DUBAI, 24 July 2006 — The Dubai Financial Market (DFM) seems to have stabilized since its correction in the first quarter of this year, but investors are still wary and a further fall is not beyond imagination. The problem is not so much overvalued stocks anymore, but rather an imbalance in the market created by the overrepresentation of the banking and real estate sectors. Of the 35 companies listed on the exchange, seven are banks and 14 are investment and real estate firms. The property developer Emaar accounts for 30 percent of the total market capitalization and 50 percent of trading. The banking sector makes up another 40 percent of daily trading. One can easily imagine a scenario where developers overestimate the demand for new hotels and office space, leaving new buildings to stand empty. Small investors who bought apartments expecting to quickly sell them for a profit cannot do so and must default on their loans from banks. A plunge in both sectors could have long-lasting effects.
The DFM can avoid this fate. The exchange badly needs firms whose share price will rest on profits from real earnings and not just the rising value of assets. Dubai should go public with its profitable state-run industries to create a diversified base so that the DFM can withstand a fall in the banking and real estate sectors. The aluminum producer Dubai Aluminium Co. Ltd. (Dubal) is a good early candidate for an initial public offering (IPO). The aluminum smelter’s profitability is likely to grow over the next 5-10 years, providing a solid investment for shareholders, and it is so large — the firm alone accounts for seven percent of Dubai’s GDP — that an offering of 30-50 percent of its shares would noticeably impact the DFM. Since the company exports most of its aluminum, its profitability changes with the world market conditions rather than the local economy. This bodes well for the stability of its stock price.
Now is the opportune time for Dubal to go public. Despite the recent downturn, investor interest in the DFM remains high: Tamweel was 500 times oversubscribed in its recent debut. Dubal could certainly raise far more than the mortgage company’s $150 million, and it has ample project opportunities as it plans to double production by 2012. New pot lines are under construction at its Jebel Ali plant, and Dubal has agreed to build a $6 billion smelter with the Abu Dhabi investment company Mubadala. Recently, the aluminum producer signed a $3.6 billion joint venture agreement with Larsen & Tourbo to build an alumina refinery and smelter in the Indian state of Orissa. Even with this investment and the acquisition of a $200 million stake in Global Alumina, Dubal is far from securing the five million tons of refined bauxite it will need annually for its smelters. With the spot market price of alumina up over 40 percent since 2005, further upstream expansion is likely.
Dubal is set to become a world leader in an industry with a strong outlook. World demand is growing at four percent each year, due largely to China’s booming economy. Aluminum prices, currently at 15-year highs, are likely to remain well above their five-year average even as new smelters come on line. In Europe, increasingly stringent environmental regulations are forcing smelters to either close or switch from coal to cleaner burning natural gas to meet their electricity needs in this energy-intensive industry.
Dubal is in a prime position to benefit from these conditions and remain competitive well into the future. With power accounting for 40 percent of the production costs, Dubal’s access to cheap natural gas is its biggest advantage. Its location in the Gulf and proximity to the importing regions of Europe and Asia mean lower transaction costs than competitors in Brazil or landlocked parts of Russia. The Jebel Ali smelter is one of the most environment friendly in the world, and Dubal’s reputation among its customers for quality and reliability allows its products to sell at a premium on the world market.
Using equity to help finance Dubal’s emergence as an industry leader is a good idea as well. Firms generally try to maximize their value by financing themselves with a mix of debt and equity. In most cases, some debt is desirable because the interest paid is tax deductible. However, as a company takes out more loans, lenders demand a higher interest rate because the risk of default increases and firms turn to equity to help lower their average cost of capital. Dubal faces a different situation because it is government owned and does not pay taxes, negating the incentive to take on debt. The flip side is that since Dubal’s debt is implicitly guaranteed by the government, it can borrow at interest rates lower than it otherwise could. Still, Dubal needs billions of dollars for its expansion, and keeping interest payments manageable by issuing equity would be beneficial.
In reality though, a public offering is less about the interests of Dubal than about the Dubai government’s commitment to developing its markets and becoming a financial leader in the Gulf. Going public means that Dubai would have to relinquish some control over one of its most profitable companies and deal with unruly investors. Revenue that currently goes to the emirate would have to be shared in the form of dividends. While the government would certainly retain a large stake in Dubal, the lost income would be felt in Dubai’s treasury.
The benefits of listing are much greater for Dubai’s economy as a whole than for either the company or the government. Dubal would serve as a much needed blue-chip stock on the DFM, helping to protect the market index against wild fluctuations and providing peace of mind to investors. Aluminum might not be as glamorous as high-tech companies or the hot property sector, but Dubal has potential for real, sustained growth. Opening up Dubal’s books in accordance with international standards would signal to the market that Dubai is committed to creating a world-class stock exchange. But Dubal alone is not enough to hold up the financial market. Listings of other profitable government entities such as Emirates Airline, DP World, and subsidiaries of Dubai Holding will necessarily be part of a robust stock exchange. Dubal should lead the movement to go public, because not doing so exposes the DFM to greater risks.
(James Plasman is a visiting scholar at the Gulf Research Center in Dubai.)