An independent assessment of Blue City: Broker analysis

As the 'debate' continues in the comments section of a previous post on Blue City and amidst the various claims and counter claims, I thought it timely to post this independent assessment of the project by emerging markets specialist BCP Securities, a fully licensed U.S. investment bank headquartered in Greenwich, Connecticut. They did the analysis to provide information to clients (and potential clients) who want to trade the bonds.

I think readers will find it pretty consistent with the story you've been getting from Muscat Confidential over the years. Enjoy!

The original Blue City Phases as planned. 'Phase zero' (just building a hotel, a few villas and apartments plus an 18 hole golf course) was ommitted...

Blue City: What Happened?

On April 21st a story broke that former majority owner, AAJH, of the stalled Blue City project had found a new partner in Qatari investment company Bin Muhanna Holding Group. The two firms announced their aim to “restore confidence in the project” and approach investors to revive it and realize development objectives.

Blue City was meant to be Oman's biggest real estate undertaking. USD 925bn was raised in a November 2006 multi tranche bond issue for the project’s first phase, however the project crashed on the back of dismal sales and the bonds defaulted. A restructuring offer remains elusive and the company says it has “no reasonable expectation to meet debt payments when due.”

Prior to the default the minority (Omani) shareholder edged out the majority (Bahraini) partner. The Omanis brought USD 879.1mn in equity in the form of land (according to a CBRE valuation) to the deal and the Bahrainis brought USD 100mn of equity and made the USD 925mn bond raising possible. They also would provide much of the design and development. Yet the Omanis (Cyclone) had only a 30% share of the project while the Bahrainis (AAJH) had a 70% share. Months after the bond issuance minority holder Cyclone brought suit against majority holder AAJH of illegally acquiring the majority stake from third parties. It lost that case but appealed and won an injunction against AAJH. Cyclone is believed to have benefited from an influential owner (a Royal Minister holds 50% of Cyclone). The dispute is now in the Omani Supreme Court and a decision is impending.

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The inclusion of the new Qatari partner has added upside to the bonds. It makes revival of the project possible through the financial and legal leverage of the Qatari partner. The Chairman of Bin Muhanna Holding Group, Dr. Najeeb Bin Mohammed al Noaimi, is both a former Qatari Minister of Justice and a defense attorney for Saddam Hussein. He has a reputation for championing various legal causes in the Arab world. If his presence causes an AAJH victory in court then the project would benefit from better management and new capital.

If the Omanis win the Supreme Court case then their claim stands, but they might still consider reconciliation. In exchange for Qatari capital and Bahraini know how the Omanis might restart the project after a renegotiated shareholding. Ownership shares might converge towards 50/50 instead of 70/30.

Downside for the bonds stems from an Omani victory, no reconciliation, and a failure of the bond insurance policy to pay out (the current concern). Recovery will also decrease according to tranche seniority and be minimal for the C & D tranches. INSOL, an association of turnaround lawyers and accountants, states that the average recovery rate in MENA bankruptcies is 30% as opposed to 55-60% in developed countries What will mitigate that here is whether an insurance policy on the first tranche is still in good force.

Blue City bond holders are supposedly secured by 25sq km of the project area, which was valued by CB Richard Ellis at USD 879.1mn in 2006. However this land was gifted by Oman to the project and it is improbable that Oman would hand over this real estate to bond holders. Hence we exclude it from a recovery valuation. There is also a series of cash reserves outside Oman and in the custody of the Security Trustee, the Bank of New York, and theoretically this cash should be available security to Bond holders.

The A1 tranche’s principal is completely (but not unconditionally) insured by Axis Capital, who refused to provide figures but stated on its 4Q09 conference call that it was comfortable its reserving provision for the Blue City project would be sufficient to bring finality to its involvement in the bonds. On the 25th March 2010 downgrade of the A1 tranche Moody’s stated there was a breach of warranty of the credit insurance policy. It is unclear if the insurance policy is still in force but Axis has seemingly provisioned for a loss and so we assume a recovery where Axis makes good on half of the insurance.

With these considerations in mind: the security land is off limits, the cash reserves are in good form under Bank of New York’s custody, a 3 year recovery process, and yields of 25% the A1, A3, B1, C, and D tranches have present value recovery values of 51, 28, 14, 0, and 0. The price of the bonds should go higher than recovery in the case of the project’s revival.

In conclusion we believe the recent developments bode positively for the bonds but we would not recommend going beyond the A1 tranche as there is still substantial risk in a recovery situation. The expected recovery of the bonds should be best for the A1 tranche with value hinging on the size of the payout for the insurance policy and the integrity of the cash reserves at BoNY.



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This document is for information purposes only. Under no circumstances should this document be used or considered as an offer to sell or a solicitation to buy the securities or other instruments mentioned in it. The information in this document has been obtained from sources believed reliable, but BCP Securities LLC makes no representations concerning the truth or accuracy of the content or substance of this report, or of the future market value of any securities, notes, or private claims mentioned within. Opinions expressed herein constitute our opinion as of the date published and are subject to change without notice, and BCP Securities LLC makes no representations that it will endeavor to update its analysis upon any change of circumstances. All views expressed accurately reflect the research analyst’s personal views about the subject, securities and/or issuers and no part of the research analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst. The products mentioned in this document may not be eligible for sale in some states or countries. BCP Securities LLC, its affiliated companies, and/or its officers, directors, or shareholders, may from time to time have long or short positions in the financial instruments of the company mentioned in this document, or may serve in an advisory capacity with respect to such instruments.

Breaking News: Shit finally hits fan at Blue City: Redesign allows contractors to get the boot (maybe)

Ah, Blue City.

Or as the BCC1 PR chaps prefer, the post-AAJH name of 'Al Madina A'Zarqa'


Photo: Blue City's aspiration before the global real estate crash.

We've had a history here at Muscat Confidential. You can check the back posts if you're new. But good news for Blue City investors and bond holders.

It's rumoured BCC1 has actually met its sales targets via bulk sales to Qatari/Kuwaiti/Saudi/Iranian money. A miracle indeed. [Though Dubai collapsing, the fact Blue City is in safe Oman AND the prices were - to be honest - a relatively good deal in this regional market.]

That was the good news.

Photo: The old bait and switch.


The bad news is that the clients want villas, not fancy Euro-style flats. So a reshuffle of the design - finish flats sold & started, plus the hotels and golf course, make the rest phased villas and town homes - means the existing contract with ACO is waaaaay too pricey. Negotiations to agree a new much reduced % for AECO broke down a while ago, and now BCC1 is (quite legally) using the clauses in the contract to dump the old contractors (well, maybe... a negotiation is seldom over in Oman) as they can get a number of local lads to slap up some villas and don't really nice some pricey foreigners so much.

Photo: Negotiation, Oman style.

Still, cash seems tight. I'm told the main Project Engineers ACE, the chaps who actually supervise the contractor AECO, have been kicked off the job* and staff will be repatriated asap. Thats around 70 guys. If AECO really do go (and they haven't yet) that'll be about 2000 workers off the job and sent home this month plus another 2000 next month, along with the people organising them.

Reports that the staff at BCC1 themselves are not getting their salaries on time lately. Money's too tight to mention.

So, good news for Oman! is how it can be spun: the scaled down ITD we all knew Blue City would be looks like it will come to pass. And the local boys will get a bit more work. And the (newly 'regionalised' from the original Japanese, at a discount) bond holders get paid, and masses of free Government infrastructure will get built. The brilliant jeweled city will come... er... later, for sure.

Nice play.

Hey Dragon! So what if a few totally legal contractual clauses get executed ... and (mainly foreign) contractors take a bit of a haircut? Its a recession! you might ask.

Well...

Fair enough. And if Richard can snatch salvation from the jaws of bankruptcy, well, I'm sympathetic. 'A man's gotta do what a man's gotta do, give me results, thats why you get the big bucks, Omelettes and eggs', etc.

Although, I'd just note that when a business starts to play the 'hard ball contract game', it usually gets expensive in the longer run. People in future don't want to work with you so much, lots of inefficiencies occur, and as a result you (and sometimes the wider industry or country) end up paying a higher 'risk premium'.

And those contractor expats will return to their home countries and slag off Oman, seeing as how some of them have just paid deposits for rent.. Making it that bit harder to recruit for everyone. And to attract tourists.

So thanks Richard. Glad those Qataris like the villas. You're doing a good job for your shareholders. Time for a press release soon?



[*several reports say for 'non compliance']

the inevitable happens: Blue City's highest rated bonds downgraded to Junk

News just breaking that, surprise surprise, Blue City's bonds have been downgraded by the Fitch Rating agency.

The commentary seems pretty balanced and, well, true. Blue City have been slow, and that slowness cost them big time as it meant they didn't have stuff to sell in the hey-days of real estate in the GCC. Now, it's a little late.

Plus they have missed by a huge margin the covenants they made on sales. Collections (ie, the cash they've taken in from people via pre-construction sales) at the last interest payment date on 7 November 2008 were just $35 million, versus the original target of $165m. Cash take even failed Blue City management's re-revised target of $49m.

Ratings are deliberately obscure: BBB and above is investment grade, which means pension funds and banks can hold them. As usual, Blue City's borrowing was split into tranches will different claim on the assets and income, thus allowing BC to have a subset (just less than 30% of the $925 million they borrowed) of their bonds classify as investment grade 'BBB' by being entitled to first call on the cash. Even when issued, the remaining 70% of the borrowed money was junk. Now it all is.

More critically, if Blue City fail to raise $455 million in sales by 7 November this year, they are obliged to repay all the debt. Ooops. Sounds like insolvency looming to me.

As a result of this Blue City are desperately trying to renegotiate the terms of the loans. Meanwhile, Bank of New York Mellon - who I think hold the cash in escrow - have (I'm told by my sources within BCC1) not released any money to Blue City for the last 2 months. So no contractors are being paid, Bovis (the project manager) have walked out in disgust (previously reported here), the shareholders are still in court, and no-one in their right mind is buying property off plan in the GCC...

Perhaps a friendly Bulgarian Bank could be convinced to throw a big loan to Blue City's well connected Cyclone shareholders?

At least the construction of the hotel has started. But it won't help the way Omani bonds are seen in the market, especially if they miss payments.

Meanwhile, Al Sawadi Investments and Blue City management continue to be very well paid even though they seem to have a policy of stiffing their contractors.

So that's alright then.

BTW, Fitch's ratings are as follows:
Investment grade
* AAA : the best quality companies, reliable and stable
* AA : quality companies, a bit higher risk than AAA
* A : economic situation can affect finance
* BBB : medium class companies, which are satisfactory at the moment

Non-investment grade (also known as junk bonds)
* BB : more prone to changes in the economy
* B : financial situation varies noticeably
* CCC : currently vulnerable and dependent on favorable economic conditions to meet its commitments
* CC : highly vulnerable, very speculative bonds
* C : highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on obligations
* D : has defaulted on obligations and Fitch believes that it will generally default on most or all obligations

PRESS RELEASE: Fitch Downgrades Blue City Invest 1 Ltd Notes
Thursday January 29th, 2009 / 13h22
Fitch Ratings-London-29 January 2009:

Fitch Ratings has today downgraded the A3, B1, C and D class notes of Blue City Investments 1 Ltd (BCC1) as detailed below. All the classes remain on Rating Watch Negative (RWN).USD262.5m class A3 (XS0267260346): downgraded to 'B+' from 'BBB-' (BBB minus); RWN USD143m class B1 (XS0259701018): downgraded to 'B-' (B minus) from 'BB'; RWN USD50.5m class C (XS0272445726): downgraded to 'B-' (B minus) from 'BB'; RWN USD70m class D (XS0273296243): downgraded to 'B-' (B minus) from 'BB'; RWN

The transaction is a securitisation of a USD925m financing package for the development of an upmarket residential, hotel and leisure resort on the Indian Ocean coast at Al Sawadi, located 90km to the west of Muscat, the capital of The Sultanate of Oman.
Fitch initially placed the notes on RWN on 4th July 2008 on the basis of poor sales performance and due to concerns relating to a legal dispute between the development's shareholders. While BCC1's new management successfully implemented operational and organisational improvements and introduced a more clearly focused marketing and sales strategy, the transaction continues to under-perform and the shareholder dispute remains unresolved. The project will also be challenged by the highly uncertain near term outlook for Oman's integrated tourism resort (ITR) market because of the global economic slowdown and the recent and rapid softening of the economy within the Gulf Cooperation Council (GCC) region.

The project has failed all of the documentation's Residential Sales Tests tested to date. Collections at the last interest payment date (IPD) on 7 November 2008 stood at USD35.0m versus the Residential Sales Test 1's target collection level of USD165.0m. Collections also fell substantially short of BCC1's revised forecast of USD49.0m.

The shortfall between actual collections and target collections as per the documentation's sales tests is largely attributable to three reasons: first, sales commenced significantly later than initially envisaged, and construction progress also suffered delays, due to changes to the master plan following the transaction's closing in November 2006; second, the actual payment plan for purchase price instalments under the project's residential sales contracts is linked to construction progress milestones, whereas the payment plan structure assumed by the documentation is linked only to a time schedule that was determined at closing and did not anticipate delays in the commencement of sales or construction; third, the Al Murjan section, which was forecast to generate sales of 800 units during 2008, proved unmarketable due to shortcomings in its design concept, forcing BCC1 to redesign this section and leaving it without any new product to sell for most of 2008.

As a result of the delayed launch of units to the market and slow sales progress to date, the project missed out on a period of strong growth in the GCC's real estate sector that the development was intended to take full advantage of. The GCC real estate boom came to an end in late 2008 and while the decline in prices and transaction volumes in Oman's ITR market is, due to its small size, more difficult to assess and quantify compared with the more transparent markets of Dubai and Abu Dhabi, the near-term outlook is negative and uncertain, undermining the confidence of both purchasers and developers. The agency understands that all the ITRs within the greater Muscat area on which construction has not commenced were temporarily put on hold by developers in late 2008.

Even if sales progress over the next two quarters is in line with BCC1's current expectations, the transaction will fail Residential Sales Test 5 on the 7 November 2009 IPD, which calls for USD455.0m of aggregate collections, triggering the immediate acceleration and mandatory repayment of all outstanding debt.

The agency understands that BCC1 is seeking to restructure the transaction via far-reaching amendments to the documents and will shortly be submitting its proposal to the issuer note and security trustee, The Bank of New York Mellon ('AA-'((AA minus))/'F1+'). BCC1 has informed the agency on an informal basis that the proposal will likely include changes to the Residential Sales Tests and Capex Tests, the launch and construction schedule of the project's different sub-sections, the payment schedule under the construction contract and the final legal maturity date of the notes in an attempt to avoid an acceleration of the debt and provide the borrower with a greater level of flexibility to respond to the changed market environment. Fitch intends to resolve its Rating Watch as more information about the proposed restructuring becomes available.

Regardless of the scope and effect of any amendments to the documentation, the agency nonetheless believes that BCC1 may face liquidity constraints and require an equity injection in the future, depending on future sales and collections volumes and the extent to which payments under the construction contract can be further back-loaded.

Following initial delays after the re-design of the masterplan, the laying of foundations of the first hotel began on 20 January 2009 and foundation works are scheduled to begin on the Al Naman apartment section on 15 February. The workers camp, with capacity for 9,000 workers, was completed in November 2008, and further enabling works on the site are ongoing.

Fitch will continue to closely monitor the performance of the transaction. Updated surveillance information and the new issue report can be found on the agency's subscription website, www.fitchratings.com.

American Taxpayers bail out Blue City - Project will continue

Sources in BCC1 tell me that Blue City’s Al Madina A’Zarqa project has just been given assurances of 100% underwriting on the credit lines needed to complete the project by Bank of New York,

the appointed representative (Trustees) of the original Bond Holders. This is of course in some part because the bond holders are in pretty deep already, at ~40% of the investment cost sunk. So going ahead is the only chance of getting any money back.




There are also proposals to scale some of the project scope down, especially those communal bits they can't they can't sell like the Golf Course, and slowing down the development, but you're still talking a huge investment effort over the next few years.

I wonder if the money is - indirectly - effectively coming from the US Government's good ol' American taxpayers, at low rates of interest too, via the massive bail-outs over there? Wouldn't that be ironic headline for an incisive 'ViewPoint' piece for the Times of Oman - "Here comes the Cavalry!! Blue City project on track thanks to the Americans"...

Even better, it means the loans won't appear on the Government's books, and there will be some continued fiscal stimulus. Plus it will unlock significant Government spending on infrastructure.



Meanwhile, the boys at Blue City are being rewarded for hiring the big executive guns (mainly... American) at vast expense, and the party can continue for the management and the shareholders.