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Dubai’s recent securitization of Salik electronic toll road receipts–an “innovative funding strategy” designed to take advantage of the assets and cash flows that it has per Chavan Bhogaita, head of markets strategy with National Bank of Abu Dhabi–will secure $800m without tarnishing the emirate’s low income and corporate tax image according to a senior government official, though ironically it also comes against the backdrop of “a surge of public transport interest in the Gulf”. Yet while some $30 billion worth of loans and bonds–linked chiefly with state-linked enterprises–will mature over the course of the next year, look for the market’s appreciation for Dubai’s newfound fiscal pragmatism as well as the implied support of oil-rich Abu Dhabi to lag and in turn create opportunities in corporate debt.  The emirate’s most recent budget, announced in January, cut spending initiatives roughly 5% to AED3.78 billion for 2011, or 1.1 percent of GDP.  This coincides with improved macro fundamentals for the state as a whole due primarily to hydrocarbon-based growth which analysts see rising 4.6% y/y in the UAE with projected inflation remaining relatively mild at 2.5% y/y.  Per Dubai specifically, “in the context of continuing turmoil in the MENA region [it] has behaved as a safe haven” according to analysts with Barclays, noting that contrary to contagion “a gradual revival in Dubai’s trade and tourism activity benefited from turmoil in Egypt and Tunisia and heightened political tension in Lebanon, [and] is likely to support growth towards 3.8% in 2011 . . . with risk to the upside as [it] could start to benefit from the delocalisation of businesses and households out of Bahrain in search for medium-term stability prospects.”  With 5y CDS continuing to trend downwards from 2009, analysts also opine that “we would not rule out oil-rich Abu Dhabi supporting Dubai in meeting some of its refinancing needs in order to avoid negative headlines and confirm its solidarity with other emirates.”  With this in mind J.P. Morgan just labeled DP World (the emirate’s once beleaguered ports operator) paper “cheap” after Moody’s made it “the first and only non-bank issuer from Dubai to regain the investment grade rating,” a move we’re not surprised by given our piece on DP World a few weeks ago vis a vis the strength of the container shipping industry in general against the backdrop of Dubai’s ever-central role in global trade.


A recent article in The Economist noted the growing divergence between container and bulk shipping; while container volumes and shipping rates are trending back towards their pre-crisis peaks against the backdrop of projected annualized global trade growth of 8-10 percent in 2011 (though whether said predictions came before the recent oil spike is highly dubious), bulk capacity is expected to double the rise in freight volumes.  Fitch reiterated several of these points while assigning DP World (DPW)–the world’s fourth-largest container terminal operator with the widest geographical spread of any of the leading operators, with operations in Latin America, Africa, the Middle East and Asia (and whose parent finally wrapped up debt restructuring)–its IDR and senior unsecured ‘BBB-‘ rating, while also noting that “export-led growth in the emerging economies” should particularly suit it “given its bias towards emerging markets which account for around 75% of its trading volumes” (to this end, expect further movement on the South American front).  Chief executive Mohammed Sharaf thinks the region’s recent unrest could ultimately bolster business even as the immediate consequence saw the firm’s equity diverge downwards some 8x versus global port peers despite the fact that Middle East and Africa (ex-UAE) represents only 8% of DPW’s gross capacity.  Either way the long-rumored London listing is now back on track (the impetus presumably being the aforementioned debt deal), though Morgan Stanley pointed out that last month that “it is unclear if the free float will increase with Dubai World selling down its stake.”  Moreover, an eyebrow raising piece in the FT Friday noted the “psychology” underpinning the latest exodus of Gulf wealth into Swiss, UK and more safe-haven, liquid assets: “local equity markets are the main victims–as family offices are among the main active investors and traders in listed companies.”  If oil and fear spike again, even container-shipping should pause, and volume-challenged equities would be especially vulnerable.

MENA CDS activity of late is eerily reminiscent of the risk “contagion” caused by investors questioning Dubai’s debt-servicing capabilities in late 2009 when [irrational] fear spilled-over to Abu Dhabi as well even though the latter’s fiscal integrity was never seriously in question, a fact later confirmed when it underwrote a bailout.  But if such objective measures are largely ignored in the market of default probability perception, perhaps it should come as no surprise that more nuanced, subjective ones such as the differences between the historical, social and economic dynamics of say, Saudi Arabia versus Egypt, also fail to be carefully analyzed.  Even The Economist’s latest stability rankings, for instance (see chart)–the result of ascribing a weighting of 35% to the share of the population that is under 25; 15% to the number of years the government has been in power; 15% to both corruption and lackofdemocracy indices; 10% for GDP per person; 5% for an index of censorship and 5% for the absolute number of people younger than 25–seem inadequate.  An accompanying piece, for instance, notes that in Saudi Arabia (whose marginalized Shia population is, unlike in Bahrain, a relative blip) the unity of unrest seen elsewhere may be structurally unlikely: “Building an opposition movement is difficult in Saudi Arabia.  [While] grievances are plenty: about living standards, poor schools, lack of jobs, the government is adept at using repression, propaganda, tribal networks and patronage to divide and weaken any opposition.  Middle-class liberals are wary of democratising steps that might give more power to anti-Western Islamists.  State-backed clerics have denounced the Egyptian and Tunisian protesters, and issued fatwas against anything similar in Saudi Arabia.  Only in the [admittedly oil rich] eastern province—home to a large Shia population—is there much tradition of protest.  But community leaders there are cautious, and desperate to avoid any accusations that they are a ‘fifth column’ for Iran.”  Barclays too notes that addressing how immediate tensions in the region may unfold is at least partially dependent on a given military: “Bahrain’s military is almost entirely composed of Sunnis and there is a significant foreign element in the ranks as well. Hence, they may be more willing to brutally suppress dissent than their Egyptian counterparts and the regime may not be as concerned about possible splits within the officer corps,” it wrote to clients.  That said, perhaps such “nuance” is just noise from the collective market’s point of view.  The real concern for Saudi Arabia may not be the emotional state of its Shias but rather the physical soundness of the 18-mile-wide strait Bab el-Mandab.

The FT noted this week that according to many analysts Dubai’s “core model, built on finance and trade and infrastructure, still puts it far ahead of its rivals as competition heats up to be the region’s hub.”  However, the city-state and its government-related companies still have a total of $110.6bn of outstanding public debt according to Bank of America-Merrill Lynch figures, of which a significant portion ($48.5bn) comes due in the next two years.  Last month Dubai World, the government-owned conglomerate, confirmed that creditors had indeed agreed to restructuring proposals regarding the $20bn of debt whose repayments the group announced a moratorium on last November, a move that analysts theorized could spur similar deveopments at other state-linked firms.  Simon Williams, chief economist for the MENA region at HSBC Bank in Dubai, thinks that the emirate has a whole has “shifted into recovery mode,” citing the fact that his firm’s UAE Purchasing Managers’ Index (PMI), which measures the performance of the OPEC member’s manufacturing and services sectors, rose to 53.8 points in October–a 15 month high.  And last month the IMF upgraded its GDP forecast for the UAE to 2.4 percent, faster than the 1.3 percent it previously forecast, based largely on robust demand for UAE services, “particularly in light of Asia’s rebound and the agreement on debt restructuring, which will resolve uncertainties and contribute to boosting real estate-related sectors.”  Yet worrisome news over this past weekend should give bulls some pause, as five-year credit default swaps (CDS) for Dubai spiked 30 basis points from the previous close to 440 basis points (a two-month high) on news that Dubai Group, a financial services firm, missed two payments on separate loans in recent weeks, including one arranged by Citibank.

Dubaibeat reports that Daman Investments, a private sector UAE-based investment management firm, announced today the launch of the Daman Fifth Fund, a $54 million closed-ended fund.  Per its press release, the Daman Fifth Fund is “a new mutual fund that will focus on blue-chip equities listed on the GCC financial exchanges, debt products and commodities, and targets an IRR of 25% per year.”  Commented Managing Director Shehab Gargash, “[The fund] is an opportunity fund that capitalizes on the upcoming GCC market recovery.  Our first closed-ended fund since the launch of the Daman UAE Value Fund back in 2001, which was also a market recovery fund that netted an impressive return of 273.84% over its lifespan.”

The release also highlighted the firm’s 2010 and beyond market outlook, reproduced below:

The GCC markets were serial underperformers in 2009 in terms of both absolute and relative numbers, when compared to EMEA (Europe, Middle East and Africa) and developed markets.

Immediate growth drivers

• The regional GCC markets are currently trading at forward estimated valuation multiples of 10.2x for year end 2010 earnings estimate which are at a discount when we compare to then historic PE average range of 18x for the past 5 years.

• Taking P/B ratios we continue to find further support for the valuation case with the GCC region trading on 1.4x 2010e.

• The FYE2010 dividend yield at regional markets is estimated to be at an average of 3.9% with many individual stocks having yields in excess of double digit figures making the region an attractive play for income related investors.

Catalysts for Long term growth

• The outlook for oil prices remains positive with most investment houses predicting stronger outlook for global growth, lower interest rates and a more realistic acceptance of the limits of energy supply.

• The IMF continues to forecast a benign macro environment for the GCC economies looking for them to increase their GDP some 10 fold from 1980 levels to 2020 equating to some US$2trn in GDP by then.

• The governments of the region continue to pursue stimulatory policies through increased infrastructure spending. This is proving to be a counterbalance to some of the pullback of private sector spending.

• On the Banking sector, we expect the banking sector NPL curve to peak in H1’10 and to start coming down in H2’10 releasing more liquidity into the system as the appetite to grant loans increases with the strengthening economic recovery.

• Petrochemical sector to remain strong for the year on strong global growth rebound trend. GCC players continue to enjoy a strong cost advantage vis-à-vis their global players.

• We continue to view the Real Estate market across Saudi Arabia and Abu Dhabi market as favourable with an improving credit environment and increased deliveries leading to both primary and secondary market demand.

• On the Telecom sector, we are positive with the Industry getting aggressive on price competitiveness and on new product introductions such as VoIP, and upgraded 3G technologies. Strong cash flow and dividend yield characteristics with a lot of the recent deal flow beginning to bear fruit this year provides us the level of comfort to remain bullish on this sector.

According to Bruce Powers, a Dubai-based technical analyst and financial commentator, “it seems like investors have now distinguished between Dubai’s problems and [those of] Abu Dhabi.”

On a relative basis the Abu Dhabi Securities Exchange General Index (ADI) has been showing strength compared with the Dubai Financial Market General Index (DFMGI).  That strength is likely to continue into the foreseeable future barring conclusion of Dubai’s debt restructuring.  Although there are similarities in the chart patterns of each market, the ADI has broken through its downtrend line resistance level while the DFMGI remains below it.

Herd-caused contagion afflicted the perception of risks for assets across the Gulf last fall on worries about possible Dubai-related defaults, as well as questions over the emirate’s vision for its long-term financing.  At their peak, even credit default swaps for five-years bonds jumped 177 basis points for Abu Dhabi, and 119 for Qatar, respectively, despite no apparent concern per se over the strength or volatility of their cash flows.  Analysts noted, for instance, that Qatar has the world’s second largest gas reserves, and oil-rich Abu Dhabi has the biggest sovereign wealth fund, worth approximately $700bn.

Bank of America’s tail-risk warning may indeed be precisely the impetus needed for another Abu Dhabi (the emirate of last resort?) -financed bailout, though there is some question as to whether the technical defaults of two state-owned firms–Dubai World, an investment firm, and Nakheel, a real-estate subsidiary of Dubai World–necessarily imply the defacto default of the sovereign emirate as a whole in the first place. In fact, argues Gavan Nolan, a research analyst at Markit Group, a financial information services company:

“It should be made clear that the Dubai sovereign is not in any immediate danger of a default. The standstill, if it is mandatory, may constitute a technical default on Nakheel and Dubai World. However, the Dubai government did not make an explicit guarantee on the companies’ debt, and are under no legal obligation to honour the debt. This is clearly the position Dubai’s wealthy sister emirate Abu Dhabi favors. Its actions this week seem to indicate that, while it will support the sovereign, its backing is conditional. The funds are available – Abu Dhabi has immense oil resources and the world’s largest sovereign wealth fund. Indeed, Dubai has already been advanced funds by Abu Dhabi. But it was quite clear that Nakheel and the rest of Dubai World will not be allowed to benefit from the largesse.”

The exact point was trumpeted by Saud Masud, a Dubai-based real estate analyst, in a comment made to Bloomberg:

“Abu Dhabi and Dubai have decided to seek to bolster long-term confidence in the market by forcing weaker parts of government businesses to take responsibility for bad decisions and could involve defaults at some Dubai firms, Masud said.”

Less debatable, however, is the absurdity of the hitherto resulting regional contagion, which immediately drove up the cost of protecting emerging-market sovereign debt against default. Default swap contracts on Abu Dhabi rose 23 basis points to 183, Qatar climbed 17 to 131, Malaysia was up 11 at 104, Saudi Arabia climbed 18 to 108, while Bahrain rose 22.5 to 217. Having said that, one could buy the theory that the Dubai announcement is merely the requisite impetus whereby the ‘risk rally’–which having essentially been on since March seemed destined to eventually taper–unwinds. If the rally does unwind, moreover, frontier and emerging markets, which represent the tail end of the risk curve, would be the first to feel it. Templeton Asset Management Ltd.’s Mark Mobius, for example, said on Friday that Dubai’s attempt to reschedule debt could indeed cause a “correction” in emerging markets.

Yet even a market correction per se should not correlate with a higher sovereign default risk–this is where the current, broad brushstroke of contagion should be arbitraged. Abu Dhabi and Qatar, for instance, remain as resource and reserve rich as ever, objectively speaking. But fund managers clamoring to keep in tact whatever YTD returns they have may be hesitant to brashly step in front of the bus so quickly–suggesting the sudden and drastic point spike may even have some more legs to it. Nevertheless, ultimately, as Silk Invest’s Baldwin Berges reminded investors on Friday, “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.” Nolan concurs:

“The sovereign CDS market sometimes has a habit of conflating geographical proximity with economic similarity (eastern Europe earlier this year springs to mind). Unlike Dubai, the countries mentioned above have significant natural resources and their public finances are in better shape. To an extent this has been reflected in CDS spreads for some time (see chart above). It seems that Dubai is something of a special case and its problems are not necessarily found elsewhere.”

Dubai’s government returned to the open bond market upon a growing sense that the notoriously ‘profligate’ emirate–as at least one analyst has previously criticized it in comparison to its more steady, oil-fueled sibling Abu Dhabi–can be trusted not to default on its $80bn or so of outstanding debt. On the heels of last week’s proposed Euro Medium-Term Note (EMTN) program which seeks to raise 6.5bn, divided into four billion dollars in EMTN and 2.5-bn in Islamic bond issue, or sukuk, the government on Wednesday successfully placed nearly $2 billion in new five-year Islamic bonds–divided into both a dollar and dirham tranche–the biggest sukuk sale from the Gulf region this year. Pricing was set at 375 basis points plus/minus 10 points over mid-swaps for the dollar tranche, and with the same spread over three-
month Emirates Interbank Offered Rate, or EIBOR, used for the
 dirham tranche.

Strong investor response was seen as a “clear indication” of increased confidence in Dubai, per one analyst. Moreover, the IMF’s latest projections for the region as a whole–a 5.2% increase next year due to climbing oil prices, revival of global demand and continued government spending–favor increased fervor in any form of ‘risk trade,’ including frontier sovereign debt. Such vigor will be welcomed by Dubai especially, which must refinance or repay $10.1bn worth of debt in 2010, $12.1bn in 2011, and roughly $15bn in 2012 (an amount equal to around 70% of the emirate’s estimated cumulative GDP for the same period), and which is the third largest re-export hub after Hong Kong and Singapore, making it particularly vulnerable to widespread slowdown. It is precisely its leverage that has made Dubai default swaps the sixth costliest of 39 emerging markets, per Bloomberg.

Yet is the premium sufficient? As The Economist noted this week, “until recently, investors were expecting Dubai to meet its obligations by running down its assets or rolling over its loans—not by issuing fresh liabilities to new investors.” The piece continued that some bankers expect Dubai’s true commitment to repayment to be a function of how visibly traded the debt in question is; that is to say, “it will try to postpone bilateral obligations, quietly and below the radar,” and local banks, as opposed to foreign ones, “will probably be asked to sacrifice the most.”

Citing Dubai’s deteriorating credit worthiness–government debt is expected to reach some 40% of GDP by year’s end–Fitch placed the UAE’s largest telecoms firm, Etisalat, which is 60.03% owned by the UAE and is the second-largest operator in the MENA region by market capitalization, on watch with a negative outlook. The firm’s AA- credit rating could be downgraded, Fitch warned, if government officials did not further articulate its willingness to cover the company’s debts (some commentators astutely noted that what this is in fact asking is to what extent will Abu Dhabi’s massive oil reserves further insure its arguably profligate sibling). “While the [UAE’s] sovereign credit remains strong, the lack of clarity on the process for non-budgetary financial transfers between the UAE federal government, central bank and individual emirates, is a source of weakness,” the rating agency noted.

The downgrading of Etisalat, however, would be curious, and almost certainly arbitraged away. The company enjoys a share price to operating cash flow ratio of 8, and a beta of .63, meaning it is less volatile than the overall market. Most important to its prospects for sustained profit growth, however, is a growing portfolio of overseas assets. This is especially vital to operations as the UAE’s mobile penetration rate has now exceeded 209%, meaning every single resident of the country currently has two lines to his or her name. While 90% of its revenues are UAE-derived, Etisalat is poised to capture emerging market share: in addition to the seventeen countries it currently operates in, the company acquired an Indian operator earlier this year and has submitted bids in Sri Lanka and Libya.

Per hospitality research firm STR Global and Deloitte & Touche Middle East, Middle East hotels in 22 cities in the region during the first half of 2009 witnessed an average 10.9% decrease in occupancies and a 17.2% drop in revenue per available room (RevPAR), an industry benchmark.  Among the worst RevPAR performers were Dubai (down 35%) and Muscat (16.6%), while other cities outperformed tremendously, including Abu Dhabi (3.2% increase), Jeddah (11.5%) and Beirut (125.2%).


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