The fall of Arabtec; market opportunity or threat?
In September 2020, Arabtec Holdings, one of the largest construction companies in the Gulf Cooperation Council (GCC), declared bankruptcy, which was a result of rising debt and continuous losses. This piece looks at the events that led to the collapse and what the consequences of this liquidation could be for the industry in the region.
Significant management changes leading up to the collapse
Founded in 1975, Arabtech Holdings is one of the leading construction players in the GCC, having built some of the most famous landmarks in the UAE - Burj Khalifa (the world’s tallest building) in Dubai and the Louvre in Abu Dhabi. Arabtec was also the first private construction firm to be listed on the Dubai Financial Market in 2005. In 2010, in the aftermath of the global financial crisis and economic downturn in Dubai, Arabtec shifted its focus to winning work in new markets but struggled to diversify away from Dubai and find traction in Saudi Arabia.
In February 2013, Jordanian businessman Hasan Ismaik was appointed CEO of Arabtec, replacing the founder after 38 years as CEO. He replaced the company’s management and pledged that Arabtec would be one of the world’s 10 largest construction companies by 2018. Subsequently, the company’s share price soared from less than AED in 7.90 per share in December 2013 to AED 25.98 in May 2014.
However, in June 2014, weeks after he officially became Arabtec’s largest shareholder, Ismaik resigned as CEO. Much of Arabtec’s senior management was fired in the months that followed, while share prices more than halved and major shareholders changed. The company, which was valued at about AED 30 billion (USD 8.2 billion) at its peak in May 2014, was valued at just AED 0.8 billion on 30th September 2020, falling by 60% YoY when it was suspended from the market. As a result, Arabtec’s share price has consistently underperformed the Dubai Financial Market Index.
Global Data’s MEED reported that in the four years since Ismaik’s departure, the company has undergone additional changes in its senior leadership and further restructuring, but, in a declining regional construction market, none have been able to turn around the loss-making contractor.
Mounting losses and unfinished projects led to bankruptcy
Arabtec reported an AED 849 million (USD 231 million) loss for 2019, a substantial decline compared to the AED 257 million (USD 70 million) profit reported in 2018, as a result of a rise in direct costs amidst falling revenues. The company had posted AED 794 million (USD 216 million) in losses in 1H 2020, with total accumulated losses of AED 1.64 billion (~USD 446 million). Analysts report that the company had around AED 5 billion (~USD 1.36 billion) in receivables as of June 2020, warning that banks and creditors would find it difficult to recover losses from liquidation.
Backed by sovereign wealth fund Mubadala, Arabtec’s single largest shareholder is Aabar Investments, while another 15% is held by retail investors. At the time of the shareholders’ vote in September 2020, the company had over USD 18 billion worth of projects under construction, as calculated by MEED, with 22 projects underway (including the Calatrava-designed Pavilion for Expo 2020). Its Mechanical, Electrical and Plumbing (MEP) division, Efeco, had 15 projects under execution and its Engineering, Procurement and Construction (EPC) subsidiary, Target Engineering, had 13 projects in progress, worth a combined USD 13 billion. The company had over 45,000 employees in 2018 but has been cutting costs since 2019 and had just over 40,000 at the time of the liquidation announcement.
Bloomberg reports that many had been hopeful that Arabtec or its shareholders would come up with the funds to see it through to the end of 2020. The company revealed this possibility in its financial statements for 1H 2020, stating that “A stakeholder had previously committed to make available adequate financial support to ensure business continuity of the Group as a going concern for a period of 12 months till June 2021.” However, those funds failed to materialise, pushing the company towards liquidation in September 2020. Arabtec’s demise follows a spate of corporate failures in the UAE. Abu Dhabi-based NMC collapsed in April 2020 with debts of USD 6.8 billion, amid claims of fraud and mismanagement. According to Century Financial, NMC Healthcare stated that it is continuing to function well despite bankruptcy proceedings.
Owing to the inter-dependencies of certain subsidiaries of Arabtec, the application to the Competent Courts also request that Arabtec Construction, Arabtec Constructions, Austrian Arabian Readymix Concrete Company and Arabtec Precast are expected to simultaneously go through insolvent liquidation. In December 2020, Arabtec stated that it had hired two advisory companies (Lumina Capital Advisors and deNovo Corporate Advisors) to sell some of its subsidiary companies as well, including Arabtec Engineering Services and Target Engineering.
According to industry sources, Arabtec was vital to the GCC’s economy, due to its status as the go-to contractor for infrastructure projects, high-profile work in the residential, commercial and oil & gas contracting space. Its collapse has now no doubt undermined investor confidence in the region’s constriction industry.
Key subcontractors face possibility of bad debts
Arabtec’s liquidation adds to the chaos of the subcontractors who are already facing crisis from the pandemic. When Carillion (the British construction giant) went into mandatory liquidation in 2018, the contagion effect left players along the supply chain with unpaid bills, forcing other subcontractors and suppliers into bankruptcy. The Chairman of the law firm Abdulla Alawadi & Associates notes that, “the supply chain is obviously going to be very concerned not just about whether they’re going to get paid, but the status of their own bonds and performance guarantees etc.”
According to Alawadi, subcontractors will have to either wait for a liquidator's appointment or apply to register a lawsuit according to the contract with the competent judicial authority to decide whether the settlement is done through regular litigation or arbitration. Once the liquidation process becomes official (there will be an ad in an official gazette), all debtors would need to register their debt with the administrator/liquidator appointed by the Dubai Financial Market.
Arabtec’s subcontractor, Nasdaq Dubai-listed interior fit-out giant Depa PLC (Depa), is awaiting clarity on the impact of Arabtec’s liquidation, being a material trading partner to Depa with a USD 22 million exposure. The company revealed that this would have a material impact on Depa’s financial performance and position. Depa’s management is implementing a group-wide transformation and restructuring programme and reiterated that it continues to pursue its pipeline of opportunities and deliver on its secured projects.
For subcontractors, the “best way to recover some portion of their monies on projects where the main contractor is being changed is to work directly with the developer and the new contractor,” said Sameer Lakhani, MD at Global Capital Partners. “There have been numerous instances where smaller developers have already done this and it has proven to be more expeditious for all parties to complete the projects and extinguish liabilities, allowing for under-construction projects to be made viable with the value preserved”.
On the other hand, this situation creates a promising market opportunity for construction companies wanting to enter the UAE market, as the absence of Arabtec removes a substantial amount of competition. Meanwhile suppliers connected to Arabtec would need time to recover their bad debts and may even have to raise external funding to meet current obligations. This gives other competing suppliers more access to developers and contractors entering the market whilst Arabtec’s suppliers struggle with debts."
Lenders face write-downs or rescheduling of debts
With Arabtec heading into liquidation, the availability of funds is emerging as the single largest threat to the Gulf’s low margin contracting industry. According to Gulf News (a leading UAE newspaper), “The reluctance by banks to lend for project finance has become obvious since August 2020, even on projects from reputed organisations with good track-records,” said the general manager at a leading contracting firm. "We just get calls from the concerned division saying they are not in a position to fund the project presently, without offering any reasons."
Ideally, banks put up the required financing instruments to match the funds advanced by the project promoter as well as to guarantee performance of the contractor, in addition to offering financing facilities such as letters of credit for procuring goods and monthly ‘progress invoice discounting'. The process is vital to get projects off the ground, and in its absence, it is likely that projects would get delayed and create uncertainties.
Banks in the UAE are suffering a rise in non-performing loans, which have negatively impacted the quality of their balance sheets and forced them to withdraw from lending to players in the construction sector. Arabtec’s lenders are said to have close to AED 2 billion (USD 544 million) of exposure in the form of loans, and it is estimated they hold another AED 8 billion of company exposure in the form of performance guarantees. Creditors and banks awaiting details of Arabtec’s liquidation face mounting uncertainty after talks to unwind the company stalled.
The liquidation has had a domino effect on its peers as several UAE companies have sought to extend debt maturities or agree to better terms in recent years to avoid defaults. For example, another Dubai-listed construction firm and Arabtec’s peer, Drake & Scull DSI.DU, is working under the UAE bankruptcy law to reach an agreement with its creditors in an out-of-court process.
New regulations introduced
The new Dubai Building Code was approved just days after the collapse of Arabtec. The new code seeks to reduce construction costs by streamlining building rules in addition to creating a unified set of standards for construction that promotes sustainable development and innovation in building design. This creates a uniform, easy process for all players throughout the construction industry value chain – from owners and investors to developers and contractors – to obtain approval from Dubai authorities such as licensing agencies and other relevant departments.
Double blow to GCC construction industry
Despite weathering a number of storms like the events and aftermath of 9/11, the real estate crash of 2008/09, and the halving of oil prices in 2014, the construction industry report by Deloitte claims that nothing has come close to the current crisis led by the double impact from the COVID-19 pandemic and collapsing oil prices. The value of construction contracts awarded in the UAE during 2020 stood at the lowest in the past five years after reaching a peak in 2015. According to industry reports, more than 550 projects, worth over USD 60 billion have been suspended or delayed since March 2020 across the GCC.
Although the UAE remains the most active market, with USD 10 billion of awards up to November 2020, it is the worst-performing market with a 61% YoY decline compared with 2019 (USD 26 billion). The UAE also completed the most amount of work in 2020, compared to other GCC countries. By the end of November 2020, the UAE had completed USD 29 billion worth of construction work (which was only a 6% YoY drop compared to the USD 31 billion worth of work completed in 2019), despite the operational disruptions caused by COVID-19. Meanwhile, Saudi Arabia completed only USD 12 billion worth of contracts during the same period.
As a result, MEED estimates that the UAE market would have contracted by USD 18 billion from January to the end of November 2020, a significant increase from the USD 6 billion shrink recorded in 2019. S&P ratings reported in March 2020 that real estate developers could record lower margins and more payment defaults given the negative macroeconomic outlook.
Low margin contractors squeezed more for survival
Apart from the negative effects of COVID-19, the low margins in the construction industry are the underlying problem. The engrained culture of bidding extremely low prices to obtain work, leaves contractors with very little margins in the case of unforeseen events.
This low-price bidding strategy seen across the market, places pressure on key parts of the supply chain, causing instability and unreliability, particularly financial, on resources and overseas procurement. Contractors’ general lack of accounting and financing knowledge further complicates their ability to secure financing during economic downturns. The infamous ‘need to borrow’, generally with no clear structure, has taken down many contractors during such difficult cycles.
The construction and contracting industry across the GCC is driven largely by government investments, meaning that low oil prices directly affect the construction contracting sector as investment slows down and new projects are delayed. In early April 2020, Dubai’s Department of Finance advised all government agencies to cut capital spending by 50%, delay new projects, and reduce spending on ongoing construction projects. Abu Dhabi’s Adnoc (the country’s largest petroleum company) asked its suppliers and contractors for “cost savings” and have cancelled USD 1.6 billion worth of contracts on its Dalma field development project just three weeks after their signing in April 2020.
According to Deloitte, beyond the immediate issue of cutting back on capital expenditure, all the six GCC nations are revising their long-term visions to reflect what may be a very different world once the pandemic has passed. Nevertheless, it is notable that the future pipeline of projects in the region remains considerable. At more than USD 2.5 trillion, even if the pipeline were to halve, it would still represent a very sizeable market opportunity.
Therefore, a larger pool of players are left to compete for far fewer wins. Such an environment is likely to encourage low-price tender bidding to secure contracts, leaving little room for investments in new technology. As liquidity dries up, contractors find themselves left with little choice but to slash down prices even further, creating a vicious cycle, damaging the long-term prospects of the industry.
Keeping the sector afloat in the near term
Many players have now adopted a “wait-and-see” attitude and are holding onto cash, which creates room for disputes, as project stakeholders find themselves unable to meet their contractual obligations. As the market slows, contractors now also face the challenge of having to adhere to contracts and maintain construction output, while meeting the requirements for social distancing and safety measures.
At the same time, payments have become slower, deteriorating cash flows, while falling building material production also threatens to disrupt project schedules as the availability of key supplies like mortar, brick and plasterboard are limited.
According to industry sources, players are not yet able to estimate the potential total increase in overall costs, which could run well into the “tens of thousands” of dirhams each day. Delays in the building materials supply chain as a result of the lockdown-induced slowdown in shipping, restricted cross-emirate transportation and longer customs clearance times, have also driven up material costs.
Shortages of workers on site, with the majority either infected or quarantined, also contributes to project delays. Rising operational costs due to transportation of workforce adhering to social distancing measures, in addition to sanitization and protective gear, are squeezing the already low margins prevalent in the industry.
In addition to this, MEED reports that neither banks nor insurance providers have been cooperative so far, despite the announcement of various relief measures like the Targeted Economic Support Scheme (TESS) with USD 70 billion worth of capital and liquidity measures aimed at easing liquidity management for banks through collateralised funding at zero cost. A contractor noted that an insurance company has quoted more than a 50% increase in premiums owing to pandemic related risks. Meanwhile, banks are refusing to have conversations about renegotiating interest rates. Developments in early stages find themselves struggling to raise debt in the manner project sponsors had originally anticipated, resulting in several projects either being halted or shelved entirely.
This has left banks in the region grappling with two issues: 1) drying up of liquidity in the market as investors seek safer avenues such as treasury bills and sovereign bonds, and 2) credit quality and the impact of credit risk on businesses in the region. The low interest rate environment has added to the banks’ woes as net interest margins are put under pressure, impacting their profitability apart from rising risk charges.
Both governments and central banks across the region responded to the crisis promptly, stepping in with enough stimulus, by injecting money at a lower rate of interest in order to ease liquidity concerns. Banks are now working with customers and businesses to help them overcome this crisis and adapt to a rapidly changing economic environment.
Demand for credit is slowing because most businesses are scaling back their expansion plans and planned new projects because of the crisis. However, companies still require credit to aid them through current cashflow issues, as revenues have typically dropped by about 30-40% since March 2020. Companies would need support from financial institutions in order to defer their payment liabilities over the next three to six months of 2021, or until the market recovers to pre-COVID-19 levels.
Moving forward: Repricing and restructuring contracts will be key
UAE contractors will have to go through price renegotiations as project promoters insist on re-pricing contracts due to the changing circumstances. Industry sources reveal even projects that were awarded as recently as weeks ago are being put through re-pricing with a take it or leave it approach. “There’s no set requirement that contract values should be revised downwards by 10 or 20 per cent,” said a top official at a leading construction firm. “But in the post COVID-19 economic reality, re-pricing contracts is the only way forward. The new norm has prompted everyone in the industry to work on reduced contract values and, as a result, even lower margins is part of the new reality”.
As Arabtec’s liquidation is yet to be finalised, and projects with sub-contractors are still progressing, it is difficult to determine the extent to which the liquidation would actually affect stakeholders and the industry at large – only time will tell.
Shamla Yoosuf is a financial analyst with over four years of experience in capital markets and equity research. She holds a Bachelor of Commerce from the University of Sri Jayewardenepura, Sri Lanka and is currently reading for the ACCA Professional Level. She is currently a part of the ReMAtics team, a freelance platform specialising in financial research, writing and analytics.
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