Revisiting Dubai (S)Inc.

News of Dubai World asking for a six-month reprieve on $60 billion in debt repayments has sent global financial markets into a downfall not seen in many months. It should not have: The Emirate's troubles are not a surprise -- many observers, including ai5000, have been warning of trouble at Dubai World for months now.

I traveled to Dubai and the Gulf in March of this year on assignment for ai5000, reporting on the state of the Emirate in relation to its neighbors and in absolute terms for our first cover story, entitled "Dubai (S)Inc." What I found was shocking: meeting with numerous sources within Istithmar World (the state-owned private-equity arm of Dubai World) and other Dubai sovereign investment vehicles, it was clear to me that Dubai was in much greater trouble than its government was letting on. The bankers I met with were clearly frightened but putting on a happy face. However, my Dubai World sources -- agreeing to meet only in dark restaurants and on the sly, for fear of being spotted in Dubai's surprisingly limited social scene -- were much more pessimistic.

A sample:

"It's real bad," Karim says. "Istithmar needs money fast or they're going to close shop. Technically, our parent company" -- Dubai World, the umbrella group that holds Dubai's publicly earmarked money, as opposed to the Sheikh's personal funds housed in Dubai Holdings -- "needs the cash. They owe the interest on a lot of non-negotiable debt, and the easiest way to get that money is to cut staff and sell assets." Staffers also say that Istithmar's equity stakes were funded by loans, not cash -- a structure reminiscent of American subprime mortgages, where the mortgager's equity stake was often another loan -- and thus it must service even more debt than a typical private-equity firm. Istithmar's CEO, American David Jackson, a Lehman Brothers and Saks Fifth Avenue alum who joined the firm in 2004, has acknowledged that the fund must return money, but he has downplayed the seriousness of any redemption. Jason and Karim laugh aloud at Jackson's public stance on recapitalization: "Who would want to give us money?" Jason asks, laughing.

I can see why many people -- reporters, businessmen, tourists, and foreign government officials -- failed to see this. Flying into the Emirate is a shocking experience. The pure scale of its buildings, of islands literally built in the shape of palms or a map of the world, are awe-inspiring and (metaphorically) blinding. How could something of this size and scope be in trouble? How could a country build the world's tallest tower and fail to adequately plan to pay for it? The fact is, just as many (or most) failed to foresee the equity bubble, so too did the masses fail to understand that Dubai -- oilless, leveraged, and extravagant -- was a blueprint for trouble everywhere.

It's sadly clear now that we were correct in our dire predictions for Dubai and its growth strategy. What ai5000 will be doing now -- as, I suspect, will the rest of the world -- is looking for other institutions where the financial markets and players have glossed over the fact that extreme leverage is no longer tenable. The first to come under scrutiny will be the financial institutions that lent to Dubai World; the second, I suspect, will be other sovereign wealth vehicles. For the sake of the global economy I hope that we find nothing similar to the Emirate's business plan and hubris. This wish, however, might be as vain as building an entire city on debt.