Events Trader # 31: How the Dubai debt crisis could create opportunities in emerging markets

1st December 2009

• How the Dubai debt crisis could create opportunities in emerging markets
• Lloyds, National Express and Dragon oil

Dear subscriber,

Welcome to this week's edition of Events Trader. In this issue we will focus on the Dubai debt crisis and on its implications for UK markets. We will also discuss the Lloyds rights issue and look at a couple of developments with Dragon Oil and at one of my old favourites National Express.

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Dubai World rattles the markets.

I've been to Dubai. It is an amazing place. Being in it feels like being in a giant Canary Wharf with over 100 skyscrapers already up and hundred and hundreds of huge office blocks at every turn, most of them under construction.

When I had to choose where to spend the night I found my choice was between over 150 four star hotels (to say nothing of the five, six and seven star ones). However there was one thing I didn't see much of - other guests. There was the odd group of Russians on a charter trip but mostly the hotels were pretty quiet. This makes sense.

Think about London - it is the biggest financial centre in the world yet even it only supports around 30 four star hotels, while its financial districts cover, in total, less than 2 square miles. Look at it like that and it should be no real surprise that Dubai's building boom isn't financially viable. Or that last Thursday Dubai World, the company behind many of the spectacular property developments underway in Dubai asked to delay scheduled payments on billions of dollars worth of debt.

No one could claim to have not known Dubai was in a bit of trouble (property prices are 50% off their highs already) but the prevailing view has long been that it would pull through. Now things aren't so certain - something that has hit markets hard. Islamic bonds issued by DB subsidiary Nakheel, which were trading at 111 cents on Wednesday, were down to 40 cents by last Friday afternoon while most global stock markets fell sharply into the end of the week.

The British press had a field day - the weekend papers were full of stories of the British banks and their exposure to the UAE. But the truth is that this event just isn't important enough to have real repercussions for the global or even the European economy. The figure of $59bn being bandied around as representative of British bank exposure is for example not really right: this is actually the number for British bank exposure to the whole UAE not just Dubai.

However while the Dubai crisis isn't enough to kick off a second banking crisis it could easily be the catalyst for a much needed market retrenchment. The rally that started in March has not yet seen a serious set back - it is about time it did. On the plus side, volatility creates opportunities and if this news causes any panic in emerging markets we should be ready to jump in. While we wait to see what happens next I'll look out for a suitable ETF for us to use when the time looks right.

National Express: finally some light.

The government has finally shed some light on the fate of National Express rail franchises: the Department of Transport has asked it to hand back its franchise to operate East Anglia rail services from March 2011. This news is bad but not as bad as it could be - there was a possibility that, given the company's default on its East Coast franchise, National Express might have been forced to give up the East Anglia service immediately.

You could also see it as good news in that at least it removes one of the largest uncertainties surrounding the company's future. National Express has also just announced its rights issue. They are to issue 7 new shares for each 3 that shareholders currently hold. Trading in the nil paid rights starts on November 30th (and going on until Dec 14th).

Exactly how this is all going to go is uncertain. The rights issue resolution was approved at an EGM on November and not all shareholders approved of it: Jorge Cosmen (whose family own 18% of National Express) refused to back the issue. Ray O'Toole, chief operating officer of National Express, has said that the family has a few weeks left to change its mind. But should it not (ie the family decide to sell their rights on and dilute their stake in the process), shares in National Express could fall sharply.

So what should we do? For now, nothing. The shares have not reacted particularly to either announcement leaving them now sitting at around 170p. That doesn't look like a good entry point to me so I'd suggest waiting for the price to fall before taking a position. I'll keep you posted.

Dragon Oil: Is the take over off?

Not everyone is impressed with the bid from Emirates National Oil Company (ENOC) for Dragon Oil. Baillie Gifford, which owns 4.2% of the company and is one of its largest minority shareholders, has become the latest shareholder to reject the offer as inadequate. That's bad news for ENOC - Bailie Gifford controls 1/3 of the votes needed to block the takeover and ENOC has already said it has no intention of paying more than the current 455p per share on the table.

Everything is likely to be decided at the EGM scheduled for December 11th but Bailie Gifford's move does raise the possibility that the deal will fall through entirely leaving Dragon still listed in the UK. Unfortunately it has also meant that the current share price has fallen to 410p - below our entry point of 447p. So what next?

As a loss reduction measure I'd suggest selling out if the price moves back to 425-435p in the run up to the EGM. If it doesn't do so, I'd hang on. I'd also be ready to buy more on the dips if - as looks likely - the offer fails. The story we've told about Dragon in the past still holds good: the shares really are worth more than the 455p offered by ENOC.

Lloyds right issue

The part nationalized Lloyds Banking Group is in the process of raising an extraordinary £21bn in an effort to release itself from the governments state insurance scheme and strengthen its Teri 1 capital ration. The first £7.5bn is to come via an exchange offer for its Tier 1 and Tier 2 securities.

This is complicated stuff but in a nutshell will see old Tier 1 and Tier 2 hybrid securities retired and converted into a new type of bond that will automatically convert into shares if the Tier 1 capital of the bank falls below 5%. I don't have the full details on all this yet but it looks as though the new bonds will be structured in a similar way to reverse convertible securities. They should, I think, carry an interesting yield and as such might be worth considering buying into. I'll keep an eye on developments here.

The second part of the cash raising involves a rights issue which is set to raise another £13.5bn via the sale of 36bn new shares. Each shareholder will get the right to buy 1.34 new shares for each one held, at a price of 37p.

The sheer scale of all this activity could make the shares very volatile during the offer period (set to end on December 11th) so I think this is one to monitor pretty carefully. I'd buy the full shares if the price dips to 40-42p - you shouldn't see them go much below this level simply because the issue underwriters are likely to want to support the price around here to make sure the whole thing looks like a success.

However there is a second way to play this rights issue if you want to trade for the short term - buy the nil paid shares (i.e. the right to buy shares rather than the shares themselves) rather than the fully paid shares. The relationship between the two is simple - the fully paid share price should equal the nil paid plus 37p. So if the fully paid shares reach our level of 40-42p the nil paid shares could trade between 3-5p. From here it is entirely possible that you could double or triple your original investment if the shares move back up at all (although you could just as easily lose your entire investment if the share price falls below 37p!).

My hope is that the end of the rights issue could mark a new beginning for Lloyds and hence a buying opportunity for a long term investor. Until then however I'd suggest being prepared to buy for the short term if the price falls - note that the worry around the Dubai story could easily push the price to our target. Then, after December 11th, we'll decide whether we want to be medium or long term buyers instead.

As usual if you have any comments or queries do e-mail me at eventstrader@f-s-p.co.uk.

Riccardo Marzi

Events Trader

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