Category Archives: Analysis

The UAE's banking paradox

August 1, 2017 By in Analysis Tags:

In this section I look at the UAE banking system and come to some startling conclusions. It seems that banks are grabbing market share in a market with deteriorating margins and increased risks.

Last week I took a look at Union National Bank’s Q2 financial results. The focus was to look beyond the headline numbers and try to understand the underlying fundamentals and what the core trend might be. This led to the idea of core revenue and expenses, ie interest income from direct lending and debt securities and interest expense of deposits and debt securities. UNB also provides Islamic financing so I added those in as well. This tells us what is happening at the basic banking level and then I look at any out-of-the-ordinary movements in other parts of the business.

Mashreq recently reported Q2 results and announced an increase in profit of 3.4 per cent over Q2 2016. But looking at basic banking, core revenue rose 9.97 per cent whilst core expenses rose 19 per cent. This is not a good sign since if it continues, sooner or later, net core income will become negative. Operating expenses are flat at about 1 per cent so had little impact on changes to net profit. Continue reading →

Dubai Financial Markets Investor Structure Improving

July 11, 2017 By in Trading, Investments, Analysis Tags: ,

My foray into DFM’s historical data unearthed some interesting nuggets, both of which I consider positive.

For the first half of this year, Arab investors, including from the GCC, withdrew a total of AED 1.6 billion from the market while UAE citizens invested a total of AED 421 million. Here is the first interesting bit, the total investments by non-Arab investors was AED 1.2 billion. That is remarkable and exactly the kind of statistic we want to see, a more balanced and broader foreign investment profile.

In essence what the above indicates is that the UAE has managed to increase foreign non-Arab investment at a time when oil prices have dropped from historical levels. This is not only a vote of confidence, it is a positive trend.

The second statistic is type of investor, with individuals selling AED 628 million to institutions. This, too, is positive as increased institutional investing is key to developing a market, not least because they have a higher tendency to impose corporate governance.

This article was originally published in The National.

Analysing Abu Dhabi Investment Authority's Performance

July 9, 2017 By in Analysis Tags: ,

Last year I did a bit of complex analysis, mostly trying to estimate returns, to understand Adia’s 7.5% 30 year internal rate of return (IRR) ending in 2015. This year I will make it easier. Adia’s 2016 30-year IRR was reported as 6.9%. Did Adia perform poorly in 2016?

It is difficult to tell as there are two bits of information that we need. First, recall that investment performance is usually against benchmarks. We do not know what Adia’s is, but I have used the MSCI World Index. It isn’t necessarily appropriate but given Adia’s size, which means it is a major global investor, it can be insightful. The other thing we need to remember is that the 30 years ending in 2016 starts in 1986 whilst for 2015 it started in 1985. Therefore the only difference between the two are the years 2016 and 1985.

So we can look at the difference in 2016 return relative to the 1985, i.e. if Adia had a return of +20% in 2016 but +30% in 1985 then the 30-year IRR drops even though Adia did well in 2016. This is because the IRR gains the +20% of 2016 but loses the historical +30% of 1985. In this case Adia would be penalised on their good 2016 return because they had made a much better one in 1985.

From a mathematical point of view we can’t get the actual difference between Adia’s 2016 and 1985 returns, but we can get the ratio. For Adia its 2016 return is 15% lower than its 2015 return. The MSCI WI as per MSCI’s website is 5.32% for 2016 and 36.62% for 1986 which is a decline of 23%. Adia clearly outperformed the MSCI WI in 2016 relative to 1985 by a large margin. Since we don’t have actual numbers we can’t tell if Adia underperformed the MSCI in 1986, outperformed it in 2016 or a combination of both.

What we can say is that Adia has, directionally, improved dramatically in its ability to manage its investments. A sign of the growth of our country not only in terms of population, real estate and economy but also in terms of effectiveness and efficiency.

This article was originally published in The National.

Dana Gas seems confused about sukuk pricing

July 7, 2017 By in Trading, Analysis Tags: ,

Dana Gas’s CEO thinks his sukuk coupons are above market even though the sukuk price is below market. This is inconsistent.

I am not discussing any Sharia law issues here, just the simple dynamics of the bond (including sukuk) market. This opinion is based on an article in The National.

According to Dana Gas’s CEO the sukuk are paying an interest rate (as I call it) of 7% and 9% depending on the tranche. He says that the market yield indicates a yield below 4%. This indicates that the coupon is fixed not floating. The fact that the yield on the sukuk has not moved indicates a fixed interest rate rather than a floating interest rate. From now on when I say interest rate, I mean fixed interest.

In general if a simple bond is paying a coupon of 10% then there are three scenarious on where the price is. If market yield is 10% then the price will be 100 (as a percent of face value). If market yields are lower < 10% then price should be > 100, and vice versa.

A couple of weeks ago DG sukuk where trading at around 40, a huge discount, which meant that the market expected a yield well above the 7% and 9% coupons (before that, the price was even lower than 40). This means that the statement by DG’s CEO that market indications are that the sukuk yield for DG should be below 4% are completely contradictory to the actual market price from a couple of weeks ago.

However, in the last two weeks the sukuk price rallied miraculously to around 100. I could not find any announcements to support such a 150% price move in three weeks which would indicate the possibility of market manipulation. But if it is a real move this still contradicts Dana Gas’s CEO as a price of 100 means that the 7% and 9% coupons are the actual market yield.

From the article it seems that the original sukuk had a convertible element which would make it a valuable option for sukuk holders. This would mean that if this element is removed, as the CEO indicates, then the actual yield in market would have to increase from 7% and 9% to compensate sukuk holders.

Dana Gas’s CEO seems to be confused about two things. The first is if a company issues a bond at a fixed coupon and later market yields drop, this does not give the company the right to destroy the bonds and replace them with something cheaper. They are a commitment, one which needs to be honoured.

The second confusion stems from  the following in the article “[The CEO of Dana Gas said] traders in the previous structure [the sukuk with the convertible element] had arbitraged and dumped the shares, depressing the shares in a manner that is unfair to existing shareholders.” This statement indicates a misunderstanding of a basic point of finance – arbitrage is good as it keeps markets efficient and in sync. The idea that market movements are unfair to shareholders because convertible sukuk holders acted legally in the market holds no water. If anything happens untoward in the market then shareholders should seek justice from the regulator, the Securities and Commodities Authority. To have the company punish sukuk holders in favour of shareholders is wrong.

Nigeria unit’s default poses questions for Etisalat

June 27, 2017 By in Due Diligence, Analysis, Corporate Governance

Etisalat Nigeria, a Nigerian telecoms company owned 45 per cent by Mubadala and 40 per cent by Etisalat, was reported to be effectively bankrupt over a US$1.2 billion default and was taken over last week by a syndicate of Nigerian banks. There are two broad themes that this represents that I think are instructive and they are the entry into the investment as well as its operation followed by the exit from the investment.

Let’s start with the exit. I have never seen research on the use of capital injections to support SWFs or their underlying portfolio but I was under the impression that this was usually always provided. The fact that Mubadala and Etisalat were willing to let go of egos and allow what they believe to be a bad investment to go is quite welcome. As we say in the region, they didn’t try to save face. This is the professional route. Only history will show whether this is an underlying philosophy for these companies or a one-time event.

The question on the exit would not be complete without also looking at whether standing back made commercial sense, as opposed to investing further funds. I will not do an economic analysis but suffice to say that a World Bank report states that due to the drop in oil prices (Nigeria is an oil exporter) Nigeria went into recession in 2016 and inflation reached 19 per cent. You don’t need to delve further to realise that there were sound economic decisions for Mubadala and Etisalat to back away.

I am not so optimistic about the performance of the two in entering and operating the investment. The company was established in 2008, which was the beginning of the global financial crisis. But nobody would be expected to forecast that and certainly it does not seem like it had a materially adverse effect on Etisalat Nigeria. The problems appear to stem from the collapse of the oil price in mid-2014, which subsequently led to a recession in Nigeria with high inflation. Under such circumstances it is understandable that the business environment deteriorates.

What is difficult to understand is why companies already based in an economy with a high exposure to oil prices would increase their exposure to oil. Especially since they each independently had already increased their exposure to oil – Mubadala via direct investments in the sector globally and Etisalat via operations in countries such as Saudi Arabia, which is even more dependent on oil.

I tried to get some insight by looking at Etisalat’s 2016 annual report. The problem is that since Etisalat owns such a large percentage of the company the financials are consolidated, ie combined with all the other operations of the group. To its credit, Etisalat does talk about each subsidiary separately. The annual report begins the Etisalat Nigeria section with “in 2016, the Nigerian telecommunications sector was confronted with considerable challenges, as the country’s economy slipped into recession and regulatory constraints persisted”. After those 22 words the next 490 words of the review are optimistic about the Nigeria operations. There is no direct warning that Etisalat would lose the company due to a default in a mere six months.

Remember, Etisalat is a listed company and has reporting standards as part of its fiduciary duty to it public shareholders. Mubadala of course has no such reporting duty to the public. Now, I said that there was no direct warning, but there certainly is at least one indirect warning. Etisalat, using large icons and large font in the margins, disclose the revenue, Ebitda and capex of Etisalat Nigeria. Here’s the warning: for its Morocco operation, reported right before Nigeria, and Pakistan, reported right after Nigeria, Etisalat additionally reports the P/L and the Ebitda margin. Why did Etisalat withhold these important numbers from the public? How can Etisalat not have known that within six months its subsidiary would default? Was it incompetence? Was it neglect? Was it an ethical issue? It is important to understand the answer.

One clue is what happened with Saudi unit Etihad Etisalat, also known as Mobily, in which in addition to holding a sizeable equity stake it also had a management contract with. A restatement of the financials at the firm for 2014 led to about Dh1.7 billion in profits subsequently being cut. This led, at least in part, to Deloitte, one of the big four audit firms, being banned by regulators from auditing listed companies in Saudi for two years. Etisalat’s management contract for Mobily was not renewed.

Given the public information available there seem to be operational weaknesses within Etisalat, at least in terms of its international operations. If a unit misstating Dh1.7bn in profit is reported as a scandal, then what do you call losing a whole ­subsidiary in a default? Worse, what do you call it when you don’t warn your shareholders?

Earlier this year, Sheikh Mohammed bin Rashid, Vice President and Ruler of Dubai, spoke at the World Government Summit and of the many points that he emphasised two relevant ones here are “We don’t tolerate corruption. We have zero tolerance here” and “Arab leaders are surrounded by officials who keep saying everything is fine”. I agree. I would, however, respectfully and humbly add one more point.

Incompetence costs us far more than corruption. We should also have zero tolerance for incompetence and when managers say everything is fine, they need to be challenged as to whether the issue is exogenous events or incompetence.

This article was originally published in The National.

Ipic profitable in 2016

June 9, 2017 By in Analysis Tags: , 2 Comments

Net profit $200 million for 2016 vs loss of $4.1billion in 2015.

Details (notes 14, 17) show a big swing in cost of sales due to a drop in impairment of oil & gas properties from $3 billion in 2015 to $1 million in 2016 (I double checked the b’s and m’s).

Digging, I found that “the Group changed its accounting policy with respect to the subsequent measurement of investment properties from the cost model to fair value model.”

To get a better picture I went to cash flow from operations and it dropped $572 million in 2016. Net position appears strong, direction of business not so much. Capital intensive, long term cash conversion cycle. Challenging business.

Ipic Financials.

Article in The National.

 

Financial Model Pitfalls

March 15, 2016 By in Analysis Tags: 1 Comment

One of my previous jobs was to be a rocket scientist – financial jargon for somebody who is good at mathematics.

Naturally, this makes you the guy who works the most on the financial models that drive strategy.

A financial model simulates the future, and by manipulating the various inputs to the model you are supposed to get an idea of how the company will perform. From these scenarios you learn which strategy to pick.
What could go wrong? Every­thing.

Continue reading →