Tainted by association

Dubai World's debt problems have cast a slur on the region's reputation, but investors should avoid forming a link between government capital and private capital.

The news from Dubai last Wednesday that government-backed conglomerate Dubai World had asked lenders for a six-month ‘standstill’ on repayment of its debt obligations sent reverberations through the world’s financial markets, but shocked very few in the Middle East.

“For those of us who are here it's been a long time coming and the only surprise is that it's a surprise to anyone,” said one Dubai-based private equity professional.

A week on and the scale of the disaster has been somewhat diminished by Dubai World’s announcement this week that it would restructure $26 billion of debt from its real estate businesses Nakheel World and Limitless World. Other entities whose finances have been speculated over in the media – including private equity business Istithmar – are, the firm says, on a “stable financial footing”.

But while the financial damage may not be as bad as originally feared – at least at this point – the reputational damage has cut deep.

“The main impact is on Dubai's reputation and ability to borrow. All credibility is gone, particularly after Sheikh Mohammed made news by telling Dubai doubters to “shut up” just a week or two ago,” commented a lawyer based in the region.

Amidst the furor, it should be business as usual for Dubai’s many private equity firms. Unfortunately, however, some in the region see the stain on the government’s reputation spreading to perceptions of the private sector too.

“For private equity investors in this part of the world, [what’s happened] is not a problem. But potential new investors in the US and Europe will not see anything in Dubai beyond this [debt default] – it will have a negative impact on sentiment and will hold them back from investing,” commented a MENA-focused GP.

Sadly, the Dubai World debacle serves as a blot on the otherwise rosier picture which had begun to emerge from the region in the past few months as economic recovery took hold and markets began to climb.

In actual fact, in the context of overall economic recovery, the government-related debt problems may offer some benefits to local private equity firms, especially on the investment side.

For example, one GP confided he was not altogether displeased to see the run in the markets curtailed as valuations had been climbing too high again.

Another pointed out that Nakheel World was a very large trade creditor to real estate- and construction-related businesses in the region. These businesses, he said, have been performing well recently due to the relative strength of the rest of the region. But while they have healthy P&L statements, they may well now be left with a hole in their balance sheet due to Nakheel’s problems and their wider repercussions – potentially offering private equity firms the opportunity to step into the breach.

With these reflections in mind, it is to be hoped investors outside the region are sophisticated enough to distinguish between government capital and private capital when it comes to assessing the Middle East as an investment destination.