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— Analysis —
It happened the weekend of Feb. 21, when the United Arab Emirates' central bank snapped up half of a $20 billion bond issue by Dubai, the second largest of the seven states that constitute the UAE. The funding should allow the tiny Gulf state to meet some $13 billion of government and quasi-government debt that is due to be repaid this year. The central bank, which is principally funded by Dubai's megawealthy neighbor Abu Dhabi, bought $10 billion of five-year notes at a deeply discounted annual interest rate of 4%. The remaining $10 billion is to be offered to other investors, though speculation is rife that the central bank will return to buy more of the issue if, as expected, the bonds fail to sell on the open market.
No matter what the fate of the bond sale, the refinancing of Dubai is almost certainly the finale to a decade-long debt-funded spending spree that turned the sheikdom into one of the world's most aggressive LBO shops, underpinned an almost unprecedented domestic real estate bubble and ultimately brought the state to its knees. "The golden age is over," says Christopher Davidson, author of four books on the UAE, including "Dubai: The Vulnerability of Success." "We can draw a line under Dubai Inc. The model failed." Under the guidance of its ruler, Sheik Mohammed bin Rashid al-Maktoum, Dubai bet its future on the premise of continued growth and an ability to roll over debt in highly liquid credit markets. To that extent it is little different from many of the other property developers, retail mortgage lenders and leveraged investors who have run aground as credit dried up. By the time the UAE stepped in to save the emirate, Dubai's total debt burden amounted to about $74 billion, according to a tally by Barclays Capital. Of that amount, some $33 billion is on the books of logistics and port operator Dubai World and its subsidiary DP World; $14.5 billion is owed by quasi-government private equity shop Investment Corp. of Dubai and a further $13.1 billion is owed by a second fund, Dubai Holding. In the weeks before the UAE central bank stepped in to support the emirate, the cost of insuring Dubai's sovereign debt, as measured by the spread on the credit default swap, or CDS, market, had broken the 1,000-basis-points barrier. That put it on par with Iceland, the highest-profile sovereign victim of the credit crisis, and was as much as twice the spread being offered on CDSs covering the debt of its regional neighbors. Spreads on quasi-government organizations, including Dubai Holding, were even wider than the spread on sovereign debt, according to analysts. Dubai was battered by a fatal mismatch of ambition and means. While other gulf states, such as Abu Dhabi and Saudi Arabia, could fund deals from their vast oil wealth, Dubai, which has relatively little in the way of oil reserves, fueled its spending with debt. Dubai's investments in overseas companies tended to be funded about 80% with debt, according to Eckart Woertz, economic program manager at a Dubai-based think tank, the Gulf Research Center. Dubai also differed from its near neighbors in its choice of targets. While many of Saudi Arabia and Abu Dhabi's investments were in unglamorous infrastructure targets in emerging markets, Dubai pursued high-profile U.S. and European corporate players. In 2006 and 2007, Dubai government-related entities spent tens of billions buying or investing in stock exchanges, European banks, Japanese technology companies, U.S. retailers and casino operators. Among the biggest deals was Borse Dubai Ltd.'s roughly $5 billion purchase of Scandinavian stock exchange operator OMX AB at the end of 2007, later swapped for a 20% stake in Nasdaq Stock Market Inc. and 28% of London Stock Exchange Group plc. Istithmar World PJSC, the investment arm of Dubai World, bought retailer Barney's New York Inc. in June 2007 for $825 million. The company is rumored to be back on the market. In August 2007 Dubai World agreed to pay $5 billion for as much as 9.5% of Las Vegas casino group MGM Mirage and half the rights to MGM's massive $7.4 billion CityCenter project on the Las Vegas strip. Dubai could reasonably argue that the pursuit of big names was a necessary acquisition tactic, aimed at fostering support from lenders and paving the way to resale. But the sheikdom also used its dealmaking as a means of announcing its arrival on the world financial stage, where it clearly wanted to raise its profile as a Middle Eastern banking hub. Yet if Dubai's overseas spending often looked extravagant, it was still overshadowed by the lavishness of its domestic infrastructure, housing and tourism projects. These included the construction of three palm-shaped islands extending into the Persian Gulf, which added some 520 kilometers of coastline to Dubai at an estimated cost in excess of $30 billion (though much of that project was privately funded); a man-made archipelago constructed in the shape of a world map that cost an estimated $14 billion; and the Burj Dubai, the world's tallest skyscraper. Today cranes stand idle over empty building sites in Dubai while projects have been put on hold or canceled. Among the victims is the ludicrous Dubai Snowdome, a 1.4 million-square-foot indoor ski complex. The property market is in free fall. Real estate prices have tumbled some 25% from a September peak, according to a Feb. 2 report by Morgan Stanley, though some experts believe the decline is much steeper. "It is probably considerably higher, but how do you measure the market when there are no sales, at least not in any meaningful volume?" asks Davidson. While Dubai is hardly alone in suffering a collapse in real estate values, the impact of the idle building sites and the wider economic downturn will be particularly pernicious in the emirate. About 90% of its population is foreign nationals whose right to remain is predicated on having a work contract. The largest group of those foreign workers are Southeast Asians, employed in the construction sector. As many as 45% of them could leave in the next year, according to Davidson, taking their spending with them and further straining Dubai's local economy. Dubai's future could now depend on the freedom that it has to distribute the new debt to its investment conglomerates, ratings agency Moody's Investor Service said in a note published Feb. 23. "Assuming that there are no such restrictions, this news [of the bond sale] is clearly supportive for the ratings of the six Dubai Inc. companies that are rated by Moody's," the ratings agency said. Those companies are Emaar Properties PJSC, DP World, DIFC Investments -- the investment arm of Dubai International Financial Centre--Dubai Holding Commercial Operations Group utilities Dubai Electricity and Water Authority and the Jebel Ali Free Zone. Moody's has said it could cut its rating on all the companies by as much as two notches. Analysts are divided on what strings will be attached to Abu Dhabi's newfound role as Dubai's banker. Some imagine the lender could effectively use its loans to begin a creeping takeover of its neighbor. It could certainly afford it. The Abu Dhabi Investment Authority, the emirate's sovereign wealth fund, is estimated to be worth about $600 billion to $700 billion, making it easily the Gulf region's heaviest financial hitter. Yet Abu Dhabi has often looked askance at the international investment strategy of its smaller peer and has been stung by devaluation in its own investment portfolio and real estate market. There seems little reason to suppose it would now discover an affection for a handful of new assets being similarly battered by the global downturn. It is even less likely to be tempted by the failed business models of Dubai's domestic developers, though assets such as Dubai's Jebel Ali Port, the biggest in the Middle East, could be interesting long-term investments. The problem is that, having intervened in Dubai's finances once, Abu Dhabi now has a direct interest in supporting its neighbor, and an implicit responsibility, too. Most observers expect that Abu Dhabi will have to back up its initial investment with more money. Dubai is probably counting on it. That's the problems with bailouts -- they have a way of growing. American banks can attest to that, too. Comments |
Bailouts by rich Middle Eastern investors are nothing new in the current economic crisis, as America's banks can attest. But it's not often that the sheiks have had to rescue one of their own. 
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So even the rich sheiks are not immune from the credit crunch. Although they can suffer in comfort more than most people, still having such an enormous debt burden cannot but lead to disaster. I am not really surprised what with all those projects costing billions of dollars.
Evelyn Guzman
Debt Challenger