Debt Watch in Dubai - BusinessWeek

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The flashy city-state's companies owe 126% of GDP, and the main hope for salvation is Abu Dhabi

By Stanley Reed

On a sultry fall evening in Dubai, Mohamed Ali Alabbar proudly shows visitors the artificial lake surrounding the nearly completed Burj Dubai, at more than 2,600 feet the world's tallest building. As an Andrea Bocelli recording plays Time to Say Goodbye over the sound system, water sprays high in the air. Alabbar, chairman of Emaar Properties, Dubai's top real estate developer, explains how the fountains were designed to outclass similar waterworks at Las Vegas' Bellagio hotel and casino and cost more than $250 million. "I said to make it 20% better" than the Vegas version, he recalls.

Bigger. Faster. Taller. Better. For the last decade Dubai thrived on this I-want-it-now credo as the Gulf emirate turned itself into a premier business hub. Today construction crews still labor on Dubai's skyscrapers and malls, and the bars at swank hotels like the Fairmont and the Emirates Towers are packed. Yet Dubai Inc.—that collection of state agencies and state-backed companies that has powered the city forward—now faces a debt crisis as scary as anything that threatened the banks of the U.S. and Europe. It has to pay back or refinance almost $50 billion in four short years. Dubai's ability to pull that off now depends very much on outside bankers—and especially on the largesse of Abu Dhabi, the nearby oil-rich emirate that has long looked on Dubai with a mix of admiration, disapproval, and envy.

The key cluster of Dubai companies owes as much as $90 billion, or 126% of gross domestic product, much of it in short-term bonds and loans from the world's top banks. Dubai could get away with so much borrowing as long as real estate and other asset prices kept rising. But they crashed. Its residential real estate prices have fallen over the past year by a world-leading 47.5%, while office rates are also way off except in the choicest areas. Office and hotel space keeps piling up as the government of hereditary ruler Sheikh Mohammed bin Rashid al Maktoum presses developers to finish their projects. Dubai officials would not comment for this story.

Dubai's debt workout is reaching a pivotal moment. The most immediate concern is a $3.5 billion sukuk, or Islamic bond, issued by Nakheel, a branch of investment company Dubai World. Nakheel, which is building the spectacular palm-shaped artificial islands off the emirate's coast, must pay bondholders back or refinance by yearend. Further out, Standard & Poor's (MHP) figures that Dubai must pay off or refinance a total of $47.4 billion by mid-2013. Regional investment bank EFG-Hermes estimates key Dubai companies have $13.1 billion in debt due in 2010 alone.

Farouk Soussa, an S&P analyst in Dubai, figures the emirate has only $3 billion to $4 billion left of a $10 billion loan it obtained from the United Arab Emirates central bank earlier this year. Meeting the payments "is not going to be easy or comfortable," he says. The $10 billion Dubai borrowed earlier this year was supposed to be just the first half of a $20 billion financing program, a mix of central bank loans and publicly issued bonds. While spreads on Dubai debt are narrowing, bankers say there is little appetite in the debt markets for more Dubai paper. What gives investors pause is that they have not yet heard a clear plan from Dubai on how it is going to clear out the debt. "It is likely that Dubai will be unable to access fresh funding for quite some time," says Simon Williams, chief Middle East economist for HSBC in Dubai. The most likely source of the next $10 billion is up the road in Abu Dhabi, the largest and wealthiest emirate in the U.A.E., about an hour's drive southwest of Dubai. A major oil producer, Abu Dhabi has several hundred billion in cash and investments and no debt problem at the moment.

Abu Dhabi may prove a tough lender. Financial sources say its leadership, which in effect underwrote the $10 billion Dubai borrowed earlier this year, is not thrilled by the prospect of writing big checks to its profligate cousins in Dubai. Abu Dhabi has a corps of financial professionals at a web of funds that invest the bulk of the emirate's surpluses. Sources say these pros are pushing Abu Dhabi's leaders to insist on hard terms in exchange for fresh funding. One idea is for Abu Dhabi to take stakes in Dubai's crown jewel companies, such as Emirates Airlines, ports operator DP World, and Dubai Aluminum. Such deals could consolidate these companies with their Abu Dhabi counterparts, such as Etihad Airways.

So far, Dubai's Sheikh Mohammed has shrewdly fended off any grab of Dubai's equity. This summer he even pulled the plug on a sale of about 20% of DP World for some $2 billion to Abraaj Capital, the Dubai private equity firm, and China Investment Corp., Beijing's sovereign wealth fund.

FAMILY TIES

Dubai's leader has other cards to play. A debacle in Dubai would shake investor confidence in the entire U.A.E., Abu Dhabi included. The other emirates cannot let that happen. Moreover, the Abu Dhabi potentates have close ties to Dubai through everything from hotel investments to marriage. Sheikh Mansour bin Zayed Al Nahyan, for instance, who recently made $2 billion selling his stake in Britain's Barclays (BCS) bank and is considered the third most influential member of Abu Dhabi's royal family, is married to the Dubai sheikh's favorite daughter. "You can be sure Sheikh Mansour hears about this every weekend when he visits the palace," says a banker. A possible compromise: a mortgage held by Abu Dhabi on Dubai assets that would let the emirate regain equity if and when it pays off its obligations.

The debt overhang, meanwhile, is putting a damper on the economy. Credit may get even tighter for local businesses: As Dubai Inc. pays off foreign creditors, it will probably lean on local banks to shoulder larger shares of the debt burden. And despite his political skills, Sheikh Mohammed has lost stature in the U.A.E., especially with the Abu Dhabi elite. Both Abu Dhabi and gas-rich Qatar are following Dubai's example in building financial hubs and are poised to exploit its stumbles. If Abu Dhabi, which is more conservative than Dubai, ends up calling more of the shots on U.A.E. policy, it could force Dubai to tighten rules on the immigrants who bring in money and do much of the work. It could also push Dubai to crack down on the bars and clubs that offer a competitive edge for the freewheeling emirate. Abu Dhabi officials declined to comment.

The best thing Dubai can do now is recover its fast pace of growth. Recently a visitor, stuck in traffic in the financial district, phoned a banker's secretary to say he would be late. "That's great," she said. "Things must be getting better." More seriously, lower office rents help companies, and hotel rooms that once fetched $600 a night can be had for a third of that, making Dubai an affordable destination once more. It's still the place to discuss any business having to do with Iran or Saudi Arabia, which sport few amenities. "As long as conditions in Saudi Arabia remain hard, Dubai will thrive," says Khaled Al-Muhairy, CEO of Dubai fund management firm Evolvence Capital.

Can Dubai change? Many see the forced slowdown as a chance to plot a more restrained course. "This is an opportunity to do things differently," says Tarik Yousef, dean of the Dubai School of Government. That means, first of all, whittling down that debt.

Demystifying Dubai

Visitors to Dubai can nowadays dine out on lobster and champagne, but during a famine in the 1940s residents of the emirate subsisted on locusts and leaves. In City of Gold, published this fall, journalist Jim Krane chronicles Dubai's journey from backwater to boomtown in rich and fascinating detail.

To read a review of the book, go to http://bx.businessweek.com/dubai-business/reference/

Reed is London bureau chief for BusinessWeek.