Another Own Goal for Team Dubai in the S&P/DHCOG Ratings Dispute

You've probably seen the press articles that Standard and Poor's lowered the rating on DHCOG from BB+ to B.  A weaker cash flow and lack of information are cited as the reasons along with some background on the Emirate and Dubai Inc.  These reports also note that S&P has withdrawn its rating.

What I want to focus on in this post is the proverbial "war of words" that they have launched.

Was this war necessary? Who stands to win? Who will be the most damaged?

As you might guess from the title, I have my own view. Team Dubai has roundly booted yet another one into its own net. And when it comes to scoring, it seems that just about everyone on the Team is capable.  To be clear here I am referring to DHCOG's reaction to the ratings downgrade and withdrawal by S&P.

Let's start by reviewing each's press release – where better to wage a war of words.

First, S&P. Their press releases, including rating actions, are password protected (though all you need is an email address and the willingness to give it to them to get access). If you can't or don't want to do that, Bloomberg has a more complete account than many of the reports in the press. 

S&P states that:

1. Materially weaker cash flow and a resulting negative impact on liquidity as well as lack of clarity on potential government support (that famous "implicit guarantee" rears its head again) is the basis for the ratings decline. 
2. Because of "inadequate timeliness of information and insufficient documentation (emphasis mine) to maintain their surveillance" they have decided to cease rating the company.  (You might ask why they didn't just withdraw quietly with no fuss and no downgrade.  It's common practice that a rating agency doesn't simply withdraw without either reaffirming or changing the rating.   This is especially the case if they have negative information and conclusions. Since this will be their last word, to do otherwise might leave the market with the wrong impression of their opinion. As to the fuss, it either came as a reaction to what I expect were rather sharp discussions between the two parties. The other less favorable interpretation is that there are significant shortcomings in the information that S&P cannot let pass without comment.). 
3. Three further important negatives. First, the rating trend is negative: more erosion in credit quality is expected. Second, the rating and the negative future view reflect their base case. In other words they are not basing their rating and view on the future on the "downside" case. Third, a broad criticism of "lack of market transparency, reliable market data, and the level of financial information" (Ouch).
   

Now over to DHCOG's press release.

Their view is clearly and starkly stated.

1. They dropped S&P as a rating agency due to S&P's "lack of understanding of DHCOG's business, its operations and relationship with the Government of Dubai." 
2. They have been "sharing adequate information frequently and in a transparent manner" with S&P. 
3. S&P has made "inaccurate statements coupled with factual errors that are misleading." 
4. Therefore, they "discredit and disagree with the content of the latest S&P report". 
5. They will continue to work closely with other rating agencies and directly with investors in full transparency".
   

Now let's look a bit deeper.

Not so long ago, November 2008 to be precise, DHCOG was rated investment grade with "A" or an "AA-".  A "B" rating is a bitter pill, though DHCOG has had prior tastes from earlier downgrades. At any time, a downgrade isn't welcome.  Given Dubai's current difficulties, the downgrade – dangerously close to CCC territory – was probably seen as a direct threat to the company, the parent, and the Emirate itself. Add on top of that a rather broad and sharp criticism of market transparency and reliability and DHCOG's strong reaction isn't surprising.  Another concern might as well be the potential adverse affect on the main shareholder's attitude to the management of the company. What I suspect is the proverbial straw on the camel's back is that S&P signaled that it was likely to further downgrade the company, probably into CCC territory.

Who dropped who?

A tricky question. 

Usually such disputes are settled in such a way that no excessive dust is raised.  The company tells the rating agency it isn't happy with the rating. The rating agency advises that it cannot change the rating. So they find a way to part – an amicable divorce. That wasn't the case here.  Both parties have kicked up quite a bit of dust and it seems more than a few rocks.

My guess would be the company made the decision to prevent further downgrades. S&P could have maintained coverage and just marked the company down further if it felt the information were inadequate or delivered too late unless of course it felt the situation was so bad that to continue would violate its integrity and potentially cause severe damage to its reputation. The question that can be posed to S&P is how does this lack of market transparency and reliability affect its ability to rate other companies. Is the situation so severe that it needs to withdraw from other rating engagements?

Just how serious is the dispute?

Both have levied fundamentally serious charges against one another that go to the heart of the other's competence. And a hint of criticism of integrity.

1. S&P contends that the company was not providing information on a timely basis and that when supplied the documentation was inadequate. 
2. DHCOG claims that S&P is unable to understand its business or its relationship with the Dubai Government – in effect the rating agency doesn't have the skills to perform its job. But more than that, compounding its deficient critical skill, S&P is making factually incorrect and misleading statements – a direct attack on its integrity.
   

Whose story is the market more likely to find credible?

In a dispute like this, outsiders are unable to conclusively determine whose story is true.  They don't have the facts so they rely on the reputation of the parties, their presumed motives, and their conduct in the dispute. Dubai is at a disadvantage on all three except perhaps in the region.

While the folks back home will probably quite naturally take DHCOG's side, the wider market will tend to believe the rating agency.

Why?

S&P enjoys a better market reputation than DHCOG. It is a "household name" and has built a perception in the market that it is a smart thorough institution.

The central reason though will be the perception that the company is motivated by defensive self interest. The downgrade affects the company's access to debt markets as well key deal terms, e.g., tenor, pricing, security and covenant packages.  It may also affect the price of the company's stock since shareholders are legally subordinate to all creditors. Faced with these potential outcomes, it's expected that the company will fight to prevent them from happening. Given the negative outlook, it's likely that S&P would have downgraded the company further. While DHCOG would prefer to avoid the "company" of single "B" rated companies, consorting with those in the "CCC" class has to be an even more distasteful prospect.  Also complicating DHCOG's sales story is the fact that many a company in this sort of situation has claimed that credit or stock analysts didn't understand their businesses or the real worth of the company. But, generally, history has vindicated the analysts.

On the other hand, the market finds it hard to believe the rating agency has a hidden agenda or gets great benefit from the downgrade. It is seen as doing its job in delivering the bad news.

So what does a smart company do in this situation?

The first is to realize that not much can be done.  The rating has been lowered.  No amount of protestation will cause the rating agency to change it. Trying to convince the market that you're right and the rating agency is wrong is difficult, if not impossible, for the reasons outlined above. And a variety of parties are locked into using the rate whether or not they believe it is correct.  Entities subject to Basel II. for their capital adequacy calculation.  Investment companies who are limited to investments of a certain credit grade.  Banks who translate external credit grades into internal models for underwriting decisions and pricing purposes, etc.

The second is to choose one's battles carefully. There is truth and there is the appearance of truth. The market does not have the facts. It will judge on appearance. Even assuming that the rating agency is dead wrong, the company has to think carefully if a bitter public dispute will help or harm it. One does not want to wind up in a worse position after the battle than before.

The third is to reply appropriately if one chooses to fight. What arguments are most likely to be plausible? As hurt and perhaps outraged as they were, the wiser thing for DHCOG to have said would be that S&P doesn't understand our business and hasn't given sufficient weight to certain factors. We disagree with the assumptions in their economic model. Their interpretation is therefore wrong. This is much better than saying that the rating agency has the facts wrong, that it lacks the requisite skills or that it is making inaccurate misleading statements. It will be very hard to convince the market that this is the case with a firm with S&P's reputation.  

Compounding DHCOG's position is that other rating agencies have been downgrading it. So in a sense DHCOG is not just fighting one agency, it is fighting the Big Three. An even larger credibility disadvantage. What the company can hope for is that there will be differences among the agencies and it can therefore discredit the lower rating. But, last December Moody's downgraded the company to "B1" – the same as S&P. Fitch's rating is "BB" – higher but by only one level. All three agencies have assigned negative future trends. This certainly takes the wind out of DHCOG's argument. Where there may be hope is that other agencies will not be so negative about the company's timeliness and quality of information and may not wield as broad a brush in criticizing the local market.  Perhaps, apparently small victories but important victories particularly in this climate.

Perhaps, in drafting its press release, DHCOG's target audience was the regional market, that in the UAE or one rather important shaykh in Dubai. And for this audience, their approach may have been the right one. But in terms of the wider market, the one that actually matters for financing, it is not. The press release is unprofessional. It sounds too emotional. It looks like it was drafted in a fit of pique. All that is missing is the sound of the foot stomping.

In the midst of a very challenging refinancing process Dubai Inc. can't seem to avoid scoring own goals.  This isn't the first.  And this isn't the only player (Dubai Inc entity) to do so.  Team Dubai needs to get a better hand on its play (public relations).  The task is difficult enough as it is without needlessly making it worse.   

Not only for the good of today but as well for the good of tomorrow.