If 2010 was a tough 12 months for Arabtec shareholders, then 2011 has begun on a disconcertingly familiar note. On January 11 the Dubai-based construction giant – which worked on the world’s tallest tower, the Burj Khalifa – announced that it was planning a rights issue as well as a $150m, five-year convertible bond. The news saw Arabtec stock drop almost 7% in the two days after the announcement, on fears of earnings-per-share and stock dilution.

Burj Khalifa
Burj Khalifa

The announcement came less than a week after Arabtec founder Riad Kamal was slapped with a six-month share trading ban following an investigation by the Abu Dhabi Securities Exchange. The long-time CEO was barred after being found guilty of selling Arabtec stock less than ten days before company announcements.

Kamal says the transactions were made in 2009 and were not profitable; nevertheless the affair has caused a scandal in a climate that is growing more attuned to the need for better corporate governance.

Twelve months ago, Arabtec was reeling from the severe downturn in the UAE‘s property market, where some $350bn worth of projects have been cancelled or put on hold. Its answer was to broker a $1.4bn deal with Aabar Investments, whereby the Abu Dhabi-based investment company would take a 70% stake in Arabtec, the UAE‘s largest listed contractor.

Stock price tumbles

That January 2010 announcement saw another marked slump in Arabtec’s share price, on the same dilution fears that shareholders are running from today. But while the Aabar deal was eventually scrapped last April, experts say the new plan is likely to be passed by shareholders at an Extraordinary General Meeting scheduled for January 16th. So what has changed, and what is Arabtec likely to spend its cash on in 2011 and beyond?

“The company definitely needs the money,” says Ahmed Badr, a Dubai-based analyst for Credit Suisse Group. “Arabtec has been writing down a lot of receivables since the beginning of last year, and we expect them to continue writing off receivables this year.

“They are getting squeezed because they are not getting paid by developers or clients,” he continues. “And as a contractor, if you have very stretched working capital you can’t really go on with new projects.”

Arabtec reported a 96% slump in profit for Q3 2010, as net income dropped to $1.9m from $45.4m a year earlier, while revenue declined 23% to $350m from $450m in the same period 2009. The company had $1.3bn of receivables at the end of the September, while it had set aside close to $11m in provisions over the nine months.

“Arabtec has been having issues with collections and provisioning over the past year, which has been straining the company’s working capital position,” says Jad Abbas, a construction analyst at investment bank EFG-Hermes.

“They haven’t been able to comfortably fund their international operations under this strain, and the Dhs950m ($259m) they’re expecting to raise would also serve as a cushion for any further write-downs of receivables.”

Abbas expects that while the company insists it has provisioned for the bulk of receivables, any future provisions will be specifically related to individual clients – if one developer can’t pay its bills, then Arabtec will provision for that particular case, rather than continue with ongoing general provisions.

“They have agreements in place with most of the developers,” he notes. “The troubled part is obviously with Dubai receivables, but even there they do have agreements in place. It’s just that collection has been slower than expected.”

Focus on international market

If Arabtec does secure its cash injection, then the company is expected to direct investment towards its international operations, in a bid to further diversify its revenue streams away from stricken Dubai, where just last month the head of the emirate’s real estate watchdog warned that 2011 would see a wave of new project cancellations.

“We have seen a lot of Arabtec’s international operations developing at a slower-than-expected pace,” says Abbas.

“But now there will be a definite tilt towards investment in Arabtec’s international arms, and Egypt, Saudi Arabia and Qatar are the key markets.”

In October Arabtec signed a joint venture agreement with the Amer Group to expand into Egypt, while the builder’s Saudi unit has a $1.3bn order to build 5,000 villas for Saudi Binladin Group in the Eastern Province. Looking forward a few years, meanwhile, the 2022 football World Cup should present plenty of opportunities for Arabtec in Qatar.

The majority of major contracts for the tournament are expected to be awarded around 2016, and Arabtec will be hoping its experience in delivering high-profile projects nets the company some lucrative new work in the gas-rich emirate.

“Arabtec established a number of international subsidiaries last year, and started growing them,” says Abbas. “We saw a lot of the revenue come from outside Dubai – in particular Abu Dhabi and Qatar – and I think the process is working well for them.”

At Credit Suisse, while Badr accepts that Arabtec could be a beneficiary of infrastructure spending on the back of the World Cup, he insists that the contractor’s presence there is not as strong as that of competitors. He believes Arabtec’s main growth market will be Saudi, but emphasises that any cash raised from the rights issue won’t just go on international expansion.

“This money won’t just be for funding capital; the majority will be used to replace short-term debt with long-term equity financing,” he explains. “They can’t replace short-term debt from working capital, simply because they’re not being paid, or payments are delayed.

“For Arabtec 2010 was a stretched year, with markets going down and receivables being written off,” he continues. “Are we going to see further receivables write-offs in 2011? Yes. But without this cash, 2011 is going to be worse than 2010.

“If they do get the money, it could mark a turnaround but you’re not going to see the fruits of it until 2012. It could be an encouraging year in terms of backlog growth, but that doesn’t mean it’s going to filter through to earnings this year.”