meeting with the governor and was told that he had no rights and if he wanted anything he should go to court. This he has done and he is suing DIFIC for $484,000 including $122,000 for “emotional damage.”

It seems to me that the new Governor of the DIFC quite reasonably wanted Barazi out once Dr. O had gone and told him to get lost. For some reason the guy decided to claim that it wasn’t his idea but that of the Finance Control department. My guess is that this is a simple administrative error. When they got rid of Barazi, nobody called HR to figure out precisely what Barazi’s contract said and he’s trying to take advantage of that for a few hundred thousand on what he surely thinks will be his way out of Dubai. Well, given the DIFCI counter-claim he’s getting more than he bargained for.

As humorous as Bisher’s complaint is the response from the DIFCI is absolutely hilarious. They begin by nitpicking when Bisher started at the DIFC, when he transferred over to DIFCI, that his 150,000 AED/month compensation was actually 90,000 in salary and 60,000 in housing allowance. Then in a bit of he said/she said they deny that the DIFIC ever told Bisher to leave the office.

This is where it starts getting bizarre and deadly serious.

DIFIC claims it did not order Barazi to leave. So if the DIFIC did not tell Barazi to leave, who did? Well, says DIFCI, the Dubai Government Audit Team. Oh, OK, and what evidence do they present for this version of events? A newspaper clipping about Dr. Omar. Yep, it's true, they present a few lines from an article in Gulf Business saying that Dr. Omar has been arrested and released pending charges of financial irregularities. Surely if the Dubai Government Audit Team ordered the suspension of Mr. Barazi there must be better documentation o this fact than a newspaper article that not only doesn’t mention Mr. Barazi by name it doesn’t name anyone but Dr. Omar. Call me crazy but I would think that the Dubai Government Audit Team would have better records than that I mean, they are an audit team after all.

Then they claim that Bisher tried to resign and they did not accept his resignation but rather placed him on “investigation leave.” What evidence is there of this? None is provided. They do say that “Although the claimant contends that the defendant has failed to provide any evidence of instruction from the Audit Department, the Claimant has in fact admitted that he was aware of the investigations.” How Barazi’s awareness of the investigation constitutes notification that he has been placed on “investigative leave” I have no idea. Sitting here in the New York Public Library, I too am aware of the investigations but I am not aware of having been placed on investigative leave. Surely the easiest way to prove the existence of instructions from the Audit Committee to place Barazi on administrative leave would be to provide a copy of those instructions. The fact that the DIFCI cannot do this actually proves Barazi’s point, not theirs.

Then come the serious allegations. DIFCI says that once it became aware of the Audit Team’s investigation it retained KPMG to conduct an independent review of the actions of the former managers of DIFCI. They claim that Mr. Barazi “breached his fiduciary duty and conducted himself in ways which would warrant his termination” it describes these things as “fraud, dishonesty, misrepresentation, and breach of trust.” Serious indeed. So what precisely does DIFCI accuse Barazi of?

Procurement of an Unlawful Bonus

This crime will be familiar to anyone paying attention to the Dr. Omar saga. DIFIC claims that Bisher and Dr. Omar conspired to pay themselves $1.2 million and $3.3 million respectively in “investment bonuses.” Then comes the zinger “The Claimant justified the Investment Bonuses by misrepresenting that DIFCI had realized an income of $60,000,000 in the 2007 financial year but deliberately failed to disclose that financial statements showed that DIFCI suffered a net loss of $80,000,000 over the same period.” At first glance this looks pretty damning and if Barazi cooked the books he should go to prison full stop. But that’s not what they accuse him of, indeed they're using his uncooked books as evidence against him. They accuse him of using realized income to justify a bonus when the net position of the firm was negative. It’s entirely possible for them to have realized a $60 million gain on a transaction while the book of open positions was down $140 million.

Then there’s the question of to whom were they making this misrepresentation? It seems from the counter-claim that the only person required to approve Barazi’s bonus was Barazi. If that is the case then who is to say ex post facto what was a reasonable level of compensation. At the time DIFCI had literally multiple billions of dollars invested. $80 million on the total value of the assets he was managing was not a material number. Paying someone $1.3 million for managing a multi-billion dollar fund, even if it has a marginal loss, as DIFCI did in 2007 is not a big number. The guys running the DIFCI today have decided ex-post facto that this was unlawful but at the time it was awarded it seems to not in fact have broken any laws. Barazi was operating in a system where there was no external review of his compensation. Given the amounts he was investing you could argue he was not taking full advantage of his capacity to pay himself. The people who set up this system in which Barazi and Dr. Omar operated sure as hell breached their fiduciary obligations to Dubai however.

Unauthorized Loans

Apparently Barazi applied for and received some personal loans from DIFCI after the board declared a moratorium on personal loans to employees. Dr. Omar approved the loans and there seems to have been no objection from the Board. They don’t claim that Dr. Omar was not authorized to approve the loans and if he was then the loans were legal. It may have been in poor taste for Barazi to ask for something that had been banned by the board but if it was within the power of Dr. Omar to grant them then I don’t see how this constitutes fraud.

Then there’s my favourite:

Failure to Conduct Due Diligence

Apparently in September 2009 as the Dubai real estate market was in free fall Barazi decided to buy $1 billion worth of off plan real estate in the Dubai Pearl development for DIFCI. He decided this on September 28, 2009. On October 5th, he sent a check for the first instalment to the Al Fahim Group and on the same day sent a letter to E&Y requesting due diligence. Thus clearly the due diligence could not have been completed before the transaction was executed. AH-HA! Caught red handed! He bought off plan real estate without conducting proper due diligence! Clearly a breach of his fiduciary duty! Given the fact that Dubai was weeks away from seeking a debt moratorium on account of a collapsing real estate market Barazi was almost certainly under a massive amount of political pressure to use DIFCI funds to shore up the market. But this is not why I think that Dubai should give Bisher Barazi a pass on this one. I think they should do it in the national interest of Dubai.

I think this for two reasons: 1.) if the Dubai Authorities are going to prosecute everyone who bought off plan real estate in Dubai without conducting proper due diligence for fraud there will be no one left to pay the subsequent instalments and the rents. Buying off plan real estate in Dubai without conducting due diligence is the national pastime of Dubai. Once the police had finished carting everyone to jail Dubai would need to hire the Saudi police force to throw the Dubai police force in jail for the same crime, and then they would have to find some other police force to throw the Saudi police force in jail for also buying off plan real estate without conducting due diligence. One may as well criminialize speeding or claiming that the reason you are late is because of the traffic, it would be an exercise in futility.

Reason number 2.) is that Nakheel and with it Dubai World have no chance of ever paying back their creditors unless a whole hell of a lot more people buy off plan real estate without conducting due diligence. The last thing Dubai wants is someone actually taking a look at the physical site of Dubai Waterfront rather than the architectural models. Someone might realize that the Crescent Shaped Islands which are valued on the balance sheet at a billion AED do not actually exist. No, no, the last thing on Earth Dubai should be doing is criminalizing the purchase of off plan real estate without conducting due diligence. Hell they should be giving out prizes for it, or allowing people to set their own bonuses as long as they invest some of the proceeds in off plan real estate for which they have not conducted proper due diligence. Now there's an idea...

In my next post I'll tell you the real reason Bisher and Dr. O are in for it.

Sunday, July 18, 2010

ESCA Gives Aabar Shareholders a ham sandwich.

I once walked into a classroom in college and was startled by something written on the board. Someone from the last class had written the following elegant proof (apologies to the Shariah compliant, I'm trying to be true to the facts):

Nothing is better than happiness
A ham sandwich is better than nothing
A ham sandwich is better than happiness

I’d like to offer my own proof for in honor of the ESCA decision on the IPIC de-listing.

Nothing is better than the rule of law
Half a Dirham is better than nothing
Half a Dirham is better than the rule of law.

What I mean by this is that while 1.95AED is certainly a better price than 1.45AED the shareholders have no say in the decision either way. Whether IPIC or ESCA decide the price it is still a take it or leave it deal for the shareholders and they have no choice but to accept what is, in the end, an arbitrary decision which differs only who is making it and at what level. The wishes of the minority shareholders themselves are never taken into consideration. You have to remember the context, 1.45 AED is 50% of book, 1.95 AED is still only 67% of book. Usually holding companies like Aabar trade at about 1 times book in other markets. KKR for example is trading just under 1 times book as of Friday. Even though the shareholders are getting a better deal than the one IPIC offered them, it’s still not a great deal.

I could make the counter-argument against myself that the market had never priced Aabar at 1x book beforehand which may well be what has spurred this in the first place. I could do that, but then I would also be compelled to make the counter-counter argument that because under the UAE/ESCA regime it was always possible that the minority shareholders would be arbitrarily stripped of their value (as they have been) and so the shares should trade at a discount (which they did.) But this soon becomes kind of a circular argument, a sort of Inception style dream within a dream.

So this outcome is not ideal but I must say that it is a step in the right direction. A strong step. I would have bet a substantial sum that ESCA would have validated the IPIC price and actually, given the trading history of Aabar notwithstanding the book value, I would say the 1.95 price is aggressive. This is unequivocally good for the shareholders but I think it goes a bit far to declare this a “milestone for investors rights.” The investors were never consulted and therefore could not exercise their rights nor do they have a forum within which to express their views. The decision of ESCA, while a good one, was still arbitrary and therefore investors in other companies can take limited comfort from it. What is necessary is for ESCA to promulgate rules as to how minority shareholders should be treated in the future and under what circumstances, if any, the shareholders can contest actions against their interests by the majority shareholders. ESCA has announced that it is working on a large number of new rules which it hopes will further refine the markets. If ESCA can succeed in empowering the shareholders to secure for themselves the justice they have just been granted by ESCA fiat, then that will indeed be a milestone for investor rights.

Given my obsession with the Damas Heist I can’t help but think of the outcome for Aabar shareholders vs. the outcome for Damas shareholders (a fate which seems sure to spread to the creditors as well.) My nitpicking notwithstanding, the domestic regulator has done a massively superior job of looking out for shareholder rights than has the regulator operating according to “international standards” over in the DIFC. I think ESCA should use its jurisdiction over the DFM which is now the owner of NASDAQ to bring the kind of justice to Damas that they have just brought to IPIC. At the very least the entire staff of the DFSA should resign in shame. The organization is clearly unnecessary as ESCA can obviously do a better job.

Monday, July 12, 2010

Aabar gets a take-under. Shareholders get under-taker.

Aabar which earlier in the year had attempted to execute a take-under of Arabtec the Dubai based construction firm at a discount to the prevailing price has done itself one better, it is taking itself private 1.45 AED per share. That’s down about 15% from the pre-delisting announcement and about 25% below the high for the past year. Those guys over at Aabar are some smart folks. Not only do they get to take their company private so there won’t be any more of these pesky disclosures as to what the investment arm of IPIC is doing but the valuation they are granting themselves is also 50% of book value. Nice trade.

Most of what I have read in the press makes no sense. There was something about how the shareholders though they might get taken out at the conversion price implied by the bonds that were issued in May. There is NO reason to think that, the conversion price in a mandatory convert is not designed to give a valuation but to imply upside. There has been some talk of ESCA demanding an independent valuation. That would shock me because clearly the IPIC guys have more power than the ESCA guys and whoever was hired to do the “independent valuation” would have a lot to gain from future business from IPIC and little to gain from the gratitude of the minority shareholders.

So what do the minority shareholders have to say about this? We’ll never know. Aabar asked ESCA to allow it to delay the meeting to discuss the delisting to August 8th, from July 27th. ESCA granted the request the same day. Given that the offer expires on August 1st the offer will have ended by the time the meeting is held. Well done Aabar, no need to discuss the merits of the offer at the meeting because anyone who takes it will of course no longer be a shareholder and therefore won’t be there. Aabar may well be addressing an empty room, quiet (rightly) as a tomb. Aabar has once again made an “O plato, o plomo” (lead or silver) offer, this time to its’ own shareholders.

The easy journalistic tack to take with this, and the one which is my natural inclination as a lazy amateur journalist, is to affect righteous indignation at the treatment of the Aabar shareholders. After all they thought they were investing alongside Abu Dhabi, the most prestigious of the Emirates, in an SWF type vehicle and instead they get a take it or leave it offer for 50% of book at multi-year lows. It doesn’t seem fair.

Well, in economic terms it’s not fair but markets have no obligation to properly value things. They do have an obligation to obey their own laws and investors have an obligation to know those laws. In the Emirates of all places investors have no excuses to not know this because the entire body of relevant law is 24 pages long. Don’t take my word for it, read them yourself. They’re sections 2/r and 3/r on the ESCA website. If you throw in another set of rules regarding arbitration which may come into play you still come up with a body of legislation shorter than the Aabar annual report. As a person who reads US financial legislation as kind of a hobby the ESCA Rules are refreshingly brief.

While the Aabar self take-under may be unfair it is not unlawful. This is not because it complies with the law, but because there is no law. If you look though the laws you’ll find nothing on the possibility of either a takeover or a de-listing, nothing about the protection of minority rights in a tender offer nor in the event of delisting. Aabar probably feels, rightly it would seem, that the fact that the shareholders are getting anything is a bit of largesse. If the shareholders are unhappy about it they can ask ESCA for arbitration but given what you can infer from the speed with which ESCA has granted the Aabar request to postpone the meeting it would seem that they will take a narrow view of shareholder rights.

So what happens next in Abu Dhabi after what would seem to be a fait accompli is actually quite interesting. What happens now will set precedent for the UAE and also for the other GCC states which have similarly thin securities laws. Most important is that this says about the plight of foreign portfolio investors in the region who will be, by definition and by law, always be minority shareholders in the region. The best outcome would be for ESCA to demand some kind of consent from at least a majority of the affected shareholders but that also seems unlikely given that the tender expires before the shareholder meeting and ESCA explicitly authorized that change. Still, the laws are yet unwritten and the precedent as yet unset. It’s too late to save the Aabar shareholders but what ESCA decides will have a big impact on how willing future investors are to put their money into the GCC.

While this is not a great episode for the Abu Dhabi capital markets it does put the DIFC under an even darker cloud. While what is happening to the Aabar shareholders is not great, it’s at least because there were no laws to protect them, which they should have known. The DIFC was created in response to the weak legal and regulatory environments in the rest of the GCC. The DIFC actually has superior laws and protections for shareholders and so shareholders should expect some protection and yet it is the site of the most egregious shareholder theft yet to occur in the Emirates. The DIFC may have better laws but lacks is leadership with the courage to enforce those laws.

Monday, July 5, 2010

WallStWTF Non-Bronzed No-Prize Award goes to....

So this is my first post after a month of silence in honor of the rule of law in Dubai.

Marvel Comics is one of the most innovative media companies in the world. I say this not because of the wonderful cast of characters they have come up with over the years though they are indeed wonderful. I don’t say it because of the fact that they have emerged from bankruptcy with a vengeance, finally marrying that great set of characters to the vastly more profitable medium of film though that too was a great innovation. No, I think Marvel deserves an innovation award for it’s invention of the “No-Prize.”

Occasionally there would be “continuity errors” in Marvel Comic books. A continuity error is when there is an inconsistency between several frames such as a character having a blue shirt in one frame and a green one in the next without having changed the shirt. Many comic book readers are a bit pedantic and would write in to Marvel to point out these errors. The staff at Marvel found this kind of annoying so they invented a fictional prize which they would award to people who found these inconsistencies. They called it the “No-Prize” as kind of a joke on the recipients in order to get them to lighten up. It’s just a comic book after all...

Though the “no-prize” was a non-monetary award the fact that you could be recognized for discovering errors created a deluge of mail from nit-picking readers and spurred on the creation of the “Non-Bronzed No-Prize.” The Non-bronzed No-Prize was awarded to readers who discovered a continuity error but also explained why the continuity error was not in fact a continuity error at all but could be explained away by some massively tortuous logic. For example how a freak burst of gamma radiation temporarily changing the color of a green shirt to blue for a single frame of a comic book. Or how a wrinkle in the space time continuum enabled a character who had been killed in episode 17 could be alive in episode 19 and dead again in 20 without having actually been killed a second time, that is to say it used pseudo-logic to explain away nonsense.

Recently I have discovered a fairly massive continuity error in Dubai and so I have decided to award myself a “No-Prize.” In addition to that I have decided to award a “Non-Bronzed No-Prize” as well to a respected Dubai publication! But first, let’s have a look at the continuity error that has to be explained.

Here is a schematic of the plot outline:

Chapter 1.) An enterprising man starts a jewellery company. He builds his business up substantially and passes the prosperous firm on to his sons.

Chapter 2.) His sons are aggressive. They expand the business, and engage in new financing schemes related to gold, a key input in the business. They occasionally depart from the main business though rarely successfully. Their commercial success brings social prominence in Dubai. They are active in the community and gain the confidence and favour of the Ruler.

Chapter 3.) Constrained by financing their activities with retained earnings and bank loans the brothers decide to sell shares to the public. They decide to list on the DIFX because it will enable them to curry favour with the ruler and, importantly to have their share offering priced not by ESCA, which will apply a steep discount, but by an auction process called book building which will produce a higher price. The company will remain a Dubai entity and so must remain 51% owned by Emiratis. The brothers will not lose control. So they raise cash, make the ruler happy, and keep control. Win, win, win.

Chapter 4.) The brothers decide that their company is worth a billion dollars. This is where things start to go wrong. At that price there are not enough investors willing to bite. The demand is so low that the brothers won’t be able to place enough shares to qualify for an offering on the exchange.

Unwilling to contemplate the idea of a lower valuation or the prospect of forgoing access to external cash the Brothers rig the auction. They take company funds and invest them in a Dubai Holding VC fund called Dubai Ventures. Dubai Ventures then submits a bid with the companies own money for shares in the IPO creating the illusion that there is enough demand at the higher price to justify it and to qualify for the offering.

This goes on undetected or at least undisclosed by the regulator and the underwriter. IPO goes ahead, raising $165 million in cash for the company from international investors.

Chapter 5.) In short order the brothers transfer to themselves the money that had been invested in the company. They do this via cash transfers, the purchase of assets in the name of the brothers with company funds and the requisition of two tons of gold from the company by the brothers. The Board of Directors, which had been hand-picked by the brothers took no action to prevent this and in some cases actually approved it.

Chapter 6.) Around the time of the Dubai World crisis, the transfers to the brothers were revealed and described as “unauthorized transactions.” One of the brothers is forced to resign as CEO though another brother takes over as MD. The disappearance of $165 million into illiquid assets not actually owned by the company combined with weakening business conditions force the company into negotiations with creditors. The board of directors appoints some accountants to conduct an investigation into the “unauthorized transactions.” The authorities declare that they are “monitoring the situation.” The markets laugh and destroy the stock.

Chapter 7.) Before the audit is complete or the authorities take action the brothers negotiate a deal among themselves, one brother representing the brothers, another representing the company. They agree to repay the money within 18 months or they will forfeit their shares which are now worth only a fraction of the amounts they have stolen. Neither the shareholders nor the authorities are consulted.

Chapter 8.) The Avenging Angel of the DFSA, Steve Glynn, issues an “enforceable undertaking.” In it he outlines the means by which the Abdullah Brothers looted the company with the acquiescence of the board. He dissolves the board and bars the Abdullah Brothers from the DIFC. He ratifies the repayment agreement the Abdullah brothers have with the company and gives it the force of law, indeed he demands that the Abdullah Brothers detail their assets and grant the DFSA a lien in event of default. Finally he fines the Abdullah Brothers $3 million though suspends $2.7 million of it lest they be put into default immediately before they can do anything to rescue the long suffering shareholders.

Chapter 9.) The Abdullah Brothers fail to make their first payment of $55 million. Shareholders and the DFSA are shocked to discover that failure to pay $55 million does not constitute an event of default. It’s not possible to know precisely why because Steve Glynn relied on the agreement the brothers negotiated among themselves and is “confidential.” That is it is a secret both to the shareholders who are nominally a party to it and also to the regulators who are responsible for enforcing it. If missing a payment for $55 million does not constitute an event of default it must be a very interesting document indeed one wonders what does constitute and event of default.

Chapter 10.) The Abdullah Brothers are appointed as Senior Advisors to the company.

So this is where I award myself a “No-Prize.”

This is a country that identified a team of Mossad assassins and within 24 hours had their passport photos all over the world. Surely these sleuths should be donning ski masks and jack boots and be battering in the doors of the Abdullah Brothers, shaking them out of bed and searching their villas for the missing tons of gold. Surely there should be a massive auction in which all their assets are blown out including their four yachts and their substantial real estate portfolio. If there are a lot of encumberances so be it. Put the Brothers into insolvency and pay the creditors off as best you can, give the shareholders whatever is left and the strip the brothers of the remainder of their equity.

This is what should be happening. Ski masks and jackboots aside this is precisely what the laws of the DIFC and the enforceable undertaking of the DFSA would indicate are required by law. Instead the brothers are not only free men but back involved in the management of their own company. In logical terms this makes absolutely no sense and so therefore I’m calling it a “continuity error.”

This leads me to the “Non-Bronzed No-Prize.” The explanation for why this continuity error is in fact not a continuity error at all goes to Damas itself for its press release and to Arabian Business for printing it.

“At a time when Damas is going through a period of transition and pursuing a renewed strategy for its sustainable growth, the involvement of the Abdullah brothers in an advisory capacity provides us significant depth of knowledge and insight. In their roles, even though the involvement is strictly non executive, the company will benefit from their valuable advice on the unique aspects of the jewellery trade."

This is great stuff. Damas is going through a “period of transition.” Periods like this have a name: insolvency. They are “pursuing a renewed strategy” for “sustainable growth” for which the Abdullah Brothers “provide significant depth of knowledge and insight.” Presumably this new strategy is to destroy the bondholders and trade creditors. Who better to advise them on this strategy than the very men who destroyed the shareholders? I have no doubt anyone able to steal two metric tons of gold will be able to provide “valuable advice on unique aspects of the jewellery trade” chiefly the portability of the collateral involved in that trade. Perhaps this should be renamed the “Non-Gold No-Prize.”

But I don’t know that I can stop there. The emerging market mutual funds who bought these shares and are not suing Damas and the underwriters into oblivion also deserve a “non-gold no-prize” though it is obvious why they are acquiescing in the continuity error. They make their money by convincing investors that they are knowledgeable about emerging markets. For them to sue to recover losses they took from having been defrauded would undermine their chief marketing tool namely the belief of their investors in their emerging market savvy. So they stand by and get robbed by the Abdullah brothers and say nothing in order not to look like the fools they are.

The deeper question is whether the DFSA is going to also garner a “Non-Gold No-Prize.” Will they be taken in by the idea that the new appointments of the Abdullah Brothers do not violate the terms of the enforceable undertaking. Do they think that the valuable advice on the unique aspects of the jewellery trade that the Abdullah brothers can provide are worth the DFSA being made completely ridiculous by the greatest thieves in the short history of the DFSA?

Deeper still is the question where the readers of this blog stand. Are comfortable that though the Abdullah brothers may have shafted thier shareholders such a thing could never happen at Emaar or Arabtec or Dana Gas or Agility or whatever company you happen to be buying shares in today....

Not to worry, I've got a whole warehouse full of Non-Bronze No-Prizes ready for the next set of unwary MENA investors....