Real value?

How will Emaar merger with three Dubai Holding cos affect its investors and the emirate's property market?
Emaar chairman Mohammed Alabbar said last November that he would be open to a merger with Nakheel.
By Alex Delmar Morgan
Sun 05 Jul 2009 04:00 AM

Emaar, the Middle East's largest property developer, plans to merge with three government-owned developers in Dubai. How will the move affect Emaar's investors and the emirate's property market?When Emaar last week announced plans to merge with three developers at government-owned Dubai Holding, the market's reaction spoke for itself.

Spooked investors embarked in a heavy sell-off of Emaar shares, worried their stake in the combined entity would be diluted, despite an assurance from the real estate developer's chairman Mohammed Alabbar that a deal will be hammered out swiftly to ensure "value accretion to our existing shareholders".

The stock plunged nearly 10 percent on June 28, the first day of trading after the announcement. Analysts questioned the motives for the move - and its timing, as Dubai's real estate market reels from the cancellation and delay of projects worth billions of dollars, as well as plummeting prices and cashflow concerns.

"What are the motives for this merger, especially when real estate conditions are not that favourable?" says Fadi Al Said, head of equities at ING Investment Management Middle East.

"Usually when you announce a merger, you reveal the terms and the valuations. The problem here is that they announce that the merger is going to happen and the details come in September.

"This lack of transparency will increase uncertainty. When you have a lot of questions that are unanswered, investors will usually sell."

As the markets digested the news, Emaar announced that the entity resulting from the proposed merger with three units of Dubai Holding - developers Sama Dubai, Dubai Properties and Tatweer - will have combined assets worth AED194bn ($52.85bn).

Again the market was left scratching its head, this time over what these assets were and what their true market value was. Indeed, Emaar gave a strong indication that most of the assets it was acquiring from the three Dubai Holding developers consisted of land, saying that "based on a preliminary review Dubai Properties, Sama and Tatweer have a robust and strategic asset base (attractive land bank) which will contribute positively to consolidation.''

"Land bank valuation can exhibit high volatility in stress markets and therefore true value of land as an asset is tough to gauge," says Saud Masud, a Dubai-based analyst at UBS.

"Will property be built upon it in the near term, what is the potential sale value per square foot and to whom may the land be sold to? How marketable is the land?"

Robert McKinnon, head of research at Dubai-based investment bank Al Mal Capital, warns some of Dubai Holding's land could be problematic from a development perspective.

"Some of it is land in the middle of nowhere with no roads and electricity.

In any environment it's not profitable for a developer to come in and buy a piece of land that they couldn't develop even if they wanted to for another five years," he continues. "It's locked up capital and it's land they can't monetise. That's the problem."

Talk of real estate consolidation is nothing new in Dubai, with Emaar's Alabbar last November saying he would be open to a merger with Nakheel, the developer of Dubai's distinctive palm-shaped islands.

Two weeks ago conglomerate Dubai World said Nakheel would be taking over the property divisions of Leisurecorp, Dubai Maritime City and Dubai Multi Commodities Centre, all of which it owns.And this is not the first time that the names of Dubai Holding and Emaar have been linked.

Back in March 2007, the two state-backed companies said they were considering a land-for-shares swap. The move, which would have had a similarly dilutive effect on Emaar's shares, was abandoned after the developer's stakeholders raised concerns. Instead the two groups entered into a joint venture agreement to develop projects together in Dubai.

But since the global crisis swept across the shores of the Gulf last autumn, Dubai's over-leveraged property sector has been badly hit - and many said consolidation was the only way forward for Dubai to meet its debt and complete nearly $80bn of projects.

Experts are agreed that this could be the beginning of a wave of consolidation that could see Dubai's developers merge under one real estate behemoth.

"It could be the beginning of consolidating the biggest companies in the real estate sector under one company, to deal with the problems [of the crisis] and create a body that could control the market in one direction," says Al Said at ING.

UBS's Masud says Nakheel could be the next to merge.

"We would not rule out further M&A with even Nakheel on the table over the next 12 months." he wrote in a note on June 29.

Analysts say that one positive aspect of the proposed deal would be increased government ownership for Emaar. The state currently owns a 31 per cent stake in the company.

However, they highlight the risk of Emaar acquiring a large chunk of Dubai land to its portfolio, which could negate the developer's efforts to diversify internationally over the last few years.

"This dilutes the diversification and international exposure of Emaar and brings Dubai back into focus, because the land bank is going to be in Dubai," notes ING's Al Said.

Credit rating agencies have also reacted negatively to the news of the planned merger. Last week Standard & Poor's decided to keep its single ‘A' negative CreditWatch rating on Dubai Holding due to concerns over the deal.

A day later Moody's downgraded the government entity to A3. Emaar was also placed on review for a possible downgrade by Moody's.

"Whilst Moody's acknowledges that Dubai's property market seems to have largely bottomed out, the financial and structural implications of its decline have taken its toll on both companies' debt protection metrics," Philipp Lotter, senior vice president at Moody's, said in a research statement.

"Moody's believes that these are likely to weaken further before the full effects of market recovery translate into stronger cash flows, irrespective of the announced merger," he added.

At Al Mal Capital, McKinnon believes the merger is less in the interest of shareholders, than it is in the interest of Dubai's real estate sector as a whole.

"The focus here is not creating value for shareholders, it's about stabilising the real estate market," he says.

As the deal is thrashed out over the next few months and details become clearer over the strategic direction of the new entity, the government must also decide whether it helps Nakheel meet its obligations when a $3.5bn sukuk expires in December.

Analysts are agreed that the future of both companies will shape the future of the emirate's real estate sector.

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