JP Morgan on Dubai’s Nakheel Bond Prospects

Dubai’s rescue by its neighboring emirate Abu Dhabi, the largest member of the United Arab Emirates federation and a big oil exporter, is undoubtedly the story of the day.

The $10 billion check written at the very last moment by Abu Dhabi, which has a sovereign wealth fund estimated to be worth $400 billion to $800 billion, enabled Dubai to avoid a humiliating default on a $4 billion sukuks (Islamic bond) that was to come due in a matter of hours. The transaction allowed the state-owned Dubai World’s property firm, Nakheel, to repay its immediate debt obligations. But what are the implications for Nakheel bondholders who have holdings in Nakheel’s sukuks due 2010 and 2011. JP Morgan (JPM) offer their initial thoughts on Dubai’s bailout and Nakheel’s bond prospects.

JP Morgan:

• We believe that Nakheel’s sukuks due 2010 and 2011 are not out of the woods as the Dubai government seems to be limiting immediate financial support primarily to trade creditors and sukuks due 2009. We would be cautious on going long these notes at current levels (price of sukuks due 2011 now around 70). These notes have no guarantees from Dubai World, estimated liquidity at Nakheel on a stand-alone basis is very weak, and real estate asset values will likely take a long time to recover.

• The Dubai government is seen limiting immediate support to repaying Nakheel 2009 sukuks and trade creditors; support for remaining creditors (Nakheel sukuks 2010 and 2011, Nakheel’s estimated bank debt of $2.7bn, and Dubai World’s estimated bank debt that is being restructured of $17.4bn) depends upon creditors agreeing to a standstill.

• Nakheel’s total trade payables (accruals, trade payables, retention payables) at the end of June 2009 are estimated to be in the range of $4-5bn. We are not sure how much of this gets paid off in the near term, but not much is likely to be left of the $10bn injection after paying off the Nakheel’s 2009 sukuks and these payables. We estimate that Nakheel is generating very limited amount of operating cash flow on its own.

• The Dubai government will also announce a reorganization law today which will be available to Dubai World’s (DW) creditors if they cannot voluntarily agree on restructuring parameters. Again, this may imply that the government would like to limit further cash injections into DW and Nakheel (beyond the $10bn just announced).

• Recourse to any newly enacted reorganization law may not necessarily be positive for Nakheel-level creditors. After all, even if creditors end up owning Nakheel’s assets and equity, their ability to monetize either the equity or the real estate assets is likely very limited in the near to medium term.

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