Capital markets

$136bn: Amount investors lost on the Dubai Financial Market between June 2008 and September 2010

$829.6m: Amount raised by eight Gulf companies from initial public offerings during the first six months of 2010

$23.9bn: Value of bonds issued in the Middle East and North Africa region in 2010

Source: MEED

It has been a torrid two years for the GCC’s stock markets. After having enjoyed a surge in share prices fuelled by declining borrowing costs and rising oil prices, the region’s eight bourses plummeted when the downturn hit.

Saudi Arabia’s stock exchange (Tadawul), the region’s largest market, fell by 53 per cent between August and November 2008. Gulf stock markets have, in pricing terms, been among the worst-performing in the world over the past five years. Shares of most quoted companies are infrequently traded and turnover remains depressed.

The Dubai Financial Market (DFM) has recorded the sharpest decline as the emirate’s debt crisis weighed heavily on investors.  

Its trading volumes have fallen by 68 per cent from March 2009 until the end of October 2010, compared to a respective drop of 43 per cent and 30 per cent on the Abu Dhabi Securities Exchange (ADX) and the Egyptian Exchange over the same period.

Investors lost AED500bn ($136bn) on the DFM between June 2008 and September 2010. Trading on the DFM stood at AED900bn in June 2008, compared to a gross domestic product (GDP) of only AED500bn.

Limited funding

All markets are still struggling. Despite the optimistic outlook at the start of this year, eight Gulf companies raised $829.65m (AED3bn) from initial public offerings (IPOs) during the first six months of 2010, compared to the $1.2bn raised by seven companies a year earlier – a drop of 31 per cent.

Gulf companies are opting for book-building, rather than floating shares at a fixed price to squeeze out more value

Saudi Arabia has single-handedly been keeping the region’s IPO market alive, with seven offerings worth $684.4m, including the region’s largest offering, the $272m Knowledge Economic City (KEC).

But its performance has been equally disappointing, with an estimated 80 Saudi companies postponing offerings worth a total of $19bn in 2009, according to Saudi Arabia’s NCB Capital, the investment arm of National Commercial Bank (NCB). Of the kingdom’s seven flotations in the first six months of the year, four were mandatory due to the government’s regulatory requirements for insurance companies to list.

Gulf IPO activity 2009-10
  Jan-Jun 2009 Jan-Jun 2010
Number of IPOs 8 7
Value raised ($) 830m 1.2bn
IPO=initial public offerings 
Source: PricewaterhouseCoopers (PwC)

The second half of the year has seen a broader geographic representation of IPOs in the Gulf, but weak retail investor appetite has seen them underperform – a reflection of the damage caused to confidence.

The three Gulf IPOs that have closed in the second half of this year have all been priced at the bottom of the range. Saudi contractor Al-Khodari failed to cover the retail tranche of its $163.2m IPO, while Omani telecoms operator Nawras had to extend its share sale period by one week until 21 October due to weak interest. Despite being the first company to list in the sultanate since July 2008, it raised $473m out of its targeted $608m.

Past Gulf IPO activity
  2007 2009
Volume 53 12
Value raised ($) 13.5bn 1.99bn
IPO=initial public offerings
Source: PricewaterhouseCoopers (PwC)

In early November, Aluminium Bahrain (Alba), the world’s fourth-largest producer of aluminium by capacity, raised just $338m out of its targeted $541m, after its IPO priced at the bottom of the range and. At the time of MEED going to press, UAE mobile phone retailer Axiom Telecom was considering excluding retail investors in its planned IPO and choosing an all institutional offering.  

This recent spate of IPOs has seen a new trend emerge. Gulf companies are opting for book-building, rather than floating shares at a fixed price to squeeze out more value. Although mostly untested in the Gulf, both Nawras and Alba opted for a book-build and Axiom is expected to follow suit.

“The book-build process for IPOs in the Gulf is here to stay,” said Jeff Singer, chief executive of Nasdaq Dubai, speaking at MEED’s 2010 Capital Markets conference in October.

“Companies won’t leave as much value on the table. Family companies will float more through the book-build process … we’re entering a new era for capital markets in the Gulf.”  

The government’s diversification strategies are expected to be the main driver of growth of Gulf IPOs. For this reason, sectors such as telecoms, transport and industry will likely see increased issuance in 2011.

Furthermore, in stark contrast to the 2003-08 boom period, when the majority of capital was raised to fund the aggressive expansion plans, the future IPO market is expected to be driven by banks looking to strengthen balance sheets, along with real-estate and construction companies looking to pay down debt.

Although the turnaround in the GCC’s IPO market has been modest to date, a slew of planned IPOs signals a return of confidence.

Dubai-based investment bank Shuaa Capital has mandates for five IPOs in the UAE that could be concluded in 2011. Saudi Arabia’s largest lender, National Commercial Bank (NCB), is currently advising two local companies on listings for early 2011 and is in the process of bidding for two new advisory contracts.

The debt capital markets are also staging a recovery, with $23.9bn-worth of bonds issued in the Middle East and North Africa (Mena) region to date this year. Qatar has led the pack, issuing $7bn-worth of bonds, followed by Dubai’s issuance of $4.3bn.      

“Total issuance will definitely hit $30bn by the end of the year – if not before,” says Andrew Dell, head of debt capital markets for the global banking division at HSBC Middle East. “The debt markets are performing very well today and have seen a strong and sharp rebound from the events of 2009.”

Corporates are increasingly tapping the bond market in order to make up for banks’ reluctance to lend. Dell forecasts the Mena bond market will record 25 per cent year-on-year growth in 2011.

Bonds are also growing in popularity as a vehicle for re-financings of maturing project finance loans. Governments in the region are fast realising the value of the instrument as a source of liquidity for the huge public infrastructure projects being carried out.

The Dubai government sold $1.25bn-worth of bonds in October. Emaar Properties, the UAE’s biggest property developer, raised $500m from selling convertible bonds and Qatar Islamic Bank (QIB) received orders for $6bn as it sold $750m of Islamic debt.

This year has also seen some significant milestones. On 8 September 2010, Kuwait appointed its first independent stock market regulator, the Capital Market Authority (CMA), with the aim of boosting transparency and combating insider trading on the Kuwait Stock Exchange (KSE).

The CMA of the Gulf’s second-largest bourse, with a market capitalisation of about $117bn, will impose fines and prison sentences of up to five years for violators through a special tribunal.   

The Kuwaiti exchange has been the only one in the Gulf without a market regulator as the law took many years to secure parliamentary approval.

In 2010, we saw the merger of Dubai’s two stock exchanges after the DFM acquired a 67 per cent stake in Nasdaq Dubai for $121m.

Under the terms of the buyout, Nasdaq Dubai gained access to DFM’s 548,000 retail investors, which considerably buoyed its performance. Nasdaq Dubai was losing $1m a month prior to the merger, but today is operating at a loss of $500,000, according to Essa Kazim, managing director and chief executive of DFM.   

This should help push the case for the long-touted merger of the ADX and DFM’s liquidity pools, expected in 2011. Merging GCC liquidity pools, rather than merging exchanges, will allow existing markets to draw on each other’s investable resources.

“There are only about six stock that are actively traded on the ADX today,” he says. “And there are already around 25 per cent less brokers in the UAE than the 105 active in 2008.”

It is estimated that under current market conditions, the smaller UAE brokerages earn an average of AED3m a day. To break even, they need no less than AED15m.

Capital markets require scale to be successful. If the GCC exchanges were to collaborate, operational efficiency would improve and cost of transactions would be significantly reduced.

Greater liquidity is also essential if the region’s markets are to successfully attract large, institutional investors who would help create depth and reduce volatility.

Christian Kern, the head of Middle East equity research at JP Morgan, predicts that institutional investment will rise in 2011. There are about 50 Mena funds obliged to invest in the region’s markets. International emerging market funds are showing fresh interest and hedge funds are eyeing up Gulf equities.

Although priorities and timelines vary, all exchanges are making a concerted effort to expand their product portfolios. The Tadawul and the ADX introduced their first exchange traded fund (ETF) in March this year.

Short selling in the Middle East

Exchanges across the region are also now confronting the markets’ biggest defect – the fact that it is effectively impossible to hedge against a falling market. They unanimously stress the need for the introduction of derivatives.

Meanwhile, leading figures from the ADX, Nasdaq Dubai and Tadawul have increasingly been calling for the introduction of short-selling. The UAE’s regulator, the Securities & Commodities Authority (SCA), is working on new regulations that should pave the way for its introduction.

Such tools would enable investors to protect themselves from the downside risk and to profit from a fall in the value of shares, thereby encouraging them to keep trading in today’s market.

Bond issuance will undoubtedly be the main driver of liquidity in 2011. There will also be an uptick in the number of Gulf IPOs – with analysts predicting a total number in the mid-to-late teens.   

Ultimately, a large-scale recovery of the markets will hinge on renewed bank lending and a revival of the private sector – neither of which are expected in 2011. While banks remain risk-averse, the private sector is grappling with indebtedness, oversupply and the inability to access credit.

The exchanges should use this current lull in activity to enhance their product offering, regulations and liquidity, so they are well-placed to exploit growth opportunities in the longer-term.