How Dubai's dream sank in a sea of debt

How Dubai's dream sank in a sea of debt

The emirate’s debt-fuelled spree has been exposed by the recession. Will UK banks and contractors get back their money?

Floundering in a sea of debt: Sheikh Mohammed

As he flew from Dubai to London last Sunday, Sheikh Mohammed bin Rashid al-Maktoum had plenty on his mind.In the four years since he had become ruler of Dubai, Maktoum had grown used to courting world leaders to visit and invest in his desert emirate. They admired the economic growth he had fostered as Dubai, fast running out of oil, turned itself into a tourism and finance hub.

Maktoum knew that on this trip he would have to strike a more humble tone. After an audience with the Queen at Buckingham Palace, he met Gordon Brown and Lord Mandelson. The damaging effect of the global economic downturn on Dubai’s growth was on the agenda. The sheikh brought reassurances that angry British contractors, caught up in the emirate’s construction collapse, would eventually get paid.

Maktoum also knew that a bigger test to international relations was brewing. But there were few clues until he had jetted out of London.

The crisis struck on Wednesday. On the eve of the Eid religious festival, the Dubai government announced that one of its main investment vehicles, Dubai World, could not pay its bills. Maktoum wanted to suspend repayment of some of its $59 billion (£35.8 billion) debts until May.

Like over-leveraged companies that are being exposed by the recession, Dubai had borrowed beyond its means to fund its building boom. But, as shocked investors saw it, this was a government at risk of bankruptcy, not a corporation.

According to the Bank for International Settlements, British banks had advanced $50 billion to the United Arab Emirates, of which Dubai is one of seven member states. Four lenders — HSBC, Standard Chartered, Barclays and RBS — are the most exposed.

The trauma of Dubai’s news was compounded by its lack of clarity. Having issued its statement the emirate shut up shop for the Eid holiday, saying no more.

The timing and manner of the announcement spooked world markets. The FTSE 100 spiralled down 3% on Thursday as traders fretted at the vacuum of information. The price of insuring Dubai debt soared. The city state that grew too fast was finally facing its comeuppance.

Fears grew that Dubai had lost control of its affairs and the contagion could spread across the Middle East and into other emerging economies. By Friday night, after two days of turmoil, financiers appealed for calm but the sense of uncertainty was pervasive.

“I am confident the leadership of Dubai and the UAE will overcome any short-term problems they face, which appear to have been somewhat sensationalised, and continue to lay the foundations for sustainable growth,” said Michael Geoghegan, HSBC’s chief executive.

Abu Dhabi, the other dominant mini-state in the United Arab Emirates, rode unenthusiastically to the rescue yesterday with an assurance that it will help its profligate neighbour but only “on a case by case basis”.

But the British banks and investors that have poured many millions into funding the Dubai dream now face an uncertain future over how much of their money could be lost. And the repercussions could be huge for the global economy, potentially hobbling the return of growth after the recession, if the glittering showcase in the Gulf collapses.

DESPITE the shocked reactions, this was not an unforeseeable crisis. Everyone knew that Dubai’s property boom, which had led to the creation of some of the world’s most luxurious hotels and resorts, had turned to bust.

The Palm Deira, one of the world’s largest man-made islands, now seems like a section of motorway on stilts — half-built, disconnected from the land and looking grey and redundant. It is not the only project that has suffered. The construction frenzy — fuelled by the biggest surge in oil prices in a generation — has ground to a halt.

“Dubai took on huge debt at the worst possible moment. It’s a pretty toxic combination of over-expansion and bad timing,” said Norval Loftus, head of Islamic debt at Matrix Group in London.

“I always thought that one of two things could happen in Dubai,” said a senior banker. “They could either let almost all the local banks fail, or they could let some of the property companies and investment companies fail. It looks like they have chosen the latter.”

Bankers emphasised that the response of the Dubai government to the emergency is critical. It is not just Dubai’s credit rating that is on the line — Dubai’s role as a financial centre is also under threat.

Much of Dubai World’s problems can be traced to its property subsidiary, Nakheel, the company that branded Dubai as a glitzy, architectural free-for-all. It owns, among other things, three Palm-like islands and a group of 300 islands shaped like a map of the world.

An Irish company went bust while promoting the Ireland-shaped island in the world map project. The property was to include a replica Giant’s Causeway and imitations of Dublin’s Georgian squares. The co-promoter, a leading Irish property developer, committed suicide amid mounting debt.

By last week, Nakheel was on the brink of collapse, with a $3.5 billion bond due to mature on December 14. Bondholders fear the worst.

The emirate’s difficulties are not confined to Nakheel, however. Unless Dubai’s debt problems can be solved, it could be forced to offload many of its investments in a fire sale.

“It is only reasonable to be more worried about what this could mean for the rest of the portfolio,” said David Lewis at Bank of America Merrill Lynch.

What does the portfolio consist of? During an overseas spending spree, Dubai snapped up many plum assets. It bought the Turnberry golf course in South Ayrshire and paid £50m for the QE2 liner. It sought luxury hotels to add to its portfolio, snapping up buildings such as the Mandarin Oriental in New York.

Financial services, too, were regarded as an essential part of the economy. Borse Dubai’s 22% holding in the London Stock Exchange is currently valued at £462m, and a few years ago, when the buyout boom was getting under way, Dubai launched its own private-equity firm, Dubai International Capital (DIC).

DIC announced itself on the world stage by buying a $1 billion stake in Daimler Chrysler, the carmaker, and swiftly followed that by acquiring Tussauds Group, owner of the famous waxworks museum and a string of theme parks.

In Britain, DIC bought Doncasters, the engineering firm, and Travelodge, the budget-hotel chain, for example. DIC was rarely out of the newspapers, not least because of a long dalliance with Liverpool football club, although a deal to buy it eluded the firm.

Dubai’s most significant investment in Britain lies in the unlovely surroundings of the lower Thames estuary, sandwiched between an oil refinery and Canvey Island. DP World, one of Nakheel’s sister companies, has planning permission to build a new container port 25 miles east of the capital. London Gateway is designed to handle more than 3.5m containers a year and eventually employ more than 12,000 people — Britain’s biggest single source of new jobs in the next decade.

At the moment, however, it is not clear when — or if — the grand plan will become a reality. DP World inherited London Gateway from P&O when it bought the British shipping group for £3.9 billion. Since March, the project has been officially under review, as DP World reassessed its investments in the light of the collapse in world shipping.

Now the problems at Dubai World have increased the doubts over whether the port will be open next year as intended. Cancellation or delay would be a blow to government plans to regenerate the area. Ministers’ reliance on Dubai’s billions to deliver a key economic strategy reveals how pervasive the emirate’s influence has become.

DP World, which owns Dubai’s worldwide ports business, is itself a prized asset, and Dubai has attempted to ringfence it from the rest of Dubai World. It has its own debt facility and a stock market listing. As it is one of the emirate’s most liquid assets, worth about £3.3 billion, Maktoum could order a partial sell-off if the debt crisis became acute.

THE money men from Dubai who came to Britain to invest the emirate’s borrowed money were low key, respectful and professional. “There was no ‘we are conquering the world’ type attitude,” said one who has worked with DIC, although he said they grew more confident after one or two early successes.

Now, with the tide turned, British bankers and advisers are heading for Dubai in the hope of picking up lucrative advisory business.

Deloitte has been appointed to lead a restructuring of Dubai World by the emirate’s department of finance — over the heads of long-term advisers Rothschild and Deutsche Bank. Aidan Birkett, the partner who has worked on tricky debt negotiations at Wembley and MyTravel, has two weeks to assess the situation.

Meanwhile, KPMG is preparing to be parachuted in to advise a creditors’ committee of 90 banks.

Most of the foreign bondholders include big banks and hedge funds, and they are expected to appoint legal advisers in the next few days to help their cause, possibly seeking redress through the British courts.

Although bondholders may try to force Dubai to sell assets to raise the cash needed to meet the repayments on the $3.5bn bond. This would be far from straightforward as an estimated 50% of Nakheel creditors are local institutions that are much more likely to accede to the Dubai government’s request for a delay in the repayments.

The likely next step would be to petition formally to have Nakheel declared in default, which would require the assent of a quarter of all the bondholders.

Meanwhile, business deals are threatened by the uncertainty. Earlier this month, Emirates National Oil Company (Enoc)agreed to pay $1.9 billion for the 48% of Dragon Oil, a producer in the region, that it didn’t already own. Sources close to the deal say it is still on track for completion on December 11; and Standard Chartered, which committed itself to put up most of the funding, reiterated its backing last week. However, there is some speculation that Enoc could scrap the deal and sell its half-ownership of the group. The Chinese and Russians have, in the past, expressed interest in Dragon.

CLOSELY observing the debt crisis — and wondering what the fallout will be — is the British business community in Dubai.

When David Eldon became chairman of the Dubai International Financial Centre (DIFC) in 2006, it marked an emotional return. The desert city had been the veteran banker’s first overseas posting when he joined HSBC in 1968.

Eldon thought it would be an interesting challenge to lead the project aimed at turning a 110-acre site into a financial district to rival New York and London.

Dubai threw millions of dollars into gleaming tower blocks and tax breaks. The only thing that it couldn’t buy was a reputation. “I wanted to make sure they earned it,” Eldon said.

Two weeks ago, the DIFC celebrated its fifth birthday with 850 registered companies. Some 256 of those arrived in 2008. Despite the global financial crisis, it was an apparent success.

However, DIFC’s ascent has not been without flashes of drama. Regulators Phillip Thorpe and Ian Hay Davison, imported from Britain to introduce western standards, were unceremoniously dumped in 2004 for asking questions about conflicts of interest.

Last week’s disclosures have inflicted far more damage, Eldon conceded.

“For the country itself, people will be asking questions. For the DIFC, I think the concept still remains sound, and the reasons for which it was created are still valid.

"Yes [Dubai will suffer] a dent. People will ask whether you can trust them [DUBAI]in the future. Dubai clearly has some work to do in that regard.”

Investors are not the only ones questioning their faith in the emirate’s future. Chinese labourers are working on hotels attached to the world’s tallest building, the Burj Dubai.

Chinese supervisors barricaded themselves on the roof of one of the camps as workers smashed up their accommodation and threw glass bottles at managers.

“It’s not our fault,” said one manager as he showed the wreckage. “The people at the top have not paid us, so we are left with this big mess.”

British contractors who piled into Dubai have sought help from Lord Mandelson to get their bills paid.

The Association for Consultancy and Engineering (Ace) estimates that UK engineers and consultants are owed at least £250m. It believes that Dubai’s main arbitration body is struggling to process almost £3 billion of disputes.

WS Atkins, one of the big players in the Middle East, has been forced to axe 30% of its staff across the region.

Carillion has quietly switched about 5,000 of its 20,000 staff in the Middle East from Dubai to Abu Dhabi in the past 18 months.

It is a transfer that is predicted for some of the region’s investments, too. The Middle East has already suffered from high-profile defaults, including the Saudi Arabian Saad Group and Investment Dar, a Kuwaiti investment fund that owns half of carmaker Aston Martin.

Nick Chamie, head of emerging-market research at Toronto-based RBC Capital Markets, believes the damage to the Middle East’s financial reputation will not be easily undone.

“Dubai will be one of the larger recession casualties and it probably will have a long-term impact. People are re-evaluating Middle Eastern credit and any companies interconnected with the ebb and flow of Middle East capital,” he said.

However, he dismissed comparisons in the international media with Argentina’s default calamity in 2001.

“Dubai is its own idiosyncratic risk. Argentina defaulted, Dubai has not. Dubai World is a government entity, not the government itself. I fully take on the seriousness of the situation but I don’t think Argentina is an instructive example.”

So much hinges on the relationship between Maktoum and the Al Nahyan family in Abu Dhabi, whose conservative investments meant that they have grown used to being overshadowed by their smaller but flashier neighbour.

Dubai is hoping Abu Dhabi will help repay $9 billion in loans due in the next four months. Their relationship was neatly summed up at Dubai’s Laughter Factory.

A comedian compared Dubai with a juvenile Monopoly player who buys up everything on the board and then goes bust. Abu Dhabi is the smug player who waits it out and then says: “Erm ... I think I’ll have your hotels ... and your planes.”

“Anyone who pretends to know the relationship between them really doesn’t,” said Loftus at Matrix. “All we can do is judge actions, not words.”

“Abu Dhabi is not going to let this go down,” said one banker involved in the negotiations.

As for the global economy, Gerard Lyons, Standard Chartered’s chief economist, who was in Dubai last week, pointed out: “This is a Dubai-centric problem and it is particularly a Nakheel problem and this, to be frank, has been badly managed.

“The world economy is worth $61 trillion, the Middle East is $1.1 trillion and Dubai is a small fraction of that.”

EXPATRIATES AT THE TOP

David Eldon, chairman of Dubai International Financial Centre

Scotsman Eldon, 64, has been working on and off in Dubai since 1968, when his first overseas posting took him to the British Bank of the Middle East (part of HSBC). He spent 11 years in the Middle East working for HSBC, before going to the Far East, where he rose up the ranks to Asia chairman. Eldon joined DIFC in 2006.

Gerald Lawless, executive chairman of Jumeirah Group

Gerald Lawless heads up Jumeirah, the hotels arm of Dubai Holding and owner of properties including the Burj Al Arab hotel. Born in Ireland in 1952, he has been with the Dubai company since 1997. Prior to that, he had spent 23 years working for Forte, the leisure giant. He moved to Dubai in 1991 to set up Forte’s Middle East office.

Maurice Flanagan, executive vice-chairman of Emirates

Flanagan, 81, once wrote a television play for Leonard Rossiter but it is as boss of Dubai’s national airline that he has received acclaim. He led the team that launched Emirates with two planes in 1985 on a budget of $10m and has overseen a huge expansion of the fleet. Flanagan, from Lancashire, started his aviation career with BOAC after serving in the RAF.

Rick Pudner, chief executive of Emirates NBD

Another experienced British banker and a veteran of HSBC, Pudner heads the merged Emirates Bank and National Bank of Dubai. He played a key role in overseeing the integration in 2007 of the two organisations. Arabian Business magazine rated Pudner as the most influential Englishman in the region in its list of powerful expatriates.

The Times