Dubai's Shuaa Capital issues 250m shares; DBG won't take them

This might sound a bit wonk-ish, but in the world of finance, it doesn't often get as dramatic as this: today, Shuaa Capital, an investment bank in Dubai, said it issued 250m shares to Dubai Banking Group to make good on a Dh1.5bn convertible bond. Then, get this: DBG said it wouldn't take them. The Dubai Financial Market agreed with DBG, saying it wouldn't put the shares in DBG's name until an agreement was reached by both parties. The Emirates Securities and Commodities Authority went along, too, saying the shares should not be issued.

Oh, boy. So here's the backstory:

Way back in October of 2007, Shuaa Capital issued a Dh1.5bn convertible bond to DBG at 6 per cent interest, mandatorily convertible into 250m Shuaa shares after a year. In layman's terms: DBG gave Shuaa Dh1.5bn and said, "Hey, you can pay us back by giving us shares in your company, because your stock price is doing well and might do even better."

Now, when Shuaa issued the bonds, Shuaa's stock was trading at Dh6.71. Multiply that by 250m shares and you get Dh1.68bn. In other words, if the bonds had been immediately converted into shares when they were issued, DBG was looking at a nice little profit of roughly Dh180m. It gave Shuaa Dh1.5bn and was getting shares worth Dh1.68bn (yes, it would have been less because of share dilution, but that's an issue to be explored separately). Simple enough.

From this it's easy to see that DBG would be making money on the conversion as long as Shuaa shares trade at above Dh6 (Dh1.5bn divided by 250m shares equals Dh6). If they go lower, DBG would lose money. Higher, and DBG makes even more money.

Meanwhile, during the year between October 31, 2007 and October 31, 2008, when the bond was to mature, DBG would receive quarterly interest payments at an annual rate of 6 per cent. That's another Dh90m right there. Cha-ching, right?

Well, sort of. DBG doubtlessly made a reasoned bet when it bought its Dh1.5bn in bonds from Shuaa: financial markets were still rock-solid in late 2007 and showed no signs of tottering anywhere near the edge of a precipice.

Enter the financial crisis. In August 2008, just three months before the bonds were set to convert into shares, Shuaa's share price dipped below the Dh6 threshold. And they kept going down. By October 31, Shuaa shares were trading at Dh2.7, which meant that DBG's Dh1.5bn investment was worth Dh675m in shares (again, not taking dilution into account).

Naturally, DBG didn't want the shares; it wanted its Dh1.5bn back. It's impossible to know what went on behind closed doors in the months following the bond's maturity last October, but it's pretty safe to say that DBG wasn't satisfied with a quarter of a billion Shuaa shares, and refused to accept a conversion. Legal issues were likely raised, with DBG claiming the bond was not a mandatory convertible and Shuaa firing back that it was. The companies agreed in November to put the issue on hold while Shuaa brought compromise proposals to its shareholders.

Through the first half of this year, that's exactly what Shuaa did. It went to shareholders and asked for permission to negotiate with DBG and settle the issue, perhaps by reducing the Dh6 strike price, an option that would have given DBG a smaller loss and a bigger stake in the firm on conversion. They also could have formally extended the bond by up to two years, letting DBG keep the bonds on its books and hope for a rise in Shuaa stock.

The companies kept up negotiations through the early part of this year, extending deadlines for a final agreement twice. In the end, though, it appears that DBG just wanted its money back and wasn't willing to accept much less than that.

So today, Shuaa just decided to go ahead and issue its 250m shares, which the company felt it had a legal right to do. And then DBG said, well, no. We don't want them; we want the money.

It was a dramatic wrinkle in what has become one of the biggest and most public donnybrooks among Dubai's struggling financial firms. Of course, it also highlights the sneaky ways in which the financial crisis is affecting the financial calculus of the UAE. When share prices go down, we tend to think that investors lose money. But we often forget that those declines can also affect the tangled web of deals and securities that are linked to them, of which Shuaa's bond is just one example.

I'll be posting a timeline on Shuaa in a bit, in case you want the blow-by-blow. Stay tuned.