Monday, September 14, 2009

(BN) Dubai's Broken Deals at Istithmar Reveal Sovereign Wealth Gone Haywire

Follow-up to my story from late last year:
Newsweek International Cover: Is Dubai's Party Over? 6 December 2008
The glitzy façade shows some cracks.



This from today's Bloomberg News, sent from my iPhone.

Dubai's Trail of Dud Deals Shows Sovereign Wealth Gone Awry

Sept. 14 (Bloomberg) -- Dubai investment firm Istithmar World may be the first sovereign wealth fund to liquidate after a $27 billion spending spree financed largely with borrowed money, people briefed on the matter said.

Unlike government-controlled funds in Kuwait and Abu Dhabi, flush with cash from oil production, or in China, backed by export earnings, Istithmar fueled purchases such as the takeover of Barneys New York by borrowing as much as 90 percent of the money, the people said. Istithmar's parent, Dubai World, tapped Middle Eastern and European banks including Barclays Plc, Royal Bank of Scotland Group Plc and Deutsche Bank AG, leaving those three with combined debt holdings of at least $1.5 billion, the people said.

"Dubai sovereign wealth funds are leveraged like private equity funds," said Rachel Ziemba, a senior analyst covering sovereign wealth funds at Roubini Global Economics, a New York- based economic research firm. "Istithmar belongs to a parent company with a significant amount of debt coming due."

Istithmar contributed about $2.5 billion of its own cash to back $27 billion of purchases since 2003, the people said, speaking anonymously because the strategy was private. It used so-called non-recourse bank loans, backed by specific assets, to finance about 75 percent of its acquisitions, one of the people said. The rest was funded with a mixture of its own cash and money borrowed from banks on a term-loan basis that was backed by Istithmar or Dubai World, the person said.

W, Mandarin Oriental

Istithmar's deals were part of Dubai ruler Sheikh Mohammed bin Rashid Al Maktoum's attempt to raise the Arabian Peninsula emirate's profile as he tried to vault it into the top ranks of the world's financial centers.

Under Chief Executive Officer David Jackson, the former Lehman Brothers Holdings Inc. executive who has led the fund since 2006, and his predecessor, Muneef Tarmoom, Istithmar roamed the world to target high-end businesses. The fund bought a stake in Perella Weinberg Partners, the boutique advisory firm run by Joseph Perella, and two of Manhattan's most exclusive hotels, the W Union Square and the Mandarin Oriental at the Time Warner Center. It acquired the Queen Elizabeth 2, the Cunard Line flagship for more than three decades, with plans to convert it into a hotel to be moored beside the emirate's Palm Island.

Istithmar also bought stakes in Cirque du Soleil, the Montreal-based company known for staging extravagantly acrobatic circus-like performances around the world, and Yacht Haven Grande, a marina complex in the Caribbean catering to so-called mega- yachts.

Some Soured Deals

"The government wanted to put Dubai in the same league as London and New York," said Victoria Barbary, a senior analyst in London at Monitor Group, a consulting firm based in Cambridge, Mass. "When times were good, the government was happy to have Jackson and his team making headlines around the world."

Many of the deals have soured.

Barneys is in talks with creditors about a restructuring or bankruptcy. Loehmann's Holdings Inc., a discount retailer with more than 60 stores that was acquired by Istithmar in 2006, had its junk- rated debt rating cut three notches last week by Standard & Poor's, based on "poor" operating performance.

Shares of GLG Partners Inc., a hedge fund with offices in New York and London in which Istithmar bought a 3 percent stake, have lost more than 61 percent of their value since the deal was announced in June 2007.

In November of 2007, Istithmar sold an office tower at 280 Park Avenue, home to the headquarters of the National Football League, for $1.28 billion. It had bought the tower for $1.18 billion 17 months earlier, public records show.

'Top of Market'

"They realized they had defined the top of the market," said Peter Slatin, editorial director at Real Capital Analytics Inc., a New York research firm that tracks commercial property sales.

The deals have forced Istithmar to halt investments and threaten to unseat Jackson, the CEO, people familiar with the situation said last week. Co-Chief Investment Officers John Amato and Felix Herlihy are leaving, according to Istithmar.

Now, Dubai World is in talks with its creditor banks to restructure at least $12 billion in debt, a person close to the talks said, speaking anonymously because the negotiations are private. Istithmar or its assets will probably be sold to help its parent repay the debt, the person said. Nakheel PJSC, the Dubai World unit behind a series of palm-shaped, man-made islands on the emirate's coast, has a $3.52 billion Islamic bond due in December. Islamic bonds adhere to a prohibition against receiving or paying interest.

Istithmar is 'Key'

Dubai World last week said Jackson had its "full support," adding that Istithmar "will continue to be a key subsidiary into the future." Sheikh Mohammed also said last week that he wasn't concerned about the emirate's ability to repay at least $4.52 billion of debt this year.

"I assure you we are all right, the U.A.E. is all right, and we are not worried," Sheikh Mohammed said to reporters at his Zabeel palace in Dubai. The government must repay a $1 billion Islamic bond maturing in November in addition to the Nakheel bond due in December.

George Dalton, general counsel at Dubai World, referred requests for comment to spokespeople for the group, who didn't reply yesterday.

Besides Istithmar and Dubai World debt held by Deutsche Bank, Barclays and RBS, much of what remains is held by lenders based in the Middle East, the people said. Spokespeople for the three banks declined to comment yesterday.

MGM Mirage Investment

The investment strategy of the funds was flawed, according to Chris Turner, the 45-year-old British risk manager who was hired in 2007 as director of risk management at Istithmar's real estate unit.

"At least half the $10 billion I was involved with at Istithmar was poorly invested and completely un-hedged," Turner said in an interview yesterday. Turner, who now lives in Europe, says he left Istithmar last year and was accused of embezzlement. He denies those claims and said he is prepared to fight the charges in court.

One example of risky investing, according to Turner, came in 2007, when Dubai World bought about $5.5 billion of MGM Mirage stock at between $82 and $95 without any hedge. The stock now trades at about $12.

"The attitude there was: We're a private equity firm and as such we don't need to hedge our investments because we understand the inherent risks and believe in our decisions," Turner said.

'More Careful Now'

Refinancing Dubai's debt became more difficult with the onset of the global credit crisis as lending froze. It has about $80 billion of outstanding corporate and government debt, according a report by Moody's in February. That almost matches the emirate's $82 billion gross domestic product in 2008, the report said.

"We'll be more careful now," Sheikh Mohammed told reporters in Dubai on Sept. 9. "The crisis came for everyone, not just Dubai. People had to fight."

Abu Dhabi, the wealthiest member of the U.A.E. with more than 85 percent of the federation's total oil output capacity, helped provide Dubai with a $10 billion bailout in February. Dubai home prices plummeted 47 percent in the second quarter from a year earlier, the steepest drop of any market, according to Knight Frank LLC.

"Abu Dhabi is now and will continue calling the shots in Dubai," said Rochdi Younsi, head of Middle East research at Eurasia Group, a New York-based political-risk consulting firm, who expects additional bailouts from Abu Dhabi. "They're making serious demands that Dubai keep only its viable arms and consolidate or shut down overleveraged ones like Istithmar."

Istithmar and Dubai World are being advised on their debt restructuring proposals by at least one outside consulting firm, people familiar with the matter said.

"It's critical that Dubai downplay any restructuring of Istithmar as business-as-usual," Younsi said. "They've put way too much money and resources to let their reputation collapse."

To contact the reporters on this story: Jonathan Keehner in New York at jkeehner@bloomberg.net Serena Saitto in New York at ssaitto@bloomberg.net .

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