Nakheel package did not have to cost so much

Wayne Arnold

• Last Updated: August 19. 2009 7:54PM UAE / August 19. 2009 3:54PM GMT

The bill for keeping the nation’s second-largest property company, Nakheel, afloat this December is US$4.05 billion (Dh14.87bn). But it could have been a lot lower.

On December 14, Nakheel will have to pay back the money to investors who bought its $3.52bn in Islamic bonds, or sukuk, as well as the profits that are due to them – another $528 million.

Normally, a company might decide to refinance that kind of debt by borrowing the money to pay off investors from someone else, such as banks or even the same investors who lent it the money in the first place. If the company had oodles of cash sitting around, it might try to pay off some of the debt.

But few people believe Nakheel can pay back the money given the state of its business. And given the sombre outlook for Dubai property, fewer believe anyone in the private sector is willing to lend it to Nakheel.

That means the money will probably have to come from Nakheel’s ultimate owner, the Government of Dubai.

Nakheel’s bonds trade like any other corporate bond or stock. Their price also depends on the appeal of their return relative to other investments and on how investors assess the company’s ability to repay. For a long time, investors feared that neither Nakheel, nor Dubai itself, would have enough cash come December.

The price of Nakheel’s bonds reflected that pessimism. From $103.97 last August before the financial crisis, the bonds dropped to below $85 and then sank to $63.50 on February 19, when Borse Dubai announced it had refinanced its own $3.4bn loan after the Dubai Government kicked in $900m.

Two days later, Dubai announced its $20bn bond programme with the Central Bank buying the first $10bn. Slowly but surely, the price of Nakheel’s bonds recovered, climbing this week to a high for the year of $92.50. Analysts say the recovery is the result of rising confidence that Dubai now has enough funds to repay Nakheel’s debt in full.

But Dubai could have saved itself a heap of cash, analysts say, if it had started buying back Nakheel’s bonds much sooner.

In other countries, such bond buybacks are a fairly standard way for companies to manage their capital. If they can spare the cash, it makes more sense to buy them back from investors at a discount than to wait and pay bondholders with interest when the bonds mature.

“It’s a lot easier for any business in the current crisis to save this kind of money through a smart move like this than to make the same amount of money through daily operations,” says Chavan Bhogaita, the head of credit research at the National Bank of Abu Dhabi.

Some companies go out into the market and buy their bonds like anyone else. Others announce a tender for their bonds at a set price. Once a company owns its own debt, it can retire it.

Nakheel may not have had the cash but Dubai’s Department of Finance did. Doubtless part of the $10bn it borrowed from the Central Bank was needed to make urgent payments to contractors and employees. But it could have also given part of the money to Nakheel to buy back its bonds.

Ideally, Nakheel would have bought the entire issue at $63.50. But that would have been impossible, if for no other reason than the surge in buying would have helped drive the bonds’ price upwards.

Since then, Nakheel’s bonds have averaged about $86. Had Nakheel been able to buy the bonds at that price, it would have saved $1bn.

Of course, it would have also been impossible for Nakheel to buy back all of its bonds but analysts say that even if it had managed to buy a significant portion, it would have substantially reduced the cost of rescuing the company.

Now that task will fall to the newly created Dubai Financial Support Fund (DFSF), which will manage what remains of Dubai’s $10bn bond proceeds and oversee the issue of the next $10bn in Dubai Government bonds.

The DFSF has said it will not divulge how or to whom it doles out its funds. For that reason, bankers say, the next $10bn is likely to be sold in full again to the Central Bank. Selling to private investors would require a prospectus detailing the terms of how the money would be used.

Most debt restructurings would entail some negotiation with lenders, who would be asked to accept lower interest payments, forgive part of the loan or extend repayment. But not when it comes to Nakheel, which bankers familiar with the situation say the Government has deemed too big to fail.

Nakheel’s $3.52bn bond is just the first in a long line of refinancings coming up next year. Anything but full repayment on Nakheel would raise questions about whether other government-owned companies might also ask for a restructuring.

Bankers and analysts say that would probably push down the value of their bonds and raise the cost of any new borrowing for not only Dubai, but for the entire UAE and even other countries around the region.

So the DFSF has to make sure of two things: that it has enough money to keep Nakheel and other companies in Dubai Inc solvent, and that it makes enough to pay the Central Bank back with 4 per cent interest.

To do that, Dubai Inc is already being shaken up. Nakheel has had a wave of lay-offs and is devising ways to pull more cash from customers. Dubai Holding’s stable of companies is being combined into four vertically integrated silos to eliminate redundancy and with it some big executive salaries.

But then the painful process of picking winners and losers will begin. Companies will have to make a case to the fund but their viability may be determined by a simple litmus test: if their private-sector bankers and investors are willing to roll over some debt, they can count on government funding. If their private backers forsake them, the fund may pull the plug.

warnold@thenational.ae