Saturday, June 5, 2010

Dubai Holdings: Review of DHCOG 2009 Financials – The Business Model

DHCOG's 2009 audited financials as well as the CEO's commentary are available at this link at NasdaqDubai. Earlier audited financials are in the "Related Documents" section here.

Before I get into detailed comments on the 2009 annual report, I'd like to start by looking at DHCOG's business model, particularly its ability to generate cash. This will provide context for understanding DHCOG's ability to address the issues it faces.  A robust cashflow can pay bills directly.  And, if they are lumpy, a sound cashflow provides a basis for accessing finance to pay bills immediately.

In that regard, DHCOG is heavily dependent on Government Grants for both income and cashflow.

Let's start with net income

All amounts in AED billions. Percentage = Government Grants/Net Income.

Net Income(23.6)9.813.97.61.5
Govt Grants0.719.
Notes 2.22 (page 27) and 29 (page 72) in the 2009 financials discuss respectively the accounting treatment of subsidies and the amounts involved. 

With respect to the first, when the Government gives DHCOG land, the Company records the land as an asset with the contra entry to the liability account "Government Grants". Upon sale of the land, DHCOG recognizes profit based on the cost of the land. It then also recognizes the gain on the Grant as a separate item. This enables readers of the financials to determine the value added by DHCOG  through its own efforts by separating out the subsidy it has received.

A hypothetical example illustrates the point. 

Let's assume that the Emirate gives the Company a piece of land fair valued at AED100 on 1 January 2009. DHCOG books an addition to Land of AED100 and reflects a liability of AED 100 under Government Grants.  Then assume a sale on 1 July 2009 for AED 110. The Company's total profit is the sale price AED110 since it paid zero for the property.  In its accounting, DHCOG splits the AED 110 into two components:  AED10 in "Revenues" and AED100 in Government Grants.  In this case the Company is only responsible for 9% of the profit. The subsidy for 91%.

That was a hypothetical example.  Let's look at actual profitability.  Over the period 2005 through 2009, the Company earned AED9.2 billion. During the same period, Government Subsidies  were AED37.2 billion. Or 4.04 times net profit! In fact without the subsidies, DHCOGwould have had a net loss of AED28 billion.

As a side comment, the subsidies result in an interesting transfer of wealth from the Emirate to the private company owned by the Ruler of the Emirate.

The pattern is the same when we examine Cashflow From Operations (2009 Note 47).

Again all amounts are in AED billions.

Gross Operating CF 2.1  5.4  4.7  2.1 0.6
Net Operating CF 0.810.016.9  4.6 1.3
Govt Grants 0.719.210.0  6.6 0.7
Govt Grants/NOPCF 88%192%59%143%54%
Customer Advances(4.2)  0.5 2.7  8.2 4.5
Deferred Revenues 3.3  7.0  6.4  0.3NM
Not surprisingly, the above table shows a similar critical dependence on Government Subsidies, this time for cashflow. In four out of the five years, Government Grants were larger than Gross Operating Cashflow – that is Cashflow before changes in long term assets and liabilities and short term assets and liabilities (e.g., Working Capital).   By way of explanation, Gross Operating Cashflow is a better measure of the ability of a firm to generate cash from its operations than Net Operating Cashflow as the latter involves transient sources and uses of cash not resulting from the basic business process.

Another key component of cashflow has been customer advances (deposits) on purchases. As the real estate sales machine slows down so will the pace of new investments by clients.  As the Company's CEO, Ahmad Bin Byat, noted in his commentary on 2009, "The real estate market is expected to continue to face challenges in 2010 and 2011 until the excess supply of the existing and expected inventory is absorbed by stronger demand." That likely means no real meaningful additions to Customer Advances. Rather these will be drawn down. And if the recovery in 2012 is delayed or tepid, the situation will continue.

Also the Deferred Revenues point to another issue for the future.  The Company has been receiving cash for projects underway. These cash receipts have been booked as deferred revenues.  That is cash  is received but income is not recognized.  When the projects are completed and handed over, DHCOG will book substantial revenues. As of 31 December 2009, the amount of outstanding Deferred Revenues was some AED17.1 billion. However, when it does, these revenues will not be accompanied by cashflow of this amount.   To the extent that liabilities have increased during this period, a creditor would have to ask where the Company will get the funds to settle these obligations.

As hopefully this analysis makes clear creditors face two issues with DHCOG. The first largley trivial. The second critical. 
  1. Continuance of Government Subsidies. A slowdown in real estate may mean an inability to utilize the remaining Government Grants, AED36.8 billion at 31 December 2009, in line with the "Master Plan's" timing. Theoretically, this could result in termination of the grants or a change in the their cost basis. However, since the good Shaykh is giving himself land, he is probably inclined to revise the terms of those grants to accommodate any slowdown. The maintenance of subsidies is the key to the Company's ability to generate significant net income and more importantly the cash necessary to repay debts. With a zero cost of land, the Company is uniquely positioned even  if real estate prices are sharply lower.  It also benefits because it does not have to finance the land prior to sale. No need to raise debt, leaving "spare" borrowing capacity, assuming it has access.  And no interest expense, improving both the bottom line and cashflow.
  2. The overall state of the real estate market. While it's highly likely that the Shaykh will continue to see the wisdom of granting land to DHCOG, the real question is whether there will be significant demand for new projects. Property in the Company's "land bank" will do creditors little good if it cannot be sold. As noted above, Byat does not expect a recovery in the next two years. And there are some critical amounts due in that period.  And if he is wrong about the vigor or timing of the recovery, the situation will be even more difficult.
With this the stage is set for a second post on the 2009 financials.


the real nick said...

Dubai Holding is majority-owned by the Ruler of Dubai, who heads the government. (The clue is in the word 'Ruler'). So the government grants billions of Dirhams in assets to the head of the government. Anywhich way you slice it, this is dodgy box-in-a-box-in-a-box...accouting. On paper, as you point out, the government remains beneficiary of the majority of profits - it's only that it never gets to see them?

Question: what's the good Sheikh's personal liability if Dubai Holding collapes?

Diogenes@Sinope said...

Technically none, since he's likely the majority (if not absolute) shareholder. Unless of course, he's pledged Dubai Holding shares as collateral, but I can't possibly think of a bank that would take those shares.

Abu 'Arqala said...


Actually, my point was a "Western" one. Today we in the West hold that there is a distinction between the ruler and the country. Thus, the assets of the country belong to its citizens in toto not the ruler. In terms of the history of Europe this is a fairly "recent" concept.

Answer: Diogenes is right. A shareholder is not legally responsible for the debts of his company unless he has explicitly guaranteed the loan.

If DHCOG were a general partnership and the good Shaykh was a partner, then he'd be personally liable to the extent of his fortune.

Abu 'Arqala said...


I can.

A good rule is to never underestimate what bankers will do to make a loan.

I've seen banks lend on revocable government contracts. That is, where a private sector party had a contract for the provision of services like rural telephony which the government could easily cancel.

I've seen banks provide bridge loans where there wasn't even a commitment to arrange the "permanent" financing. We used to call those "pier" loans.

Diogenes@Sinope said...

I think its the same in Dubai as well technically, since the government is in theory separate from the Ruler.

I can imagine the local banks facing pressure to do it. I'm also curious as to what exactly is going to happen with the "other" DH - DHIG which consists of DG and DIC. It is such an odd situation, it looks to me like they're protecting the shareholder at the expense of the debtholders, and everyone is basically agreeing with it.