Dubai World's Consolidated Assets More Than Twice Its Consolidated Debt: So What?

 

 

You've probably seen the press reports carrying the "good news" that Dubai World's assets (even after the market decline) exceed US$120 billion and could therefore easily "cover" its debt of US$57 billion.  Here's one sample.

The original article is here in Al Ittihad.

As you might expect, I've got some comments on the headline.  More on that later.  In the interim,  two words neatly sum up my reaction: "so what?"

But first to the real meat of the article: a discussion of the restructuring negotations.

Quoting an unnamed source, the article states that DW has been involved in intensive negotiations with its creditors and has achieved "tangible progress" during the past 25 days.  Creditors have reportedly shown "positive reactions" to the proposals submitted by DW.  The Company is concentrating its efforts on convincing creditors of the high probability of success because of two key factors.  Sadly, only one of them is mentioned in the article - the durability of its real estate and investments assets which have begun to demonstrate recovery of value recently.  The strategic nature of investments was noted.  That would I suppose make the financings that support them "strategic" as well as the repayments.  I am not certain, though, if the margin on such a loan would be strategic or just tactical.  One hopes that DW does not consider itself a "day trader".

The article then states that DW is focusing restructuring on its two "real estate" subsidiaries: Nakheel and Istithmar (?: I think Istithmar has wise investments in a variety of non real estate ventures).  Specifically mentioned as being excluded were Dubai World Ports, JAFZA, and Dubai Drydocks - all of which are recording "excellent operating results despite the world financial crisis which has affected world trade and transport."  Hopefully their bottom lines (net income) are doing equally well.

No mention of a formal request for a debt standstill.  No mention of any sort of draft proposals.  It still seems to me - despite this article - that progress is painfully slow.  And largely at the "touchy - feely" stage.  With nothing concrete to respond to, bankers are of course going to evidence all sorts of "positive reactions", especially if the coffee is good.  Or reactions that might be interpreted as positive because since they have nothing in hand concrete, they have not rejected anything.

Of course, such negotiations are not going to be conducted in the media.  It's going to be difficult enough herding the creditor cats.  But one would expect that some news beyond this rather superficial account would be in the press if really serious results had been achieved.  In that regard, it seems to me that securing the debt standstill is a key initiative.  This should be the easiest to achieve of all that will have to be done.  Once done, it is a visible milestone.  An accomplishment that gives a bit of psychological momentum to the process.  We've seen the opposite of this effect at The Investment Dar - where the standstill process has been a negative rather than a positive.

That being said, Mr. Birkett is an expert in this field so clearly I am missing something. I sure hope so.

Now to my comments.

It makes no sense to talk about the consolidated assets of Dubai World versus its consolidated debts unless those assets are going to be applied to the US$22 billion of debt to be restructured.  To do that Dubai World needs to take certain steps.  If it does not, then lenders to Nakheel or Istithmar have cold comfort from assets at Dubai World Ports or any of DW's other subsidiaries.

Why?  Two words (actually five):  "A will and a way"

The Will:  The article itself reconfirms what DW has said earlier.  It is restructuring these companies. The other companies and their assets are outside the restructuring.  Just as the fact that Shaykh Mohammed is the owner of DW does not mean that his personal assets are available to pay or support the restructured debts.  DW has evidenced no desire to make these assets available. 

The Way:  But, more importantly, is the way this would be accomplished.  In that regard it seems there may be some confusion about a very fundamental issue:  the difference between an economic entity and a legal entity.  Understanding this distinction is critical to understanding the "way".

Consolidated financials do not represent a legal entity, they represent an economic entity.  DW Group is not a legal entity.  The legal entities in the Group are the various subsidiaries (and their subsidiaries and so on) and the parent company - Dubai World Holding.  The Group is a combination of all these legal entities into an "economic" entity. From a legal standpoint it is a fiction.

Legal entities - not economic entities - own assets.  Legal entities - not economic entities  -enter into contracts, including those for debt. It is the wise lender indeed who understands precisely what assets  the potential borrower owns.  And then reacts appropriately to that understanding.

As a holding company, Dubai World legally owns shares in Dubai World Ports, Nakheel, etc.  It does not directly own the assets of these companies.   Those companies do.  And, if they are holding companies, this same pattern repeats itself.

At each subsidiary level there are a variety of legal relationships and requirements governing those assets.

First, in a liquidation, each and every creditor of that subsidiary gets paid back before the shareholder gets a single fil.

Second, any transfer, pledge or other disposal of an asset owned by that company (the subsidiary) is subject to the completion of legal steps as required by the local law in the jurisdiction where that company is incorporated and where the asset is legally domiciled.  This is both a matter of corporate law (which governs how corporations conduct their affairs) and of laws setting forth the legal requirements for a sale, pledge, etc.  For example, if a US company owns an asset in England, then both US and English law will govern what is needed to be done to dispose of or otherwise deal in that asset. In some cases assets may be subject to additional requirements, such as those imposed by financial exchanges (stock markets), etc.

Third, contracts can create new requirements beyond those mentioned above.  For example, any sensible lender puts covenants in its loan contract restricting the borrower's ability to pay dividends or to transfer, sell  or pledge its assets.   Loan agreements typically include financial ratios (debt to equity) etc. which the company must maintain.  To do so the company has to take or refrain from taking certain actions.  A properly structured set of ratios can impose all sorts of constraints on a company - constraints that if enumerated might require volumes. 

Some hopefully illustrative examples.

Let's look at the 2008 financial report of JPMorgan Chase.

Total consolidated assets (of the economic entity, the JPMC "Group") are an impressive US2.2 trillion. (page 131).  Total assets (of the legal entity JPMC, the holding company) are US$436 billion (page 225).  20%!  As you look at these assets, you notice "Investments in Subsidiaries" is a major category.   It is here that JPMC the Holding Company's ownership (through equity shares) in the separate legal entity JPMorgan Bank, NA is reflected. 

And, it's important to note, that at these subsidiaries, the same pattern may apply.  Think of DW's subsidiary, Istithmar.  It owns a variety of investments, Cirque de Soleil, Barneys, etc.  Each of which is a separate legal entity.  In fact, it probably owns these companies through one or more intermediate holding companies (for tax and other reasons).  When Istithmar's NY hotel got into trouble, lenders were not able to force Istithmar to pay (as it had apparently not given a guarantee for the hotel's debt).  Nor could they attach assets at the Cirque  - taking, say, the lead acrobat or his safety net.

How then does a lender get access to the assets?

An indirect way is to get the holding (parent) company to give its guarantee.   This establishes the holding company's obligation to pay the loan if its subsidiary does not.  However, it gives only an imperfect and indirect access to the assets.  The lender is an unsecured creditor of the holding company, which as indicated above has its main assets in shares of other companies.  If the holding company defaults, the lender can take possession of the holding company's shares in the subsidiaries.  However, as a shareholder, the lender still remains subordinate to all the creditors at those subsidiaries.   In effect the lender has merely "stepped into the shoes" of the shareholder.

A "better" way is to get the subsidiaries themselves to provide a guarantee.  In this case then the lender becomes a creditor at the subsidiary level and has the direct  lender's access to the subsidiary's assets along with all other creditors of that subsidiary.

There are a variety of issues involved in implementing these two previous steps.  The most important of which is establishing the legal basis for the giving of the holding company or the subsidiary's guarantee  so that it is legally binding on the subsidiary.  "Consideration" in English or "US" law terms.  Other issues would be the existence of any restrictions put on the subsidiary by its existing creditors to prevent just such actions - out of their own concern to maximize their share of the company's assets.