A number of my banker friends and friends of friends have been in touch with me recently about the Nakheel‘s $3.52 Sukuk that matures at the end of this year.

There has been a run of good news related to Dubai‘s debt obligations recently.

First was February’s Borse Dubai‘s successful refinancing of its $3.4 billion syndicated loan via a $1 billion equity injection from shareholders including the Investment Corporation of Dubai (ICD) and a last minute $2.5 billion loan ($1.2 billion of which was raised from international banks and $1.3 billion provided by state-owned Dubai banks after I.C.D. using proceeds of its own $6 billion syndicated loan, made in November, deposited cash with them).

Then came the FT-dubbed Dubailout $20 billion long-term bond program with the UAE Central Bank subscribing to the first $10 billion tranche in February. This was particularly meaningful as it followed a move by Abu Dhabi to go it alone and inject $4.4bn of tier 1 capital into five of its own banks causing concerns about the level of financial support available to Dubai from Abu Dhabi.

April brought two more successful refinancings. A US$600 million syndicated loan facility raised by the Dubai Government to pay off part of a $1bn Dubai Civil Aviation (DCA) debt. The remainder was paid off by the Dubai Government, its first post-Dubailout capital injection. DEWA refinanced $2.2 billion through 18 local and regional banks at 300 points over Libor (rising from 50 points). That brought total loans raised in April to $2.8 billion.

Dubai has done very well to get through a tough few months. Of course if we’ve learnt anything in the last year it’s been the Nassim Taleb truth that past performance is no indicator of the future. Bloomberg:

Dubai government companies need to repay $10 billion of bonds and syndicated loans maturing in the remainder of the year, $7 billion in 2010 and $25 billion in 2011, S&P analyst Farouk Soussa said last month. This doesn’t include money owed by banks.

What is of particularly interest is the Nakheel Sukuk (the biggest ever launched of course) that matures at the end of the year. The instrument is backed with a large chunk of the Dubai Waterfront land which would be handed over to the bond holders if Nakheel defaulted. The last time I checked the 12/09 $3.5 billion was trading at 09 cents to the dollar with a juicy 30% yield – which pre Dubailout was trading at lows of 60 cents to the dollar.
Now is there any chance the Dubai Government would decide to or have to resort to defaulting on these bonds and giving up a large part of the Dubai Waterfront – admittedly a currently pretty worthless piece of beachfront desert? Doubtful I think, especially assuming the full $20 billion bond facility is subscribed to this year (If I was the Dubai Government I would be looking to sort that out ASAP rather than wait until it’s needed). If the default it as unlikely as it seems, those bonds would appear to be pretty good buys even factoring in potential dollar weakness.
There is a marked difference though between Nakheel and the other entities that have tapped the markets thusfar. Dubai Airports and DEWA and even Borse Dubai to a lesser extent have strong predictable and relatively resilient cash flows that make them strong candidates to tap debt markets. Nakheel is in a completely different class, its cash flows are dependent in great part on land and property sales that have practically come to a standstill in its main market. Its balance sheet is full of over-priced assets that need to be marked down. It will inevitably be much tougher to rollover the Sukuk affordably which would mean the Dubai Government would need to contribute a significant capital contribution to avert default. I doubt the local UAE banks will be in a strong enough situation to contribute much either, I am expecting further asset deterioration from the fallout of plunging property prices and a slowing economy (especially as the Central Bank seems serious about restoring their loans to deposit ratios).
Even so, can you really imagine the Dubai Government handing over a chunk of beach front desert neighboring Abu Dhabi to foreign creditors? Default will surely be averted come what may.
So here’s an investment tip for what it’s worth. Buy Nakheel 12/09 Sukuk.

Update: I have been hearing a lot of talk about Nakheel restructuring the Sukuk – backed up by an article in The National today – so the buy recommendation was a dud.

More about debt structuring from the FT:

A person close to the government said there had been an audit of holders of Nakheel’s sukuk, adding that it would be naive not to consider restructuring debt in this current economic climate.

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