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Bullish Case for Nakheel Sukuk

Matein Khalid / 11 December 2009

DUBAI — As a fund manager, I cannot afford the luxury of letting go any opportunity to expand the frontiers of my own ignorance in the chaos of world financial markets. So why find new ways to lose money when the old ways were working just fine—punting oil, gold, FX, NASDAQ hotties, Chinese IPOs and Valley 
software Cinderellas?

Because, there are moments in life you have to take a stand, to not hedge/fudge/dodge/fumble the ball. This is such a moment, a defining moment for all of us who live in and love Dubai.

My friends all over town have asked me to give my precise, honest call on the Nakheel 2009 sukuk. I will not hedge, fudge and dodge the issue by talking about Greek debt, Qtel, Dubai sovereign, Mubadala and the next wiggle in Euro/dollar, cable, gold, whatever. I will try to predict the scenario for Nakheel sukuk.

My heart and instincts are bullish. My intel tells me to expect a 35 – 80 range in the near future. I have no unique insight or knowledge, so please accept this caveat. This is my honest, personal view. Mine and mine alone, cocooned amid my Bloomberg screens, expanding the frontiers of my ignorance in real time.

Here are my reasons:

One, with the sukuk’s primary listing suspended on Nasdaq Dubai, all trades are taking place in a fickle, illiquid market. Margin calls, suspension of leverage, trading in grey OTC markets by arbs, vulture funds and distressed debt is no passport to liquidity (no pun intended!). So even a minuscule $10 million order can move prices when there’s a 46 – 48 bid/offer spread. This means pricing, ipso facto, is irrational, as the market depth is irrational.

Two, the prices are being moved not by GCC banks or fund managers but by specialist offshore arb/distressed debt hedge funds. This makes the market unpredictable and even traumatic. This is what happened last week.

Three, an Ashurst bondholder syndicate forcing technical default before a standstill is standard operating strategy in a restructuring, as I learnt in my Latin sovereign debt-trading days in the early 1990s. Big deal. This is the beginning, not the end, of any restructuring.

Four, Dubai World has already separated its empire along the lines of a good bank/bad bank concept. Assets and cash flow will be identified. This is, prima facie, tangible evidence of a commitment to engage creditors. This is not the action of a company preparing a unilateral repudiation of debt. This is not Russia in August 1998 or Argentina in 2001. Chicken Little does not exist, and the sky is not falling.

Five, Dubai World has vast, valuable assets. It will never be dismembered even if certain subsidiaries are recapitalised.

Six, a parallel banker’s syndicate restructuring is taking place. A default on the sukuk could kill everything. So why default?

Seven, the Nakheel sukuk will make history not just for Dubai but for the entire zeitgeist of Islamic finance. It will be all about access to assets, enforcement rights, international jurisdictions, seniority of capital structure. The credibility of the entire global sukuk market hinges on this deal. The stakes could not be higher. Default is not an option. Not now. Not ever, though never say never.

Eight, the Nakheel sukuk (2009) is guaranteed by Dubai World. This means recovery values limit the downside to 35 – 40. Not coincidentally, that was last week’s low. The risk/reward calculus is OK compared to Russia sovereign debt, which traded down to 9 – 12 a decade ago in 1998. Believe me, I remember. I was there.

Nine, bondholders are not dumb. Ok, not all of them. They know it will be a nightmare to enforce sukuk mortgages in a local court. So why play Russian roulette? Why not negotiate? Why not accept a restructuring? Can I really imagine New York hedge funds wanting to value Dubai Waterfront land? Please. Would you like to buy the Brooklyn Bridge from me?

Ten, do HSBC, Standard Chartered, Paribas, RBS, Citibank et al really want or need another loan loss hit on their balance sheet? Why will they not do their best to support the Nakheel sukuk? Eleven, the director of the Dubai Department of Finance has explicitly mentioned the principles of asset sales to repay the debt. This means the willingness and ability to repay is explicit.

Twelve, Dubai World is trapped in a horrible asset-liability maturity mismatch, not a solvency crisis. Short-term marketable sukuk can never finance 10-year development projects without black-swan rollover risk. This was why Dubai World became collateral damage in the post-Lehman global credit crunch.

Thirteen, the risk of contagion across GCC, global markets will soar, not fall, if Nakheel defaults. So it will not. Descartes was wrong. I think, therefore I trade. But I do not know, just as I do not know when I cross the street or board a plane. Nobody knows. The butterfly’s wings and chaos theory. Black swans. Karma, naseeb.

Bottom line? Nakheel sukuk will not collapse. It cannot and will not.

The real black swan. What if the world sees full repayment tomorrow?

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