With US$30bn of projects in the pipeline, Nakheel visited the capital markets in 2006–07 to raise more than US$5bn from a stock-settled sukuk and an Islamic loan. By Helen Bartholomew.
No development company is more active in the fastest growing city in the world than Nakheel. It currently has 16 major projects under way, including the Palm developments, Dubai Waterfront and The World development. Part of the world's biggest holding company, Dubai World, which manages and supervises businesses and projects of the Dubai Government, the property developer is chaired by Sultan Ahmed bin Sulayem.
The developments will add more than 1,500km of beachfront to the coastline and are spread across more than 2bn sq ft, representing half of the city's total development area. Nakheel plans to supply half of Dubai's forecast annual real estate supply of 74,000 units. The company expects to supply 100m square feet of property per year for the 20-year development span of the current projects.
While the company is already selling properties in many of its developments, it is yet to report any profits, so to support its ambitious development plans, Nakheel went to the capital markets in November 2006 for what remains the largest sukuk issue to date, and followed up the success with an upsized Islamic loan that was completed in August 2007.
Nakheel's US$3.52bn pre-IPO sukuk was something of a market event for Islamic financing. The sukuk-ijara started life at just US$2.5bn, but strong demand saw the deal increased to become the largest ever sukuk issue. A similar US$3.5bn transaction for PCFC into shares of Dubai World-owned ports operator DP World, was certainly a driver, but many bankers viewed the Nakheel offer as more ambitious given the concentration of assets and lack of any reported profits.
Having been a previous visitor to the loan market, DP World was reasonably well known when it brought its convertible sukuk. Nakheel was a newcomer, with the pre-IPO convertible representing its first foray into the capital markets. As such, the success of the previous deal for PCFC/DP World was certainly an important driver behind Nakheel's decision to tap the market.
"The fact that PCFC went out and did a successful sukuk certainly gave us confidence, but the two deals are very different investment propositions. PCFC has broad international operations and ongoing reported profits. Initially, we weren't sure how our deal would be received as Nakheel is entirely Dubai risk and entirely concentrated in real estate. Also, while we have sold a lot of property, we haven't reported any profits yet," said Kar Tung Quek, CFO of Nakheel.
Sukuk success
Despite the ambitious nature of the transaction and the fact that a number of investors were sceptical of real estate investment in the region, the bond closed more than twice covered with half of that demand coming from international investors. The result highlights the increasing level of comfort that the global investor base is gaining with sukuk. PCFC saw just 20% of its convertible bond placed outside the region, and more recent transactions have seen further improvements in international participation – In February 2007, Abu Dhabi based Aldar Properties saw 80% of its US$2.53bn convertible placed outside the Gulf region.
The numerous similarities with the PCFC/DP World exchangeable sukuk included the appointment of Barclays Capital and Dubai Islamic Bank as lead managers. Notable changes included the shift away from a mandatory structure. The Nakheel sukuk entitles investors to convert into the shares at a 5% discount to the offer price at any qualifying public offer, including an IPO and subsequent qualifying share sales. Conversion is optional and investors can choose to hold on to the paper even in the event of a public float.
As a land developer, it made more sense for Nakheel to use the common ijara structure, which involves the leasing of land assets and also allows the coupon to pass through earnings.
A number of conversion limitations ensure the sukuk does not have any negative implications for an equity offer. Only 25% of the sukuk can be stock-settled and the remaining economics are paid in cash. Only 30% of any qualifying public offer can be earmarked for sukuk conversion, which would be particularly important in the event that an IPO was smaller that expected.
As development projects are completed, the company's financial profile will change dramatically and its cost of funding should fall as credit metrics improve. As such, the company opted for a reasonably short three-year tenor. In the event that an IPO does not emerge for the life of the paper, investors see the 6.345% yield on their investment boosted by 200bp. A 12-month lookback period gives investors additional equity exposure beyond the three-year life.
The additional yield features should encourage the company to complete its IPO within the three-year life of the bond. Company officials expect the flotation within that time-scale, but delays are always possible, as shown by DP World, whose planned 2006 flotation was postponed to 2007 to allow for the integration of the P&O acquisition.
The deal is still on course to materialise before the end of the year, although some bankers believe that early 2008 is a more likely timetable. Like the sukuk, the DP World IPO result will provide an important benchmark for Nakheel and anything short of success could be a setback for the property developer's flotation.
International support
A global roadshow brought in strong international support for the Nakheel sukuk and helped to boost the profile of the company's development projects with the international financial community. The company could become a regular visitor to international capital markets given its huge development pipeline, so international accounts received better allocations than were seen in the sukuk for PCFC. Middle East investors represented 38% of the final allocations, while European investors took 40%.
"Because of the size of Nakheel and the size of the fundraising, we wanted to be able to do it on a global basis. If we do an IPO in the near future, it is likely to be a very large transaction and would certainly be a global offer. The sukuk roadshow helped to profile Nakheel and its activities. The fact that books closed twice subscribed, with half of that demand from non-GCC countries, just goes to show that sukuk issues are no problem for international investors," said Quek.
Following the success of its sukuk, the company gave lead managers Barclays and Dubai Investment Bank the seal of approval, mandating them to arrange a US$1.5bn Islamic loan in May 2007.
The five-year facility, which was launched in late June, has a two-year grace period and then amortises in seven equal semi-annual instalments. The profit margin for the company is 85bp over Libor and banks were invited on tickets of US$75m earning 45bp, US$50m for 35bp and US$25m for 25bp.
Given the scepticism of many syndicated lending banks to the property development sector, the profit margin of 85bp is viewed as a particularly good result for the company. But with most Middle East loans offering a margin of 1%, participation by international players was expected to be limited. Even so, demand from local banks was exceptionally strong, such that the loan was increased to US$1.85bn. Twenty foud banks joined the deal.
The company is unlikely to return to the capital markets before the end of 2007, given that it has already hit the US$5bn funding target that was determined in September 2006. Current gearing is 20% against asset value and 27% against equity, a level that Quek expects to maintain for the time being.
"Our future capital markets activity depends on our cash requirement, which is determined by how quickly we carry out the developments, sell the properties, and how much of the landbank we can sell on to other developers. We hope to be able to get the capital structure in a more efficient form, but we expect to keep debt volume at US$6bn–$7bn for at least the next three years," said Quek.
At the end of 2006, total assets stood at US$29.9bn, with total equity of US$22.6bn. Quek expects assets to stand at US$35bn by the end of 2007 and US$29bn by the end of 2008.
With the jumbo financing transactions out of the way, Nakheel is planning new ways to diversify its funding base. The company has already generated a huge amount of interest from international funds through its global roadshow presentations and is keen to capitalise on that interest, and the increasing flow of money rushing into Dubai.
Real Estate Investment Trusts are one area of potential interest and Nakheel is currently in the early stages of building up a capital arm, from which it can issue tax-efficient REIT securities. It is also planning infrastructure trusts and private property funds.
Ultimately, the company's next steps in the capital markets will depend on the speed at which it can sell property. Tourism continues to grow, with Dubai attracting just 5m visitors in 2006 and 10m expected for the whole of 2007, rising to 15m per year by 2010. The huge growth potential has sent property prices soaring, thereby dampening rental yields. Even so, with yields stabilising at around 7% compared with the 3%–4% that can be achieved in the UK, bankers believe that there are still a few years of upside before supply outstrips demand.