Monday, February 15, 2010

UAE Real Estate Stocks: "The Switch is now Obvious"

“The obvious is that which is never seen till someone expresses it simply”-Khalil Gibran

Some thoughts on Aldar…..

When the headline came across I thought it was a q4 number, it turned out to be the fy09 number. That’s never good. In this case the miss was large, but then again what’s a miss when you sell nearly zero cost land. Though when you factor in the zero land sales and the provisioning these numbers are not that bad, but that’s not the point I am going to focus on in this note. I have received some emails questioning whether or not this report pokes a hole in my sudden relative bullishness on the UAE or in particular Emaar. The short answer is no, but before I get into that a little background.

When I first showed up in Dubai late 2007 I had an interview with the real estate analyst at what was then a notable bulge bracket bank. (At the time I thought I wanted to be a research analyst) I had done some homework on the local market and concluded that I preferred Abu Dhabi to Dubai when it came to property stocks. My logic was really simple. I was uber bearish on America(I was leaving the states to look for work….my parents had done exactly the opposite 35 years ago), and Dubai’s largest publically listed company had just recently made a large acquisition of US homebuilder. When you’ve been shorting Fannie Mae and Freddie Mac, and abandoned your country to pursue a career opportunities; you are going to have a hard time believing a European real estate analyst that thinks a luxury homebuilder in California is a good idea. The question was really quite simple: Why would I buy a late cycle Dubai developer that was pouring retained earnings into what I felt were stupid acquisitions in the US and that was now focusing on expanding outside of its home market when I could buy an early cycle similar version of that developer in Abu Dhabi?

If you asked me, Emaar had done Aldar’s work for them. It had created the property frenzy that Aldar would now be able to cash in on. The equation was simple:
Almost zero cost massive land bank+ surging oil price= pure play high margin printing machine

I wanted to be long Aldar on an absolute basis, and definitely on a relative basis against Emaar. I thought it was a no brainer.

The analyst didn’t seem to see it that way. He really liked Emaar. His argument had shifted from smart acquisitions and diversification( what I’d read in his earlier reports) to cheap valuation and know-how. See, in his mind, Aldar’s land sale driven earnings quality was not sustainable(he would eventually be proven right), while Emaar’s US hiccup wasn't going to get any worse(he would eventually be proven very wrong).That is not to say I didn’t see his point on Emaar. They had operating assets coming on line that would be generating somewhat predictable cash flows, and the market didn’t seem to care.(some could argue it still doesn’t) But at the time his overall thesis felt weak. We agreed to disagree. I never heard back from them.

Fast forward to the summer of 2008. After an eye opening experience at Mall of the Emirates(Dubai Real Estate- On the Ground Floor), I concluded that the odds of a devastating property crash sometime in the immediate future were improving. This changed my entire property stock thesis. I no longer wanted anything to do with land sales or early cycle developers. There was nothing complex about this sudden shift in outlook. It was property investing 101, you steer clear of land bank stories when a property bubble pops. Surprisingly or not surprisingly, depending upon how you view the world, few people seemed to be making this argument. Once the crisis started we were inundated with the Dubai-to-Abu Dhabi switch argument. I got the economic argument. Dubai has virtually no oil; Abu Dhabi does. A fifth grader could figure that out. What I didn’t get was how all these rather intelligent people felt this argument should also apply to the Emaar-to-Aldar switch thesis.

The story was simple. Abu Dhabi has oil, less units, and more demand; buy Aldar because property prices there will hold up. Seeing as I was from North America I had a hard time buying this argument. Most people don’t pay multiples per square foot in one city when they can find an abundant supply of completed brand new apartments or villas 45min away. What they end up doing is commuting until the prices start to converge to a point where the convenience factor/ opportunity cost/ quality of life differential is no longer negated by the cost savings. Thus, I strongly felt there was no way you could make a compelling real estate argument for Abu Dhabi property that didn’t also involve some element of a solid dubai property recovery. What you could make was a sustainability argument that favored Abu Dhabi over Dubai. So, buy Aldar debt, but not Aldar stock, that’s what I recommended. Of course the market didn’t seem to agree with me on that; Aldar largely outperformed for almost all of 2009. See, if a billionaire is willing to burn a lot of money to achieve a certain goal you have to respect the fact that he doesn’t care, but you don’t have to buy a residual claim on that venture. After yesterday’s report, I think more than a few people will start to rethink their relative value Aldar arguments. I emphasize the word relative. If you are going to love this stock just because Abu Dhabi has oil, that’s an absolute property market argument which involves across the board asset reflation. In my book, that argument works for every real estate and financial name in the region, and not just Aldar. In Aldar’s case, it is relatively attractive when compared to real estate related names in the region largely because it can survive and execute its strategy, but once the argument goes beyond survivability the compelling reasons to buy equity in it drastically decline. This is because, relatively speaking, the alternative choices of Emaar and Sorouh are much more compelling.

Emaar is cheaper, operationally attractive, and gradually climbing the value food chain by diversifying into life-style services. Sorouh on the other hand is more return on equity oriented and less sovereign development focused.

So, what’s my point?

I guess what I am trying to show is that the reasons put forth for buying Aldar shares have never made much sense to me since the property market in Dubai froze up. It similar to the criticism I made early in the summer of last year regarding buying UPP shares because Emirates bank would roll over their debt. I didn’t doubt that UPP’s loans would not be called in, but I also didn’t care at the current billion dollar valuation. Aldar has a market cap of 2.6billion USD. I don’t doubt that the company will continue to be able to operate and meet its development goals, but at the current market cap I don’t think that’s the debate we are having.

Now back to why I don’t think this report is bad news for the whole market…….

The Aldar news if you look closely demonstrates that local firms are showing a level of proactivity that we have not seen before. That’s a good sign. Taking a write-down and recognizing costs upfront shows that management is becoming more realistic. Furthermore, the sales of assets to the government should not go unnoticed. Aldar has ways of addressing funding issues that most other real estate developers don’t posses. Which brings to the topic of policy flexibility.

I just spent a good deal of time explaining why Aldar is not relatively attractive, but that argument only holds water if certain tools that I think are clearly available are not employed.

First, the government of Abu Dhabi could if it so desires buy land at inflated values from Aldar to support profitability. It could then transfer this land back to Aldar at zero cost somewhere down the road. Why would the government to this? Well, there is only one reason, to support the market. It is tantamount to the fed buying GSE paper. The only difference is that the fed is doing it electronically. In this case, the sovgn would be using their own wealth to support the liquidity of the real estate market and the profitability of one of the Adx’s most liquid names. This would be the most aggressive way of addressing deflation in asset prices in Abu Dhabi, and Aldar would be the biggest beneficiary of a move like this if we got one down the road.

Second, the government of Abu Dhabi could directly buy Aldar debt and the debt of Abu Dhabi lenders. This would be almost a replica of what the Fed is doing and similar to some of the stuff we have seen out of the Qatar government.

Third, they could buy delivered operating assets and take over ownership of these long-term assets to continue to facilitate development. This is the least aggressive reflation choice, and the one that it looks like AD has chosen to implement.

So, yes i do think the switch from aldar to emaar has now become quite obvious. Your only caveat is that maybe the two end up becoming one sometime in the future.

Oh, some quick thoughts on Dubai World...

Dubai world shook up the market yesterday. My short answer to that is that’s ridiculous. If you ask me there is no real equity market news here that goes beyond anything but noice. Dubai World will seek to pay the least amount it possibly can at the most accommodative terms it can obtain. The creditors will push back with an approach that will be completely defiant up until that point in time at which they believe Dubai World will respond with a simple ‘Good luck, and I’ll see you in court’. However, as dubai wants to maintain its image, and the bankers can't politically or legally afford to play real dirty hard ball, an agreement will be reached somewhere between these two poles. Whatever that agreement may be it is better than what Dubai is currently expected to pay. So, Dubai World as a selling point catalyst continues to be in my opinion not worth the weight the market is putting on it. It only factors into the equation if you view it within the context of the larger global sovereign debt situation.