TNI Market Insight

INVESTMENT RESEARCH COUNTRY STRATEGY | July 3, 2007 UNITED ARAB EMIRATES

Amer Halawi
Tel: +971 (2) 619 2300
ahalawi@tni.ae

Brian Davidson
Tel: +971 (2) 619 2322
bdavidson@tni.ae

Initial Public Offerings: The end of easy money

Disclaimer

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July 3, 2007 | 02
Contents

The rise and fall of Emirati IPOs 4

The UAE IPO process is unique 6
A reminder on Western IPO practise 6
Four major differences with the “West” 8
Historical reasons for such differences? 10
SWOT of the current IPO system 11
Going public for the wrong reasons 12
The re-distribution of private wealth 13
Risk and reward are skewed 16
Leverage is breaking the market 18
An inefficient money-raising instrument 22
Unprecedented UAE IPO boom 24
Impressive performance 24
Disappointing after market 24
No more steam 25
The DFM case study 28
The end of easy money? 28
You shouldn’t have subscribed! 28
For whom the bell tolls 31
The way forward 33
Consequences of the market slowdown 33
The pipeline is still generous 35
Seven recommendations for a “better IPO world” 37

July 3, 2007 | 03

UAE stock markets are
nascent but growing fast.
They are largely retail-driven
IPOs pulled markets up.
They have been viewed as a
way to get rich fast
The IPO process is sub-
optimal and overly regulated
Now is the right time to
better understand IPOs, and
to encourage change
The rise and fall of Emirati IPOs
In the UAE, the first official stock market trades took place on DFM and
ADSM in 2000, barely 7 years ago. This highlights how young the UAE
capital markets are. However, due to very favourable economic
conditions fuelled by oil surpluses, the development of local markets has
been extremely fast. Aggregate market capitalisation today amounts to c.
$200bn, and daily turnover may at times exceed AED5bn ($1.35bn).
Market growth has largely been based on wealthy retail investors looking
for fast capital gains, and often believing that “the only way is up”.
Table 1: UAE stock markets summary
DFM ADSM
Date of first trade 26-Mar-00 15-Nov-00
Total market cap AED (m) 357,485 349,140
Total market cap USD (m) 97,407 95,133
Total number of listed stocks 51 64
Average daily turnover AED (m) 843 250
Average daily turnover USD (m) 230 68
Source: TNI Investment Research, Reuters, Bloomberg
One of the biggest drivers of the UAE capital markets boom has been the
IPO activity. 2005 and 2006 saw the largest ever number of public
offerings. It seemed there was no limit to capital markets financing, even
as the stock market fell from its historical peak. Individuals and
corporations annually poured some USD 1.77bn to finance the growth of
existing companies or start-ups. Subscribers invested aggressively in
what seemed to be an endless, virtuous fortune. Every IPO was a chance
to get richer. Like the Californian gold rush of the 1840s, anywhere you
dug you found gold.
All along, the gigantic capital gains which were being generated
concealed a sub-optimal, overly regulated IPO process. Contrary to
popular belief, the market correction which started in November 2005 did
not bring about a dry-up of deals – there was about as many of them in
2006. However, it was accompanied by a wave of public offering
disappointments: deals barely subscribed, and leverage costs
overshadowing early trading gains.
Today we see increasing hope of resurgence in IPO activity, and we feel
it is the right time to “go back to basics” – understanding the subtleties,
inner workings and flaws of the Emirati IPO process. In particular, are
local public offerings an efficient money-raising instrument? Do they
warrant appropriate valuations? Who benefits from them? How do they
contribute to the re-distribution of public wealth?
The objective of this piece is to make sense of the UAE IPO process, and
to understand ways in which it should evolve. We dedicate the last part to
making seven recommendations for a “better IPO world”.
July 3, 2007 | 04
 The rise and fall of Emirati IPOs
Table 2: UAE initial public offerings since 1995
Sub. Sub. Shares Issue price Offer % Over
List IPO Total raised Lead
Issuer Market open Close offered per share size Equity sub- Eligibility
date type US$ (m) manager
date date (m) AED (m)* US$ (m) offered scrip
Deyaar DFM 6-May-07 16-May-07 n/a 3,178 Primary 1.02 866 55% 14 12,123 Shuaa/MFC GCC
Air Arabia DFM 18-Mar-07 27-Mar-07 n/a 2,567 Primary 1.02 699 55% 1.5 1,049 Shuaa All
DFM DFM 12-Nov-06 23-Nov-06 7-Mar-07 1,600 Secondary 1.03 436 20% 308 134,278 DB All
Gulf Navigation DFM 24-Jul-06 7-Aug-06 7-Feb-07 910 Primary 1.02 248 55% 3.5 868 Shuaa GCC
Arkan ADSM 6-May-06 16-May-06 8-Jan-07 858 Primary 1.25 292 49% 7.5 2,189 HSBC UAE
Tamweel DFM 27-Feb-06 8-Mar-06 10-Jul-06 550 Primary 1.02 150 55% 484 72,479 TNI All
DU DFM 4-Mar-06 13-Mar-06 22-Apr-06 800 Secondary 3.03 660 20% 167 110,207 EFG UAE
Sorouh ADSM 22-May-05 6-Jun-05 20-Dec-05 1,375 Primary 1.01 375 55% 176 65,940 TNI/FGB UAE
Dana Gas ADSM 20-Sep-05 3-Oct-05 6-Dec-05 2,006 Primary 1.01 561 34% 140 78,512 HSBC n/a
Aabar ADSM 9-Apr-05 21Apr-05 19-Nov-05 495 Primary 1.02 135 55% 800 107,816 TNI UAE
RAK Properties ADSM 30-Mar-05 12-Apr-05 30-Oct-05 1,100 Primary 1.01 299 55% 57 17,070 NBAD GCC
Taqa ADSM 23-Jul-05 1-Aug-05 10-Sep-05 600 Secondary 1.00 163 14% n/a n/a NBAD UAE
Aramex DFM 3-Mar-05 12-Mar-05 13-Jul-05 550 Primary 1.02 150 55% 80 11,979 TNI/Shuaa All
Finance House ADSM 10-Apr-04 22-Apr-04 27-Jun-05 110 Primary 1.00 30 55% 75 2,250 TNI n/a
AGTHIA ADSM 27-Dec-04 13-Jan-05 10-May-05 294 Secondary 1.03 80 49% 8 640 HSBC/ADIC UAE
Aldar ADSM 30-Oct-04 26-Nov-04 5-Apr-05 825 Primary 1.03 225 55% 448 100,710 TNI/ADIC UAE
Arabtec DFM 14-Aug-04 23-Aug-04 5-Jan-05 220 Primary 1.01 60 55% 65 3,900 Shuaa All
Dubai Islamic Ins. DFM 19-Oct-02 31-Oct-02 20-Jul-04 3 Primary 10.30 9 55% 5 45 DIB UAE
Amlak DFM 18-Jan-04 28-Jan-04 21-Mar-04 413 Primary 1.00 112 55% 34 3,808 Shuaa All
National Gen. Ins. DFM 2001 n/a n/a n/a Primary n/a 9 55% 0.81 7 EFS n/a
Manasek OTC 1998 n/a n/a n/a Primary n/a 15 55% 6 90 TNI n/a
Int. Fish Farming ADSM 1998 n/a n/a n/a Primary n/a 45 55% 1 45 TNI n/a
Tabreed DFM 1998 n/a n/a n/a Primary n/a 75 55% 5 375 TNI n/a
AD Islamic Bank ADSM 1997 n/a n/a n/a Primary n/a 150 55% 19 2,850 TNI n/a
Oasis Int. Leasing ADSM 1997 n/a n/a n/a Primary n/a 75 55% 6 450 TNI n/a
July 3, 2007 | 05

AD Shipbuilding ADSM 1995 n/a n/a n/a Primary n/a 11 55% 5 55 TNI n/a
Total 729,735
Source: Zawya, Reuters, TNI Investment Research
*Share issue price including all issuance costs and premia

“Western” IPOs are driven
by offer and demand
Proposed valuation is based
on the market price of, and
appetite for, similar assets
Price adjustment is possible,
depending on the appetite of
the market
The issuer and his advisor
remain masters of the timing
The UAE IPO process is unique
A reminder on Western IPO practise
Not all mature markets have the exact same IPO rules and procedures.
For instance, there may be slight differences in the way public offerings
are conducted in Europe versus the United States. However, they share
the same underlying principle: the appetite and the timing for the capital
raising are determined by the market.
Market-defined valuation
A Western company in need of capital for its growth goes to the public,
asking for financing. The offering price is based on a valuation range for
the company, which is proposed by the placing agent (usually an
investment bank) in consultation with the issuer.
Such valuation is normally based on prevailing market conditions, and on
the pricing given by the market to comparable assets. Ultimately, the
market may “refuse” a proposed valuation, by deciding not to bid for the
asset at the offered price. Generally however, every effort is made by the
issuer and its placing agent to propose an “acceptable” price range.
Book-building as an offer-supply balance check
Once the offering price-range is determined, the company goes to the
market via a book-building process. An under-subscribed book often
means that the offered price of the asset is too expensive, and vice
versa. In most cases, there is room to adjust the final issue price within
the range (and sometimes outside the range), after the close of the book
and in response to market feedback.
Timing at the issuer’s choice
Throughout the process, it is understood that the issuer as well as its
advisor (the placing agent or investment bank), are total masters of the
timing. It is the issuer, with the advice of the investment bank, who
decides when to offer the shares. The issuer is therefore entirely free to
opportunistically choose the timing of his stock offering.
Underwriting to mitigate risk
Stock offerings may comprise total or partial underwriting, where the
advising bank guarantees purchase on its books of a portion of the deal.
This ensures the issuer that the underwritten portion will be taken up by
the bank, regardless of market demand for the remaining portion. The
bank, on the other hand, exchanges a balance sheet risk with the
possibility of greater profitability. It “intermediates” the placement
transaction.
July 3, 2007 | 06
 The UAE IPO process is unique
Chart 1: The UAE IPO process

Approach File application with Regulator approves or IPO announced in local

ESCA for regulator including 1 – 2 months rejects application and 1 – 6 months newspapers and
approval to valuation valuation prospectus released
file

At least
5 days
Normally 10 days
14 days (Previously 21 (Must be between 10
and 30 days) and 90 days by law)
Shares allocated and Subscription Subscription
surplus funds returned closes opens

1 week –
2 months

Company holds Company obtains official At company’s

first AGM for Up to 1 month incorporation approval from discretion Company files listing
official ESCA and economic application with
incorporation department ESCA

Up to 3
months

Company lists on 10 days Publish financial Listing application

stock market statements and board of accepted by ESCA, admin
directors’ report in local processed and time of
newspapers listing decided
July 3, 2007 | 07

Source: TNI Investment Research

Note: Timings based on historical evidence and publicly available information – May be subject to change at ESCA’s discretion

IPO valuations have been
approved by the Ministry of
Economy
There has been no market
consultation on price
IPO timing has also been
controlled by the Ministry
Underwriting is an important
missing link
The UAE IPO process is unique
Four major differences with the “West”
The UAE IPO practise is similar to that of other Gulf countries. It bears
significant differences with the West, however.
Regulator-defined valuation
Firstly, the valuation of a company going public has historically been
approved by the Ministry of Economy, and has essentially been based on
accounting value rather than an assessment of market value. This has
recently changed, and the Emirates Securities and Commodities
Authority (ESCA) currently allows the valuation to be determined by an
accounting firm (usually one of the “Big 4”), but insists on vetting it and
has the ability to impose a counter-valuation.
No book-building
Secondly, while there has historically been a book-building period during
public offerings in the UAE, it has generally been an invitation to
subscribe at the offered conditions, but not a consultation with the
market. In other words, local book-buildings have seldom (if ever) aimed
at fine-tuning the offered price. The assumption has naturally been that
“any IPO will fly”. Indeed, until the Gulf Navigation IPO, every IPO made
its issuer and subscribers substantially richer.
Timing at the regulator’s choice
Thirdly, while the IPO pipeline is constituted of companies filing with the
ministry for floating authorisation; such authorisations have largely been
at the discretion of the Ministry. In other words, the timing of the IPOs has
been artificially driven, not market driven. One of the reasons why the
Ministry has tried to constrain the supply of IPOs is to regulate the market
– fears that multiple issues coming to market simultaneously might drag
the markets lower, through a liquidity squeeze.
No underwriting
Finally, UAE IPOs have essentially been a direct offering exercise
between the issuer and the market. This is to say that there has been no
underwriting to date. Underwriting is an important missing link, because it
would allow specialised institutions to intermediate the IPO process, and
to share the upside and the risk.
Minor differences also exist
Going deeper into the detail, one might find further particularities to UAE
IPOs.
July 3, 2007 | 08

Four particularities of UAE
IPOs make them resemble
European privatisations
The UAE IPO process is unique
No sell-down of shares
To date and to the exception of privatisations such the DFM IPO, no
company going public has been authorised to sell down any of its shares,
and the IPO has essentially been a capital raising exercise. The
regulation allows companies to finance their growth, but not existing
managers to take profits along the way. While this may stem from a good
intention to provide stable shareholding, it also discourages
entrepreneurs who are no longer free to monetise their stakes.
No Greenshoe
A related issue to the lack of underwriting is the inexistence of a
Greenshoe, or over-allotment option. Such option is a provision which
allows the underwriters to put together a stabilisation mechanism, with
the agreement and participation of the issuer. Typically, 15% of the total
deal size offered to investors is reserved as a supplementary capital
increase to cushion strong under/over-subscriptions and their potential
impact in the secondary market.
Founder Shares as lock-up proxies
The current UAE regulation demands, in most cases, that a company
going public lists at least 55% of its capital. The remaining, privately-held
45% must belong to a special type of investors called “Founders”. The
latter are meant to be core long-term shareholders, hence the regulatory
lock-up on their stake, which spans two Ordinary General Meetings
(OGMs) post-IPO – roughly two years.
On paper, this is the equivalent of a traditional lock-up on the stakes of
company insiders. In reality, founder shares constitute a separate class of
shares which are tradable OTC between founders only, generally at a
discount to the listed price. Becoming a founder in a UAE corporation is
considered to be a privilege. However, it is unclear if such privilege is
related to the status of core shareholder, or to the knowledge that such
shares have generally traded at improbable premia to IPO prices (up to
22 times).
IPOs that look like European privatisations
Taking a step back and looking at UAE IPOs reveals a few important
takeaways:
1 The regulator defines the IPO framework and has a hands-on
approach throughout the listing process;
2 The timing of the application to the money-raising exercise may
correspond to a genuine corporate financial need, but the allocation
of IPO authorisations by the regulatory authorities seem to be
managed with wider, macro-economic objectives in mind (investor
protection, market stability and proper wealth distribution);
3 The IPO pricing, which is controlled by the regulator, has empirically
been verified to be significantly lower than the prevailing market
July 3, 2007 | 09
 The UAE IPO process is unique

value of the asset. This has created unprecedented investment

opportunities to subscribers;
4 Special tranches have traditionally given preferential allocation to
UAE nationals, or to employees of the firm being taken to market.
Roughly 25% of IPOs (mostly privatizations of government
institutions such as DFM) had special tranches for company
employees and/or civil servants. Of the IPOs open to foreign
investors, one-third had preferential tranches.

With the four particularities above, UAE IPOs increasingly look like the
privatisations which have historically taken place in Europe. As is
generally documented, the principal aim of such privatisations is to raise
money for the government while keeping in mind broad macro-economic
objectives.

Historical reasons for such differences?

Four reasons explain the Multiple reasons explain the particularities of UAE IPOs:
difference between Western
1 The process is quite young. The first formal IPO took place in 1995
and UAE IPOs, most of
and the Commercial Law regulating IPOs dates back to 1984;
them are related to the
country’s history 2 The UAE market characteristics during the early days of local IPOs
were different from now, and much different from any Western
market mechanism. They needed a specific IPO framework, which
looks outdated when applied to the current markets;
3 The process currently in place has proven right until 2006. After all,
every IPO was indeed flying, and everyone was making too much
money to even question the process – if it ain’t broke, don’t fix it;
4 It appears that the government also sees its mission as one of
proper wealth distribution, guidance and protection of minority rights.
After all, this market has been largely retail driven, with most IPO
subscribers to date having very little stock market or financial
education. We have seen instances where some investors believed
that the nominal share price provided a stock’s valuation. In other
words, a stock listing at AED 3 would be understood to be more
expensive than a stock listing at AED 1, hence the psychological
importance of listings at AED 1.

The UAE are changing fast. The UAE are emerging fast and having to deal with a significant amount
It is now time to make of change, across the board and in a very short period of time. It is
“recommendations for a difficult to implement all changes at once. However, the Great Correction
better IPO world” is now behind us, and we have a large number of operational and
regulatory modifications under our belt. The new Companies Law is
under way. We feel that today is the right time to look at improvements in
the IPO market. We make “recommendations for a better IPO world” at
the end of this piece. But first, let’s take a closer look at the advantages
and drawbacks of UAE IPOs.

July 3, 2007 | 10
 SWOT of the current IPO system

We feel that the best way to understand properly the advantages and
drawbacks of the UAE IPO process is to lay down a SWOT analysis
(Strengths, Weaknesses, Opportunities and Threats), as per the table
below.

Table 3: SWOT analysis of the UAE IPO process

Strengths Weaknesses
Protection of retail investors: The subscription and Valuation gap: Ministry-defined valuation has resulted in
allocation methods imposed by the regulator are favourable distortions to the real prices of listed assets. While this may
to retail investors. have helped some people get richer faster, we believe this
may also have provoked the bubble and ensuing
correction.
Protection of banks: The regulation and lack of Pre-funding: The obligation by the subscriber to physically
underwriting has created an opportunity for banks to pay the amount of his subscription to the receiving bank
generate substantial profits with very little risk. has created much feared “liquidity drains”, which have
weighted on the markets.
Capital markets driver: The IPO boom has allowed a very Timing uncertainty: Because the timing of issuance is
fast and significant development of UAE capital markets. controlled by the Ministry, corporate finance needs are not
being catered to in the most appropriate way. A company
seeking market financing could be delayed by up to one
year.
Micro-economic driver: The focus by the Ministry on No sell downs: Companies are only allowed to raise new
capital raising (as opposed to sell-downs) has allowed the capital and not allowed to sell down. This has often lead to
proliferation of greenfield businesses, thus pushing overcapitalised companies.
renewed economic dynamism into the economy.
Lower issuance fees: In the absence of underwriting, Outdated Companies Law: As explained earlier, the law
fees to the issuer are low compared to Western practise. dating back to 1984 no longer captures the current market
We believe such fees to be in the region of 1% of total needs, and needs a long awaited overhaul.
deal size.
No underwriting: The lack of underwriting means a lack of
intermediation. This translates into a skewed distribution of
risk and reward, notably resulting in very high profitability to
receiving banks with very little balance sheet risk.
Over-regulation: The government’s initial intent to protect
the investors has resulted in a sub-optimal process, driven
by forces other than offer and demand. Those who stand
most to gain are no longer the subscribers.

Opportunities
Regulatory overhaul: Most of the weaknesses and threats
highlighted can be readily addressed, with the appropriate
regulatory changes. We cover those in detail in the last
section of the report.
Attracting foreign institutional investors: Admittedly,
the best way to significantly enhance local market
standards is to provide a sound investment platform to
foreign institutions. This needs straight-forward, transparent
procedures. Again, regulatory change is key.
Threats
Financial leverage: The leverage extended by banks is a
direct consequence of the flawed IPO process. The latter
has created an economic opportunity (high profitability at
low risk), in which banks are naturally engaging.
Liquidity drain: This is a direct consequence of pre-
funding and the resulting leverage extended by banks. It
creates significant, artificial volatility and constitutes a very
significant threat to local markets.

Source: TNI Investment Research

July 3, 2007 | 11

The most universal reason
to go public is to raise
capital, in order to finance
the growth of an existing
business
In the UAE, IPOs have been
used to finance start-ups
and to get rich faster
By early 2006, start-ups had
disappeared from the IPO
pipeline
SWOT of the current IPO system
The immediate SWOT analysis takeaway is that weaknesses outweigh
strengths. This results in a significant volatility risk, best illustrated by the
“liquidity drain” scenarios, which have been highly speculated about by
the market in the past.
On the other hand, the opportunity to overhaul and rationalise the
process remains very much intact, and depends entirely on the regulator.
We have grouped the above items into four topics, discussed below.
Going public for the wrong reasons
Corporations go public for many reasons – from gaining corporate
visibility to monetising a stake, creating acquisition currency or changing
ownership. The most common and obvious reason for going public,
however, is to raise capital in order to finance the growth of business.
In some circumstances – such as the dotcom bubble or the “UAE
bubble”, companies have resorted to IPOs to raise initial capital. The
purpose is no longer to finance the growth of an existing concern, but
rather to finance a greenfield operation on the basis of a strong business
model and economic prospects. As we have seen with the dotcom era,
starting up businesses with IPOs is not a sustainable trend.
Table 4 illustrates the start-up trend in the UAE. Between late 2004 and
early 2006, business and stock market confidence were such that one-
third to one-half of all IPOs was new ventures. We have distinguished
between the “Legal” and “Commercial” definition of brown/greenfield. The
former corresponds to a new legal structure hosting an already existing
business. The latter corresponds to a new legal entity hosting a brand-
new commercial activity.
Du, the alternative mobile telecoms operator, is an unambiguous
example of greenfield or start-up operation – one year after the listing of
its shares on the DFM, the company was yet to launch its mobile
network. Air Arabia represents a typical brownfield IPO (an existing
company going to market to finance its growth). Aabar is an example of a
legal start-up which acquired existing commercial assets (Delma Energy).
We suspect that the unbelievable amounts raised in a very short period of
time have encouraged UAE business-owners to get into “IPO mode”,
regardless of the fundamental need to raise money – in other words,
going public just to get rich, or richer.
Since the deflation of the UAE stock market bubble, the market seems to
be back to a more reasonable trend. Most of the IPOs which we have
seen since mid-2006 are by companies with established businesses
looking to finance the growth of their commercial operations. By early
2006, start-ups had disappeared from the IPO pipeline, mostly because
the regulator had decided to prevent them from coming to market.
July 3, 2007 | 12
 SWOT of the current IPO system

Table 4: IPOs classified

Brownfield / Brownfield / Fair value or Fair value or
Subscription Listing Government
Issuer name greenfield greenfield Book value book value
period date or private
(Legal)* (Commercial)* (Legally) (Commercial)
Deyaar May 07 n/a Private Brown Brown Fair Fair
Air Arabia Mar 07 n/a Government Brown Brown Fair Fair
DFM Nov 06 7-Mar-07 Government Brown Brown Fair Fair
Gulf Navigation Jul-Aug 06 7-Feb-07 Private Brown Brown Fair Fair
Arkan May-06 8-Jan-07 Government Brown Brown Fair Fair
Tamweel Feb-Mar 06 10-Jul-06 Private Brown Brown Book Book
DU Mar 06 22-Apr-06 Government Green Green Book Book
Sorouh May-Jun 05 20-Dec-05 Private Green Green Book Book
Dana Gas Sep-Oct 05 6-Dec-05 Government Green Green Book Book
Aabar Apr 05 19-Nov-05 Private Green Brown Book Book
RAK Properties Mar-Apr 05 30-Oct-05 Government Green Green Book Book
Taqa Jul-Aug 05 10-Sep-05 Government Brown Brown Fair Fair
Aramex Mar 05 13-Jul-05 Private Green Brown Book Fair
Finance House Apr 04 27-Jun-05 Private Green Green Book Book
AGTHIA Dec 04 -Jan 05 10-May-05 Government Brown Brown Fair Fair
Aldar Oct-Nov 04 5-Apr-05 Private Green Brown Book Book
Arabtec Aug 04 5-Jan-05 Private Green Brown Book Fair
Dubai Islamic Ins Oct 02 20-Jul-04 n/a n/a n/a n/a n/a
Amlak Jan 04 21-Mar-04 Private Brown Brown Fair Fair
National Gen. Ins. 2001 n/a n/a n/a n/a n/a n/a
Manasek 1998 n/a n/a n/a n/a n/a n/a
Int. Fish Farming 1998 n/a n/a n/a n/a n/a n/a
Tabreed 1998 n/a n/a n/a n/a n/a n/a
AD Islamic Bank 1997 n/a n/a n/a n/a n/a n/a
Oasis Int. Leasing 1997 n/a n/a n/a n/a n/a n/a
AD Shipbuilding 1995 n/a n/a n/a n/a n/a n/a
Source: Zawya, TNI Investment Research
* Legal refers to the structure of the entity. Commercial refers to the underlying business operation. A greenfield, or new, company by
Legal standards may have no underlying business operations, in which case it is also a Commercial greenfield.

The re-distribution of private wealth

The way in which public issues are brought to market today in the UAE
suggests that a re-distribution of wealth is taking place, away from micro-
economic fundamentals. We understand that the initial purpose behind
this was to protect individual investors.

The example of Aramex

Aramex is a freight and logistics company which was incorporated in
1982. When it decided to go public in the UAE, the purpose was clearly

July 3, 2007 | 13

Aramex is the example of a
shift away from micro-
economic fundamentals
By over regulating, the
regulator has brought more
serious issues to the market
SWOT of the current IPO system
identified: raising money in order to engage in a far-reaching expansion
program via acquisitions. However, due to the prevailing UAE regulation,
the company could only sell primary shares at book value (par).
This effectively allowed new shareholders to come into the capital
structure of the firm at a comparable cost to that of the historic owners of
the business, who had invested years of hard labour into creating value
for themselves. It would have resulted in stealing hard-earned capital
creation from the legitimate owners of the business, only to distribute it to
the IPO subscribers. Such re-allocation of private resources is unseen,
even in the most radically socialist of European countries, and was
clearly unacceptable to Aramex. Ultimately a start-up was created and
taken public, only to acquire the Aramex assets at market value.
This is a situation where the regulator was overly concerned about
protecting investors, to the point of distorting micro-economic
fundamentals by forcing a re-distribution of private wealth. It sheds some
light on one of the major flaws of the UAE Companies Law which
regulates IPOs: by wanting to ensure a sound IPO process, the regulator
has over-regulated and brought about other, more serious issues.
Pre-funding and the wealth-transfer diagram
In a Western-type IPO, the wealth transfer process is very easy, and
results in the company cashing-in the value of the shares it sells to
subscribers. Net proceeds to the company are the result of the sale of
shares at a given price, less advisory fees. Presumably, the company
gets a reasonably accepted market price for the shares it sells.
Chart 2: Wealth transfer during Western IPO process
Subscribers /
shareholders
Shares Cash
Issuer Fees Investment
bank
Source: TNI Investment Research
July 3, 2007 | 14
 SWOT of the current IPO system
Chart 3: Wealth transfer during UAE IPO process

Loan
Subscribers /
Commercial banks shareholders

Interest + loan repayment

Over-
Subscription to subscribed
IPO funds
Issuer Capital raised returned

Interest earned in money Receiving

market banks
IB Fees

Subscribed
Subscribed amount +
amount interest

Investment
bank Money market (money
held here for 15 – 30
days)

Source: TNI Investment Research

July 3, 2007 | 15

High leverage situations are
due to the combination of
pre-funding and order-book
inflation
Leverage hikes subscription
costs. Over-leverage is a
result of a flaw in the
valuation process
Corporations have lost value
to banks and founders,
during UAE IPOs
SWOT of the current IPO system
In the UAE, the process is made more complicated by pre-funding, which
is the legacy system of a retail-driven financial market. It essentially
stems from issuers wanting to remove any counterparty risk from
defaulting retail subscribers, who initially place an order in the IPO book
but do not honour the payment on due date.
The consequence of pre-funding is that any subscription to a deal results
in currency physically changing hands – from investors to banks to
issuer, and back. In addition, when combining order-book inflation (quite
a common practise to help increase allocation in hot deals) with pre-
funding, the demand for leverage by investors soars.
Commercial banks, which are often the same as receiving banks, will
meet the demand for leverage and lend money to subscribers at a flat
rate which accrues to the lending bank. In addition, the receiving banks
will invest the (large) cash amount of the subscription in short term
deposits over 14 days (down from 30 then 21 days), which will accrue
interest to the issuer (Chart 3).
The net result of pre-funding is a gigantic transaction cost to the
subscriber, sometimes representing as much as half the total amount
raised by the issuing corporation. We argue that if subscribers are ready
to increase their subscription cost by multiples of the initial AED 1 unit
price, then the issuing company is getting so much less per share on the
stock it issues.
This comes as a confirmation that the valuation process is flawed, and
that wealth is being transferred away from the issuing corporation and
subscribers, to the banks.
Risk and reward are skewed
Throughout the process, we believe that two categories of financial
market participants have had to face larger risk and lower reward than
they were entitled to, while two other categories have had it all good –
high reward with little risk.
Who are we kidding?
Corporations have lost value
Corporations have issued stock at a price which was historically met by
very large subscriptions. This suggests that issuers could have obtained
a higher price for their stock, should they have tested market appetite
beforehand. In other words, the differential between the nominal issue
price and the net subscription price (after leverage costs) could have
been cashed-in by corporations via a higher issue price. Instead, this
wealth was transferred to lending banks and, to some extent, founders.
July 3, 2007 | 16

Subscribers have overpaid
and taken undue risk in UAE
IPOs
Due to pre-funding, banks
have been able to make a
lot of money at little risk
SWOT of the current IPO system
Today, as the ESCA allows third-party valuations by auditing firms, we
continue to believe that two reasons stand in the way of corporations
maximising the market price of their shares: 1/ the valuation exercise
remains theoretical and is not completed by a consultation with potential
investors, and 2/ the IPO process remains largely driven by the regulator
rather than market forces, which may divert wealth from its normal
economic destination.
Subscribers have born the financial risk
For historical reasons discussed earlier, public issues have mostly come
to market with a nominal subscription price of AED 1. In reality, the
subscription price has very seldom (if ever) been as little as that.
Systematic leverage has always driven the cost much higher (as we will
illustrate in the DFM case study). In addition, subscribers have run the
risk of seeing the deal fare badly, with opening prices below their
subscription cost.
In short, we believe that the combination of pre-funding and leverage has:
1/ significantly increased subscription prices to investors, 2/ encouraged
investors to take very large, undue personal financial risk, and 3/ has
generally resulted in individual investors taking the risk on behalf of the
lending banks, and paying for such risk. We argue that historically,
individual subscribers have overpaid for their share of the IPOs.
Who are we protecting?
Tons of cash for the banks
Commercial banks have had a structural, natural interest in the UAE IPO
business, due to the abnormally high profits historically generated to
them by such stock issues.
The role of banks in IPOs has been two-fold: 1/ leveraging their network
by reaching to the millions of end retail investors and 2/ processing the
very large number of deal subscriptions. Their other, optional role has
been to lend money to individuals desperate to get a chunk of the IPO
allocation.
Presumably the lending business is a risky one – if your client becomes
insolvent, you lose your capital. In the particular case of UAE IPOs, and
considering the levels of leverage (up to 100 times), a subscriber would
lose a lot on a sour deal, and the banks would consequently be risking
significant capital.
The trick is that lending banks have also often been receiving banks for a
deal, which means they have had visibility over the IPO book. In such a
case, it is easy to calibrate the aggregate level of leverage extended to
subscribers, to the level of over-subscriptions – Whatever happens, you
get back your capital, on aggregate!
July 3, 2007 | 17
 SWOT of the current IPO system

In summary, due to the pre-funding regulation, UAE banks have been

given phenomenal opportunities to make very large amounts of money
from IPOs, at very little risk.

The more leverage, the The self-fulfilling prophecy of the Founders

more profits founders stand Founders have also historically been treated with financial respect. As
to make they gained the critical status, they were guaranteed to be able to
purchase up to 45% of company shares at book value, and to contribute
this in kind to the IPO. The remaining 55% would be raised from the
public. Thinking that they were acquiring shares at AED 1, subscribers
would leverage themselves to get allocation, which would result in a
higher unit cost and opening price for the shares. In fact, the more
leverage is extended by the banks, the more profits founders stand to
make!

Leverage is breaking the market

Leverage extended by banks has mobilised extraordinary amounts of

cash during IPOs. For example, Du was 167 times over-subscribed and
mobilised a total of USD 110bn. DFM, with an over-subscription of 308
times, collected USD 134bn.

Table 5: Liquidity drain

Subscription Subscription Offering size Over- Total raised
Issuer
open close US$ (m) subscription US$ (m)
Arabtec 14-Aug-04 23-Aug-04 60 65 3,900
Aldar 30-Oct-04 26-Nov-04 225 448 100,710
AGTHIA 27-Dec-04 13-Jan-05 80 8 640
Aramex 3-Mar-05 12-Mar-05 150 80 11,979
RAK Properties 30-Mar-05 12-Apr-05 299 57 17,070
Aabar 9-Apr-05 21-Apr-05 135 800 107,816
Sorouh 22-May-05 6-Jun-05 375 176 65,940
Taqa 23-Jul-05 1-Aug-05 163 n/a n/a
Dana Gas 20-Sep-05 3-Oct-05 561 140 78,512
Tamweel 27-Feb-06 8-Mar-06 150 484 72,479
DU 4-Mar-06 13-Mar-06 660 167 110,207
Arkan 6-May-06 16-May-06 292 7.5 2,189
Gulf Navigation 24-Jul-06 7-Aug-06 248 3.5 868
Dubai Financial Market 12-Nov-06 23-Nov-06 436 308 134,278
Air Arabia 18-Mar-07 27-Mar-07 699 1.5 1,049
Deyaar 6-May-07 16-May-07 866 14 12,123
Total 719,760
Source: TNI Investment Research, Zawya

July 3, 2007 | 18

Such huge leverage must
have impacted the country’s
liquidity, let alone the stock
market
Three parameters make up
a liquidity drain
The simultaneous IPOs of
Du and Tamweel caused the
DFM to dip by 15%
Investors went as far as
arbitrating the liquidity drain
SWOT of the current IPO system
Stock market participants (including individual and institutional investors,
corporations and banks) have been understood to liquidate their positions
shortly before a placement, in order to be able to subscribe in larger size.
Consequently, the aggregate selling has created “liquidity drains” on the
exchange, prior to public issues. In fact, the numbers are so large that we
believe they must have had an impact on the country’s liquidity not just
on the stock market.
We have not seen any prior hard evidence of such liquidity drains, and
have decided to test this hypothesis ourselves. To this end, we graphed
the aggregate daily turnover of the ADSM and DFM, along with the index
prices since July 2004. We then identified and added the IPO
subscription periods and historic refunding dates of the over-subscribed
amounts, for every issue which took place since mid-2004.
Any evidence of liquidity drain would be verified by the simultaneous
advent of the following events: 1/ a decrease in market turnover around
subscription times, 2/ a dip in the market around subscription times, and
3/ a volume pickup after the refund. The result is visible in Chart 4.
Liquidity drain is clearly visible
Most of the time, the conjunction of the three factors defined above has
indeed taken place, making the liquidity drain easily visible on the chart.
The following periods in particular, have been quite spectacular: April,
May, July, and September 2005, August and December 2006. However,
the most impressive in terms of market impact remains February/March
2006, when the Tamweel and Du subscription periods overlapped,
causing the DFM to dip 1,034 points (-15%).
In other instances, when investors felt that the potential allocation in a
given deal was going to be too small, they went as far as arbitrating the
liquidity drain. In other words, they would wait for a market dip
subsequent to a liquidity drain. When they felt the dip had reached a
satisfactory level, they would buy some of the most liquid names in the
market and wait for a technical rebound, post IPO-refund.
Some impressive examples of liquidity drain
Next, we zoom-in on issues which have drawn particular interest, either
highlighting a particularly visible liquidity squeeze, or showing a surprising
lack thereof. Market impact is generally more visible on DFM than ADSM.
The charts are classified by chronological order of listing. The impact on
the smaller, zoom-in charts may seem less dramatic than on the larger
chart due to the effect of re-basing.
July 3, 2007 | 19
 SWOT of the current IPO system
Chart 4: UAE IPO liquidity drain analysis, July 2004 to April 2007

550 4,000

500
3,500
11

450

3,000
7
400 5
9
2,500
350

AED (m)
300 2,000

250
1,500
12
6
200 15

1,000
13
150

2 4
3 14 500
100 6 11
1
1 2 3 4 5 7 8 9 10 12 13 14 15
50 0
Jul 04 Sep 04 Nov 04 Dec 04 Feb 05 A pr 05 May 05 Jul 05 Sep 05 Oct 05 Dec 05 Feb 06 Mar 06 May 06 Jul 06 A ug 06 Oct 06 Dec 06 Feb 07 A pr 07

Daily turnover, RHS Turnover during subscription period, RHS DFMGI rebased, LHS A DSM, rebased, LHS IPO ref und dates, RHS

Source: TNI Investment Research, Reuters, Zawya

July 3, 2007 | 20

Numerical Key:
1/ Arabtec, 2/ Aldar, 3/ AGTHIA, 4/Aramex, 5/ RAK Properties,
6/ Aabar, 7/ Sorouh, 8/ Taqa, 9/ Dana Gas, 10/ Tamweel,
11/ DU, 12/ Arkan, 13/ Gulf Navigation, 14/ DFM, 15/ Air Arabia
 SWOT of the current IPO system

Chart 5: Aldar liquidity drain analysis Chart 6: Aabar liquidity drain analysis
175 1,500 4,000
250

1,200 3,200
155
210

900 2,400

AED (m)

AED (m)
135
170
600 1,600

115 130
300 800

95 0 90 0
13 Sep 04 6 Oct 04 30 Oct 04 1 Dec 04 27 Dec 04 25 Jan 05 22 Feb 05 17 Mar 05 10 A pr 05 7 May 05 30 May 05 38526

Daily turnover, RHS Turnover during subscription period, RHS Daily turnover, RHS Turnover during subscription period, RHS
DFMGI rebased, LHS A DSM, rebased, LHS DFMGI rebased, LHS A DSM, rebased, LHS
IPO ref und date, RHS IPO refund date, RHS

Source: TNI Investment Research, Reuters, Zawya Source: TNI Investment Research, Reuters, Zawya

Chart 7: Dana Gas liquidity drain analysis Chart 8: Tamweel liquidity drain analysis
160 4,000 4,000

110

3,200 3,200
140

2,400 95 2,400

AED (m)
AED (m)

120

1,600 1,600

80
100
800 800

80 0 65 0
2 A ug 05 25 A ug 05 19 Sep 05 12 Oct 05 8 Nov 05 1 Dec 05 31 Dec 05 2 Feb 06 26 Feb 06 21 Mar 06 15 Apr 06 8 May 06

Daily turnover, RHS Turnover during subscription period, RHS Daily turnover, RHS Turnover during subscription period, RHS
DFMGI rebased, LHS ADSM, rebased, LHS DFMGI rebased, LHS ADSM, rebased, LHS
IPO ref und date, RHS IPO ref und date, RHS

Source: TNI Investment Research, Reuters, Zawya Source: TNI Investment Research, Reuters, Zawya

Chart 9: Du liquidity drain analysis Chart 10: DFM liquidity drain analysis
105 4,000
4,500
105

3,200
3,600

95
90 2,400
2,700
AED (m)

AED (m)

1,800 1,600
85
75

900 800

60 0 75 0
12 Jan 06 7 Feb 06 2 Mar 06 26 Mar 06 19 Apr 06 13 May 06 17 Sep 06 15 Oct 06 19 Nov 06 18 Dec 06 23 Jan 07

Daily turnover, RHS Turnover during subscription period, RHS Daily turnover, RHS Turnover during subscription period, RHS
DFMGI rebased, LHS ADSM, rebased, LHS DFMGI rebased, LHS ADSM, rebased, LHS
IPO ref und date, RHS IPO refund date, RHS

Source: TNI Investment Research, Reuters, Zawya Source: TNI Investment Research, Reuters, Zawya

July 3, 2007 | 21

Not every situation has
created a liquidity squeeze
Weak markets seem to be
more prone to liquidity
drains
At least seven reasons
highlight the flaws of the
UAE IPO system
It is the regulation which
creates undue stock market
volatility
SWOT of the current IPO system
Some counter-examples exist
Aldar was 448 times over-subscribed and mobilised over $100bn in cash.
Surprisingly however, the market and turnover kept rallying throughout
the subscription period, showing no sign of liquidity squeeze.
Similarly, there was no visible market impact from the Aabar IPO despite
its record size ($107.8bn), subscription level (800x), and the fact that it
overlapped with RAK Properties (total cash subscribed of $17bn). Others
like Arabtec, Aramex, Emirates Foodstuff and Mineral Water, and RAK
Properties had no visible impact on the market.
Generally, we notice that the first real liquidity drain impacts took place in
mid-2005, towards the end of a phenomenal market rally. Hence the
question of the correlation between market levels/activity and the liquidity
drain issue.
We conclude that liquidity drains are a reality. They are mostly created by
the need for IPO pre-funding, and would be avoided in the case of post-
funding. They are also more likely to happen when market sentiment is
weak, therefore requiring a re-allocation of resources rather than the
injection of fresh money into a new issue.
An inefficient money-raising instrument
Going public should help successful corporations raise money in order to
sustain and expand their businesses. In the UAE however, the purpose
has been different. In addition, government control of issuance timing has
made it difficult for companies to obtain additional capital in a timely
fashion when they needed it.
We take a rather harsh stand on UAE IPOs and conclude the following:
1 Most companies have gone public for reasons not directly related to
the micro-economic fundamentals of growing their business;
2 For the most part, IPOs have been perceived in the UAE as extra-
ordinary liquidity events providing windfall profits;
3 IPOs have been somewhat inefficient as a money-raising instrument
for corporate finance purposes;
4 The IPO process has been overly regulated;
5 The re-distribution of IPO wealth may have taken value away from
some market players;
6 Protection of individual investors may have not worked properly.
Other entities may have been better treated than retail investors;
7 Leverage and liquidity drain are the result of the regulatory pre-
funding.
July 3, 2007 | 22

Regulatory change is on its
way, but remains muted
In depth regulation changes
are now needed
SWOT of the current IPO system
For a long time, the UAE regulator has been directly involved in the public
issues, with the Ministry of Economy approving the timing and valuation
of IPOs. Recently, this power has officially been transferred to the ESCA.
Although we believe the Ministry still has indirect operational input, this is
definitely a step in the right direction – letting an independent authority
regulate capital markets.
However, this remains largely insufficient in light of the regulator’s will to
make regional stock market investment more institutional. We believe
that the time has now come for serious, in-depth regulation change. We
make our recommendations for such change in the latter part of this
report. Nonetheless, UAE IPO performance has been quite impressive to
date, but also reserves some surprises to he who analyses its
performance!
July 3, 2007 | 23

It looks like the sky is the
limit, but where does the
limit really lie?
The best IPO performance
comes from subscribing,
and selling at the open
Secondary performance has
been disappointing, up to
one year after listing
Unprecedented UAE IPO boom
Over the past few years, regional retail investors have repeatedly flown
from across the GCC to the UAE, in order to subscribe in person to “hot
issues”. In the short lifetime of our research department, we have come
across IPO situations which seemed at best unreasonable – limitless
profitability assumptions, infinite banking leverage, and crazy over-
subscription rates. This has triggered our curiosity: what has IPO
performance effectively been like, and what has historically been the best
strategy for investing in IPOs?
Impressive performance
We have looked at the details of all IPO listings since 1995, and have
calculated their performance against issue (subscription) price, over
multiple periods up to one year.
One major conclusion comes out of this exercise: the best, absolute
performance was historically achieved by subscribing to the IPO and
selling at the open, on the first day of trading. Such a strategy has
historically yielded an average return across issues of 366%, nearly five
times the investment – significantly above any administrative or leverage
cost.
Disappointing after market
Another, less obvious conclusion, concerns the secondary life of UAE
stocks. In aggregate and on average across the universe that we have
analysed, IPOs have consistently been in negative performance territory
for one year after listing.
Chart 11: Average, absolute market and IPO performance post listing
25%
15%
5% 1D 1W 1M 3M 6M 1Y
-5%
-15%
-25%
Market perf ormance IPO perf ormance
Source: TNI Investment Research
Note: The performance compares each IPO’s opening price on the first day of trading to
the closing price at each period end - D Day, W Week, M Month, Y Year
July 3, 2007 | 24
 Unprecedented UAE IPO boom

This absolute performance snapshot is pretty bleak, particularly if one

takes into account the corresponding market performance – on a relative
basis, IPOs have under-performed their reference markets by up to 50%.

Chart 12: Average IPO performance post listing, relative to market

1D 1W 1M 3M 6M 1Y
0%
-3.2% -3.6%
-10% -5.0% -5.8%

-20%
-21.4%
-30%

-40%

-50%
-49.1%

Source: TNI Investment Research

Note: The performance represents the aggregate average of the sample. Each sample
constituent was compared to the relevant market benchmark (ADSM or DFM).

No more steam

These IPOs are for flippers,
and their performance is
eroding
The main takeaway from the above is quite straight-forward: investors
who fared best are the “IPO flippers” who subscribed only to sell on the
first day of trading. They could also do it in large scale, since bank
leverage was widely available, and would cost a fraction of the capital
gains.

But as the great UAE boom turned into a major bust, this translated into a
significant loss of IPO steam. Chart 15 below presents all known IPOs in
chronological order and appears quite explicit: since 2005, the profitability
of new issues has dropped significantly and consistently.

July 3, 2007 | 25
 Unprecedented UAE IPO boom

Chart 13: IPO performance on first day of listing

DFM 144%

Gulf Navigation 20%

Listing in 2007
Listing in 2006
A rkan 40% Listing in 2005
Listing in 2004
Tamw eel 194%

DU 124%
IPOs by chronological order of listing

Sorouh 563%

Dana Gas 321%

A abar 459%

RA K Properties 296%

Taqa 780%

A RA MEX 361%

Finance House 1500%

A GTHIA 583%

A l Dar 533%

A rabtec 215%

Dubai Islamic Ins. 45%

A mlak Finance 46%

0% 350% 700% 1050% 1400%

Source: TNI Investment Research

Note: Performance is the opening price on the first day of trading against the share
subscription cost (including issuance costs)

Watch out! You can now As a matter of fact, potential short term capital gains from IPOs have
lose money with UAE IPOs decreased to the point of making them dangerous: any leveraged IPO
investment today runs the risk of making investors lose money. In order
to illustrate this point, we have taken a closer look at the DFM IPO in the
next section. Below we present for reference a table summarising both
absolute and relative performances of all IPOs.

July 3, 2007 | 26
 Unprecedented UAE IPO boom
Table 6: Absolute and relative performance of IPOs post listing
1 Day 1 Day 1 Week 1 Week 1 Month 1 Month 3 Month 3 Month 6 Month 6 Month 1 Year 1 Year
Issuer
Abs Rel Abs Rel Abs Rel Abs Rel Abs Rel Abs Rel
DFM -6% -6% -16% -14% -15% -6% 29% 23% n/a n/a n/a n/a
Gulf Navigation 6% 6% 2% 3% -3% -1% -9% -4% n/a n/a n/a n/a
Arkan -10% -8% -24% -20% -34% -29% -34% -27% n/a n/a n/a n/a
Tamweel -6% -5% 3% 4% -2% 1% 62% 50% 40% 45% n/a n/a
DU -9% -7% -12% -6% -15% 4% -26% 0% -3% 14% -22% 11%
Sorouh 0% 1% -10% -8% -9% -7% -24% -7% -43% -12% -62% -20%
Dana Gas 0% 2% 18% 21% 12% 18% -24% -5% -45% -14% -64% -17%
Aabar -10% -9% 6% 10% -9% -1% -32% -14% -51% -11% -56% -11%
RAK Properties 0% 0% -11% -13% 2% 3% -13% 0% -47% -16% -57% -21%
Taqa -10% -10% -15% -14% -32% -34% -37% -39% -61% -43% -68% -37%
ARAMEX -15% -13% -15% -13% -16% -21% 13% -15% 36% 3% -32% -5%
Finance House -10% -9% -31% -29% -34% -17% 20% 28% 9% 22% -38% 2%
AGTHIA 10% 9% -11% -10% -21% -17% -45% -26% -44% -41% -77% -36%
Al Dar 2% 3% 8% 9% 41% 30% 37% 27% -7% -6% 23% 35%
Arabtec 0% 0% 17% 13% 8% 9% 41% 5% 46% -98% 49% -137%
Dubai Islam Ins 0% 0% 10% 9% -4% -2% -8% -20% -9% -77% 26% -248%
Amlak Finance -8% -7% -28% -27% -10% -28% -1% -34% 8% -66% 68% -155%
Average -4% -3% -6% -5% -8% -6% -3% -4% -12% -21% -24% -49%
Source: Reuters, Zawya
Note: Performances are measured against share opening prices on the day of listing. Relative performance is against the index of the home market.
July 3, 2007 | 27

There was much anticipation
before the DFM IPO
Over-subscription was very
high, but the stock opened
at relatively unimpressive
levels
DFM is the most visible
signal that the days of easy
money are long gone
The DFM case study
The end of easy money?
In November 2006, the long-awaited IPO of Dubai Financial Market
(DFM) was initiated. At the time of the deal, visible anticipation was
heightened by three factors: 1/ renewed appetite for share issues after a
long period with no deals, 2/ the perceived high quality of the issuer and
its belonging to the Dubai government, and 3/ the unusually large size of
the deal.
Sure enough, the result was an over-subscription multiple of 308 times
for the general tranche. This was less than the maximum ever achieved
by Aabar (800 times), but certainly a lot considering the size of the
offering (AED 1,600m or USD 436m). With all this hype, the outcome was
relatively unimpressive, as the stock opened at AED 2.51 and ranged
between AED 2.22 and AED 2.60 on the first day of trading. Furthermore,
the stock reached its lowest historical level of AED 1.89, only 8 calendar
days after listing.
Considering the large amounts of leverage extended by the banks in this
transaction, we argue that many investors may have lost money in the
deal. In our opinion, the days of easy money – characterised by
systematic and significant capital gains at the IPO open – are long gone,
and DFM is the most visible sign of that.
Unsurprisingly, the waning of the IPO cycle has corresponded with two
very interesting trends: 1/ a surge in fixed income issues to replace equity
financing, and 2/ a very significant increase in regional private equity
activity – moving up the value chain in order to sustain profitability.
You shouldn’t have subscribed!
Our argument, that some investors have lost money in the DFM IPO
trade, is based on our understanding of the mechanic and economics of
subscribing to the deal. Our analysis is limited to the public tranche (55%
of the offering), and excludes the preferred tranche (including Dubai
government employees, retired UAE nationals from Dubai, DFM
accredited brokerage companies, DFM-listed companies and Dubai
government-owned companies).
Subscribing was easy
Subscribing was quite easy and in line with other, earlier company listings
in the UAE. All it took, as per the prospectus, was for the subscriber to go
to a receiving bank, fill a form, and submit it along with a check and
passport copy. In addition, due to the high visibility of DFM, there was a
record number of receiving banks (17 of them), which made it all the
more easy.
July 3, 2007 | 28
 The DFM case study

The process was slightly different for someone wishing to invest with
leverage, as one had to have an open account with the receiving bank.
Upon acceptance of the loan, the latter was credited to the account and
simultaneously debited towards the subscription. Due to the large number
of receiving banks, and to the length of the subscription period from
November 12 to 23, we believe the necessity to have an open account
with a receiving bank did not come in the way of subscribing.

The subscribed, unallocated amount was reimbursed fully on December

10, 2006 by crediting the account of the borrower with the receiving bank.
Some delays to this deadline may have been experienced, where
investors have subscribed indirectly through brokers, and where
reimbursement checks were involved.

Borrowing was easier

Banks financed generously
principal and fees, at a flat
rate
Receiving banks also loaned money at a negotiable, fixed rate for the
duration of the deal, in this particular case one month. The lowest rate we
have heard of in this transaction was a flat 35bp, although we believe a
more normal rate must have been 50bp. In addition to lending
subscription money, banks also offered to finance the 3% subscription
fee.

Table 7: Net DFM unit subscription price calculation

Item Unit Amount
Assumptions
Nominal price per share Dh 1.00
Commission per share Dh 0.03
Initial Capital Dh 1,000.00
Leverage factor x 1.00
Amount borrowed Dh 1,060.00
Cost of debt % 0.35%
Over-subscription x 308
Allocation factor % 0.32%

Calculation
Initial Capital Dh 1,000.00
+ Amount Borrowed 1,060.00
- Nominal Cost of Debt 3.71
= Capital available for investment 2,056.29
÷ Nominal price per share incl. commission 1.03
= Total shares subscribed 1,996
x Allocation 0.32%
= Total shares allocated 6.48

July 3, 2007 | 29
 The DFM case study

x Nominal price per share incl. commission 1.03

+ Nominal Cost of Debt 3.71
= Nominal amount paid for my shares 10.39
÷ Total shares allocated 6.48
= Net price paid per share 1.60
Source: TNI Investment Research, DFM Prospectus

Our central scenario of 50bp
financing and 10x leverage
brings the DFM unit price to
AED 2.48, a flat trade at
best
As was the case in a number of earlier IPOs, leverage ratios reached
dizzying heights. In some instances, banks would lend the full
subscription amount – meaning 100% financing. In our unit-price
calculation illustration (Table 7), we take the example of a 1/1 leverage.
We show that an individual investing AED 1,000 and borrowing the same
amount against a 35bp interest rate, would achieve a net subscription
price of AED 1.60 per DFM share.

This, however, is not our central scenario. We believe that financing costs
have averaged a higher 50bp, with leverage reaching on average a
multiple of 10 times. Under such conditions, the unit subscription price
rises to AED 2.48, turning the DFM IPO into a flat trade. Because readers
may have other cost calculation assumptions, we have included the
sensitivity table below.

Table 8: Sensitivity of DFM subscription unit-price to leverage and interest paid

Cost of leverage
0.30% 0.35% 0.40% 0.45% 0.50% 0.55% 0.60% 0.70%
1 1.52 1.60 1.68 1.77 1.85 1.93 2.01 2.18
Leverage, factor of initial

2 1.68 1.78 1.89 2.00 2.11 2.21 2.32 2.54

3 1.75 1.87 1.99 2.11 2.24 2.36 2.48 2.72
4 1.80 1.93 2.06 2.18 2.31 2.44 2.57 2.83
capital

5 1.83 1.96 2.10 2.23 2.37 2.50 2.63 2.90

10 1.90 2.05 2.19 2.34 2.48 2.63 2.77 3.07
20 1.94 2.09 2.24 2.40 2.55 2.70 2.86 3.16
30 1.95 2.11 2.26 2.42 2.57 2.73 2.88 3.20
50 1.97 2.12 2.28 2.44 2.59 2.75 2.91 3.22
100 1.98 2.13 2.29 2.45 2.61 2.77 2.93 3.24
Source: TNI Investment Research

Leveraged, trading investors lost most

Clearly the best way to make money in this trade was to subscribe
without leverage – but with a tiny resulting allocation, yielding insignificant
nominal capital gains. Leveraged investors who have held onto their
shares, may still have managed to make handsome profits as the shares
currently trade above AED 3.00.

July 3, 2007 | 30

Banks must have generated
on aggregate AED 600m to
1bn in interest from the IPO!
Revenues to banks totalled
about half the total deal size,
according to us…
… and the credit risk taken
was minimal. It’s time for
regulation change
The DFM case study
However, we argue that all in all, it would have been a better choice not
to subscribe, and to pick-up the shares on the market after listing. In
addition, we repeat our argument that the hey-days of “subscribe-and
cash-in” are gone. In the future, cashing-in will certainly require some
more investment skill. Nevertheless, the DFM IPO was a success… but
for whom?
For whom the bell tolls
As discussed earlier in our SWOT Analysis, one breed of financial-market
participants has historically had all the benefits. This continues to be the
case, as DFM proves once more.
Big bucks for the banks
Banks seem to be the big winners in this trade. Consider the numbers:
the public tranche represented 680 million shares and was over-
subscribed 308 times. At a net subscription price of AED 1.03, this means
that AED 215bn were mobilised by local banks. If the lending multiple
was 10/1 and average interest stood at 50bp, the local banks must have
generated interest revenues of AED 975m in the space of one month –
some USD 265m! Our most conservative estimate would place this figure
at AED 600m, still a very generous amount – Too generous?
Let’s look at this from another angle: interest revenues of USD 165m to
265m (depending on your scenario) represent 38% to 61% of the total
size of the deal, to be split between 15 banks who are taking minimal
credit risk. Now compare this to the traditional 2% to 5% investment-
banking fee billed by underwriting banks, who take the stock-market risk
of lodging issuer shares on their balance sheet.
How much risk has such remuneration entailed? A common argument is
that lending banks are often also receiving banks. As they take
subscriptions from clients, they have visibility over the IPO books. Banks
can therefore adjust their lending limits in real-time, in order to ensure
that they are always, on aggregate, lending with no risk.
We conclude that in the UAE, and more generally in the region, the
remuneration of banks in the process of IPOs has been
disproportionately large compared to the risk they have assumed. Such
profits have led strong volatility in the financial accounts of regional
banks, as the markets boomed then busted.
Clearly, UAE IPO revenues generated by commercial banks have
resulted in windfall profits, which by any accounting definition are
unsustainable. As a matter of fact, with the advent of more reasonable
deals such as the Air Arabia IPO, we are probably at the dawn of a new
era – time for IPO regulation change?
July 3, 2007 | 31
 The DFM case study
Chart 14: DFM IPO – Timeline of events

4,600 3.5

November 12
4,500 Beginning of book-building:
Books open to 3.3
subscription
4,400
3.1

4,300 March 7
Listing 2.9
date
4,200
2.7

4,100
2.5
4,000 January 16
December 10 Constituent
A llocation General Meeting 2.3
3,900 announcement and
excess f und
reimbursement 2.1
3,800
November 23
End of book-
3,700 1.9
building:
Books closing

3,600 1.7
Nov 06 Nov 06 Dec 06 Jan 07 Feb 07 Mar 07 Apr 07 May 07 Jun 07

DFM General Index DFM stock

July 3, 2007 | 32

Source: TNI Investment Research, Reuters

 The way forward

To date, the best year for IPOs seems to have been 2006, at arms’ length
with 2005. 2006 saw six deals come to market with a very decent
average size of AED 1.1bn, and the largest ever aggregate amount
raised of AED 6.55bn. In reality, if we consider aggregate money raised,
there does not seem to be a slowdown from the market bust. 2007 is off
to a very good start, and promising to exceed the preceding year for total
deal size.

Chart 15: Historical IPO pipeline, measured by the year in which funds were raised

8,000 8
7
6,000 6
5
AED (m)

4,000 4
3
2,000 2
1
0 0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
YTD

Total amount raised, LHS Number of deals, RHS

Source: TNI Investment Research, Bloomberg, Zawya

Consequences of the market slowdown

The market correction has had no visible impact on aggregate, nominal

IPO activity. This may due to two factors:
1 The real GDP of the UAE continued to grow at a stunning rate of
+9.7%;
2 Time management of IPOs by the regulatory authorities may play a
role in smoothing out the cycle. In other words, in the absence of
pipeline control by the regulator, we could have had more deals
come to market in 2005 (no bottleneck), less deals in 2006, and
significantly more in 2007.

Most surprisingly, the market slowdown has had retrospectively little

impact on corporations. Companies not only continue to show significant
growth, they are also engaging in significant outbound M&A activity,
buying an increasing number of foreign assets.

July 3, 2007 | 33
 The way forward

Chart 16: UAE M&A activity

80,000

60,000
AED (m)

40,000

20,000

0
2001 2002 2003 2004 2005 2006 2007

Inbound Outbound

Source: Thomson Financial

We argue that the single, most visible impact of a stock market slowdown
could be the significant boom of debt issuance – as companies continue
to grow and the stock market loses steam, debt issuance soars. In 2006,
debt issuance reached a record AED 69.7bn in the UAE.

Chart 17: Total debt raised by UAE companies and governmental bodies

75,000 75

60,000 60
AED (m)

45,000 45

30,000 30

15,000 15

0 0
2001 2002 2003 2004 2005 2006 2007

A mount rais ed, LHS Number of deals , RHS

Source: Bloomberg Note: 2007 figure is up to 23 May 2007

The contra-cyclical nature of bond issuance is best illustrated in the graph

below.

Chart 18: Debt vs. equity raised by UAE institutions

8,000 80,000

6,000 60,000
AED (m)

AED (m)

4,000 40,000

2,000 20,000

0 0
2001 2002 2003 2004 2005 2006 2007 Y TD

Equity issuanc e (IPOs ), LHS Debt issuanc e, RHS

Source: TNI Investment Research, Bloomberg, Zawya

July 3, 2007 | 34
The way forward

The pipeline is still generous

Notwithstanding the glitches in the IPO process and the recent market
correction, the IPO momentum is still good and share issuance is back in
fashion. The visible IPO pipeline summarised below shows no less than
13 deals expected in 2007 alone, with another 8 being “whispered” for the
same year. It is based on market talk, not on our proprietary information.

Table 9: Expected IPO pipeline

Company Name Expected

Expected
Al Nahda International Education Sep-07
Al Qudra Holding Q3/07
Palm District Cooling Q4/07
Emirates Post Q4/07
Dubai Ports World Q4/07
RAK Petroleum 2007
Damas Jewellery 2007
Dubai Bank 2007
Abu Dhabi Holding 2007
International Petroleum Investment 2007
Nakheel 2007
Rasmala Investments 2007
Showtime Arabia 2007
Middle East Broadcasting 2008
Rotana Hotel Management 2008
Damac Holding 2009

Whispered
Abu Dhabi Vegetable Oil 2007
Abu Dhabi Securities Market 2007
Al Shafar Industries 2007
Crescent Standard Investment Bank 2007
DEPA United 2007
Emirates Central Cooling Systems 2007
Future Pipe Group 2007
Varkey Group 2007
Dubai Aerospace Enterprise 2008
Al Mansoori Specialized Engineering 2008
M'Sharie 2008
Source: Reuters, Zawya

July 3, 2007 | 35
 The way forward

The pipeline expected by Such numbers are obviously quite aggressive, of course. In light of timing
the market provides many control by the regulator, and the fact that we have only seen two deals so
more years of IPO activity far this year, it is unlikely that we will see as many deals as is expected
by the market. However, we believe the IPO pipeline to be “fat” enough to
provide for multiple more good years ahead.

There is evidence that we The recent history of this market tells us that indiscriminate, systematic
are moving towards more subscription to IPOs will no longer provide the exceptional returns that we
reasonable, more mature have seen in the past. Going forward, we believe a sound method would
IPO practises be to invest based on valuations and fundamentals.

Finally, as we have started seeing with the more recent transactions, we

are bound to see sustained, albeit more reasonable IPO activity in the
future. As we progressively move from book valuation to market valuation
for stock issuance, we expect to see over-subscription levels decrease
significantly, and come more in-line with those of other, more mature
markets.

July 3, 2007 | 36
 Seven recommendations for a “better IPO world”

As we highlighted The IPO process as we have known it in the UAE was probably a good
throughout this note, more one at inception. Considering the growth of the market however, this is no
regulatory change is needed longer the case. Below we detail what we believe are the necessary
changes to make the process more adequate for the UAE market, going
forward.

Increased transparency and
disclosure, as well as
reduced volatility are a must
In particular, we aim at recommending changes which, in our opinion, will
increase transparency and disclosure in order to reduce market volatility
and risk to the retail investors. We are also quite eager to see market
forces at play, because we believe this is a necessary step towards more
efficient markets.

Less but more appropriate
regulation is needed
In our previous publications about quarterly results publications, we have
repeatedly recommended more, harsher regulation – in order to force
corporations to comply with better disclosure requirements. When it
comes to IPOs, we firmly believe that less, but more appropriate
regulation is needed.

Stopping the liquidity drain

Post-funding will stop We believe that pre-funding combined with leverage creates market
liquidity drains, reduce distortions, in the form of liquidity drains which increase market volatility.
volatility and institutionalise In order to avoid such incidence in the future, the market needs to see
the market the occurrence of either leverage or pre-funding, but not both at once.
This can be achieved by implementing one of the three solutions below:
1 Allowing pre-funding but legally restricting leverage, by imposing a
legal leverage cap to banks.
2 Allowing pre-funding but ensuring flat allocations, in the purest form
of European privatisations. Investors who are informed about the
allocation cap will be pre-funding the deal, but will not be tempted to
increase dramatically (unreasonably) their subscription.
3 Implementing post-funding, in particular by transferring any credit
risk to the banks who would subscribe on behalf of their customers.

All three solutions have virtues. However, our recommendation would be

to favour the third, for many reasons. Firstly, it simplifies the regulatory
framework by easing the regulation. Secondly, it re-attributes more
naturally the roles of economic agents. In particular, it imposes on banks
to bear the credit risk, which is presumably what banks know best how to
do. Thirdly and most importantly, it institutionalises the business by
intermediating the market - encouraging subscriptions to be channelled
through financial institutions.

July 3, 2007 | 37

Founder’s shares are
inefficient lock-up proxies.
Proper lock-ups are required
Sell-downs would allow to
reduce the size of deals and
increase their number
They would also allow more
appropriate capitalisation
Less stringent free-float
restrictions would increase
market depth
Seven recommendations for a “better IPO world”
Ensuring proper lock-ups
Currently the lock-up on the stakes of the founders are only theoretical:
on paper they last very long (two general assemblies post listing). In
reality, founder shares consist in another class of shares which are
effectively tradable OTC. This means that founders are by no means
locked-up in the proper sense of the word. They can sell their shares at
another founder, and at a discount to the market price. In addition, there
is no disclosure requirement when a founder sells his/her stake, which
makes it difficult to monitor insider trading.
We recommend implementing a proper, shorter lock-up which will prohibit
original shareholders of the business to sell before the expiration of a
specific period. In addition, such shareholders would own regular shares,
and would need to comply with strict disclosure rules.
Authorising sell-downs
It is currently impossible for owners of a business to sell any of their
existing shares during an IPO process. Rather, IPOs are reserved for
capital increases. This severely restricts the purpose of an IPO, as well
as the profitability opportunities for local entrepreneurs. Allowing sell-
downs means business owners can monetise some of the value they
have added over the years, thus allowing a fairer allocation of private
resources.
In addition, allowing existing shareholders to sell down a portion of their
stake would mean allowing a mix during the IPO, between the issuance
of primary shares and the selling of secondary shares. Because IPOs
today are systematically (and by law) constituted of a 55% capital
increase, this has inflated deal sizes beyond the real financing needs of
corporations.
Allowing existing shareholders to sell down would therefore mechanically
and significantly reduce the average IPO size, and increase
proportionately the number of deals. Finally, it would allow companies to
be appropriately capitalised, as opposed to the current status of structural
over-capitalisation.
Decreasing the minimum allowed free-float
This is a topic which has been discussed and rumoured for some time, as
it is expected that the new Companies Law will allow private companies
to sell a minimum, minority stake of 30% as opposed to the current 55%.
This has not yet transpired formally into the regulation, however. The
reason why this is important is because many businesses need raise
capital in order to finance their growth, but few are willing to give up
majority control. Reducing the minimum float would encourage more
businesses to come to market, thus participating in greater depth,
breadth – and ultimately liquidity – for the market.
July 3, 2007 | 38
 Seven recommendations for a “better IPO world”

Allowing underwriting
Underwriting should be In an effort to impose more institutionalisation, we believe the regulator
imposed, in order to improve should impose underwriting. This would allow intermediating the market.
deal pricing as well as the In other words, it would force a professional intermediary to step-in
risk/reward of market between the investor and the issuer, namely investment banks. On the
participants face of it, this would probably increase the cost to the issuer by way of
higher fees. In reality, it would allow the issuer to obtain a more relevant
issue price for his stock than is currently the case – raise money under
better terms.

The net impact, in our opinion, would be positive for corporations. It

would also allow a better pricing of market risk (by professionals) and
increased consultation with investors. Ultimately, the price as well as the
risk/reward ratio would make more sense to everyone.

Book-building with value-added

Current book-building simply allows potential investors to walk to the
bank and subscribe to a given public issue. Such public issue is generally
offered at a fixed, non-negotiable price.

Book-building also allows
better pricing of deals
We are advocates of price ranges and market consultation, which allow
the issuer to test the market for a given price. Such a practise often
results in adjustments to price ranges (up or down, either within or
outside a range). It also allows the issuer to gain a certain degree of
confidence, and to minimise mis-pricing mistakes.

In our opinion, this practise will inevitably become necessary, as the

market matures. It also requires more institutionalisation and market
intermediation – while it may be feasible to get feedback from institutional
investors, it is difficult to obtain the same from retail investors.

Pre-filing should be done by the banks

Banks would take a load off
the regulator by being given
the responsibility to screen
their own deals
One detail in the IPO process consists in pre-filing with the regulator. It
consists in providing basic preliminary information, for the regulator to
make an early due-diligence and approve the file. We believe this
process consists in filtering the deals, in order to ensure a sufficient level
of quality and a minimal level of risk for the investors.

As the market becomes more institutional in nature, we believe that the

regulator will be able – to some extent – to delegate this task to the
financial intermediary. After all, why not provide minimum requirements
for investor protection and let the banks take the risk of choosing and
advising the issuer. If the banks make good choices of issuers and
pricing, their deals will fly. Otherwise, they will be punished by the market.

July 3, 2007 | 39
The National Investor
st
TNI Tower, Zayed the 1 Street, Khalidiya
P.O. Box 47435 – Abu Dhabi, UAE
T: +971 2 619 2300
F: +971 2 619 2400

www.tni.ae