Aabar Investments - Behind the 2009 Earnings Press Release

You've probably seen press reports on Aabar's 2009 performance.

1. Comprehensive income of AED2.075 billion versus AED727 million in 2008.  Roughly 2.9x.
2. Shareholders' equity up 5.5x to AED12.7 billion versus AED 2.3 billion at FYE 2008.
3. Total assets up 11.7x to AED37.3 billion from AED3.2 billion at FYE 2008.

Let's look a bit closer at Aabar's 2009 performance.   Not a full credit or investment analysis but just some points that caught my eye.

And what better place to look than its 2009 audited financial statements.

Income

1. The company's 2009 income was largely driven by non cash changes in fair value in one investment, Daimler.  That resulted (Note 8) in some AED 9.1 billion of income.  Interestingly as disclosed in Note 9 Aabar incurred an expense of AED6.8 billion from derivatives on the Daimler shares - put options and a collar.  Note 22 (i) describes the collar range.    I'm guessing that  the hedge is in place at the request of the lenders of Term Loan 1 and 2 who financed some AED10.7 billion equivalent for the purchase price.  
2. What's a collar?   Here's a simple definition.  In short a technique to reduce the cost of buying downside protection (buying a put)  by giving away some of the upside (by selling a call).
3. Aabar acquired its 9.1% stake in Daimler in March 2009.  A glance at a stock price chart for 2009 will show that this was the absolute ideal time.  During that period Daimler's shares were at their lowest - in fact at their lowest in the past five years.  Aabar got the shares at Euro 20.27.  At YE the shares were Euro 52.95 and are trading currently at about Euro 36.00. And I suppose in this context one might be tempted to remark that at least it didn't buy Chrysler or GM.
4. In essence then from an income statement perspective, Aabar is currently a "one trick" pony.   As Note 38 states a 10% change in European equity prices results in a change of AED2.04 billion in its income statement.
5. For 2008, the company's income was driven by one event, the sale of Pearl Energy Limited.
6. Of course balancing this fact is that the company adopted a completely different strategy in 2009 so one would not expect it to have fully achieved  its goals in one year. But this is definitely a point for lenders and investors to keep their eyes firmly on.

Equity Increase AED10.4 Billion

1. AED6.7 billion was from the conversion of a mandatory convertible bond issued to IPIC (Aabar's 71.23% shareholder and an Abu Dhabi Government company).  
2. AED1.6 billion from a shareholder loan - also from IPIC.
3. AED2.1 billion from income and related events.

Debt

1. Borrowings increased from AED893 million to AED 15.1 billion or AED14.2 billion.  And since we're keeping score that's 16.9x the level in 2008.
2. What's even more important to note is that on a net debt basis Aabar went from a negative debt (it actually had cash in excess of its debt at FYE 2008) to a debtor position.  Now having debt is not in itself bad.  One would expect an investment company to use leverage.  But leverage is something to watch if one is an investor or creditor.  Especially where investment values are volatile.  Or where they may prove to be illiquid.
3. On that latter point, of the company's six borrowings, five were secured by its investments (Note 22).  Some brave lenders extended a US1.6 billion short term loan facility repayable in 2010.   At a lower rate  than that on the company's secured debt!  ?  Against which Aabar had drawn USD0.6 billion.  As a general rule, it's not the wisest of ideas to be an unsecured lender when the borrower's most liquid assets are pledged to other creditors, including the asset that generated the company's income.   The unsecured creditor is the one who gets "squeezed" first and hardest if there is a problem.  

Other Assets - Advances on Properties

1. Aabar has roughly AED7.8 billion in Advances on Investment Properties.  That's roughly 24% of assets.  There's no descriptive footnote to explain what these assets are and where they are.  I also note that the company depreciates buildings over 67 years (Note 3, page 20) on a straight line basis. 
2. There are some "banking assets" in the consolidated financials related to Falcon.  But creditors and depositors at Falcon have first claim on these.  Probably to the tune of approximately AED4 billion (Due to Banks and Customer Deposits).

Cashflow

1. You knew I'd get here eventually.
2. On a cash operating basis Aabar was negative for both cashflow from operations and cashflow after working capital changes.  Considering the latter (AED1.1 billion)
3. Investing Activities and Financing Activities were in a roughly balance at (AED21.4 billion) and AED22.2 billion. 
4. Leading to an overall decline in cash of very roughly AED300 million.

Other

1. The company has advised that its Board is recommending to the shareholders that they authorize the issuance of AED7.3 billion in convertible bonds  with a AED2.5 per share conversion price (roughly the current trading price).  The bonds would be issued to IPIC.  If the bonds are converted in full,  IPIC will own 85%.
2. Since the bonds are not mandatorily convertible, they do not appear to be legally subordinate to other creditors.  Maybe some attorney out there who practices in the UAE can say if equitable subordination is a UAE-law concept.  (Editor's Note: The mere fact this question is posed here is perhaps a fairly clear sign of a bit of manifest delusion by the writer about the readership of this blog).

Summary - Trends to Watch

1. Ability to diversify income.  Right now as described above the company is a one trick pony. Not something that realistically can be  changed overnight.  But something that should be worked on.
2. Diversification in investments.  Beyond single name concentration (Daimler), the company is heavily skewed to the auto industry and has made some additional investments in this space  - though it has also diversified since then with an investment in Virgin "Space"! 
3. What the additional AED7.3 billion in convertible bonds are used for.  Replacement of debt? Additional investments?    
4. What is the investment philosophy of Aabar?  What sort of portfolio is it building?   Does the portfolio exhibit a common theme?  Or competence resident at the company (Aabar) level?  Is Aabar merely a financial investor?  Or somehow will it be involved in developing value?  Or is it just  buying "stuff" that looks good at the time?  And which might later be discovered to be "non core" assets? There doesn't appear to be a clear statement on investment strategy on Aabar's website.  The last analyst presentation posted on the site dates from 2007.
5. How do Aabar's investments fit in with IPIC's mandate?  As per its website, "The International Petroleum Investment Company, IPIC, was formed by the Abu Dhabi government in 1984, tasked with an ambitious mandate to invest in hydrocarbons industries across the globe."  And how  might that affect its contribution of future cash to Aabar in the future?
6. Use of secured debt.  Are the key cash generating liquid assets pledged to creditors?  What does that mean for investors and unsecured creditors?
7. Cashflow, cashflow cashflow.  The life blood of companies.  "Man" does not live by capital appreciation alone.

Potential Merger of the ADX and DFM - Beginning of the End of Dubai as a Financial Center?

You've probably seen the press reports about the discussion of a potential merger of the Abu Dhabi Exchange and the Dubai Financial Market.  Those I've seen outline the compelling economic case for the merger.  There just isn't enough volume to support two markets in the UAE.  While not as dire a case as that for the merger of Nasdaq Dubai with the DFM, there is strong rationale:  consolidation will lower costs.

Not as often directly emphasized but much more important is that a merger would increase liquidity for both issuers and investors.  A robust capital market in both equity and debt will foster greater economic development.

All well and good. 

But I haven't seen any discussion of what perhaps is another key issue.  Who will control the merged entity?   And  the consequence of that control.

The old saying is that cash is king.  And the guy with the cash  is primus inter pares among royalty. 

Before its recent problems, Dubai had a constrained cashflow from resources and operations  (as opposed to borrowed funds).  That situation has been made even worse by the demands of the DW rescheduling and other likely problems already on the horizon or just below.  A merger offers Dubai the chance to monetize some of its foreign assets (LSE,  Nasdaq) to meet its cash flow needs as it deleverages.  

Abu Dhabi is flush with cash.  And its credit is sterling with bankers and investors.  It has a much stronger hand.  It can make significant new investments - acquisitions and build outs.  It can, if it wishes,  use this opportunity to accelerate a shift in the economic landscape of the UAE.  To become the financial center.

Control of the merged exchange would be more than a matter of prestige, though one shouldn't discount the ego factor as a motive in transactions.  Prior to the takeover by Chemical Bank, Chase Manhattan Bank  was in discussion with Bank of America about a merger.  The deal foundered on the "substantial" issue of where the merged entity's headquarters would be.  San Francisco or New York. Chase wound up as prey not predator.  BofA in less tender hands.

Control of the merged exchange will affect the financial landscape in the UAE.   In rather broad brush strokes we can characterize the current financial situation in the UAE as Abu Dhabi  for project finance and Dubai for more market oriented financial transactions.  

But  if the center of gravity for the  merged stock market shifts to  Sowwah Square  / Sowwah Island, then how seriously does this undermine Dubai's dream of being a full service financial center?

I think fundamentally. 

In such a situation what is the appeal of Dubai?

It's probably not going to be access to issuers at least for several years.  Access to investors?  Maybe.  But if the economy in the Emirate has a slow recovery as is anticipated and Abu Dhabi is relatively speaking booming, where will the interests of investors and bankers be focused? 

To be clear, this isn't a prediction of an immediate reversal of Dubai's role as a financial center.   A financial Armageddon.  Nor is it meant as the sole variable to explain a shift to Abu Dhabi from Dubai.  There are other factors as well.

Rather it's about a shift in emphasis and slower growth in Dubai vis a vis the financial center in Abu Dhabi.  Not the "End"  but the "Beginning of the End".

Think of  Philadelphia and New York.  Within a five minute walk in Philadelphia, you can see the impressive buildings of the first two Banks of the United States.  Once the undisputed financial and commercial capital of the USA, Philadelphia was eclipsed by New York.  Not overnight.  And it still retains its own role and stock exchange.