On the same day as having effortlessly raised $5 billion, Dubai World issued a statement in which it essentially said that ‘Dubai World intended to request its finance providers to extend the maturity on its outstanding debt by six months’. It was a short and arguably vague statement and was released ahead of the Eid and Thanksgiving holidays. This has now caused much speculation and seems to be taking on a life of its own in the international financial markets.
First of all we need some perspective here. Dubai is not and never was ‘bullet proof’. If it indeed claims to be a modern economy, there should be room for both success and failure on the company level and Dubai World, after all, is a company. In difficult times it is only normal and logical that companies may have to restructure debt or even go bankrupt. In most western economies we have recently seen unprecedented bankruptcies and bail outs both in numbers and in dollar value. Unprecedented even to the extent that some major companies are no longer amongst us today. Regardless, the global markets are up significantly this year.
The Middle East, and especially Dubai have over the last years become a business hub with significant exposure to global growth. Specifically, Nakheel has used a lot of leverage to finance growth and has concentrated most of its investments in Dubai. This has made it very vulnerable to dramatic decreases in Real Estate prices and a difficult credit environment. The issues of Nakheel and Dubai World, should, however, not be confused with general state of ME economies. It is not pragmatic to cast a verdict on the entire Middle East based on the current issues at hand in Dubai, it would mean ignoring the strong case for some of its neighboring economies, especially those of Saudi Arabia, Qatar and, yes, even those of Abu Dhabi.
Investors should understand that the worst case scenario is full bankruptcy or 100% default. This scenario does not seem probable but even if this happens, the effects may end up to be positive. Investors will realize that the Middle East is indeed not indestructible and build a more realistic view. More importantly this may be a catalyst to rationalize the property market and take out supply (by the way, there is a shortage of supply in real estate in Abu Dhabi, Qatar and Saudi Arabia). Again, this news release is very vague and should for now be interpreted as a request to specific debtors to delay a part of the outstanding loans. There are still a few options on the table which are still not entirely understood yet. The most important lessons will however be learnt regionally. Singapore or Hong Kong have learned from every crisis and have grown solidly over the years.
To return back to the events of last days, our best explanation is that Dubai is leveraging its raised $5 billion to get tougher on the debt investors in Nakheel. These investors have invested in a real estate company which was highly leveraged. Not in UAE government bonds. On this debt they have received a spread which is higher than of Western peers. Nakheel is facing financial difficulties and it is normal that investors should share some of the burden. Dubai has been navigating through challenging times and secured needed capital to limit the impact of the global downturn. It is only wise to spend to expect them to spend this capital in an efficient way and to share the burden with the investors who would have also participated in the upside if the environment would not have changed.
For further perspective, while other markets have risen strongly this year, the Middle East has lagged. If we look at the valuations of the GCC markets versus their 5-year highs, one could argue that much of the concern may have already been priced in. Despite the rise in global markets, the UAE (Dubai + Abu Dhabi) is trading at just below one third off peak value as is Saudi Arabia. Compare this to the MSCI World index, where it cannot be ignored that its recovery has for a part been fuelled by bail outs.
The major driving forces for the GCC region’s economy are still intact: high reserves, low taxes (competitive advantage) and geographic location. It’s all about perspective, investor sentiment and above all valuation. The medium term investor could be looking at a great opportunity here…