THEMATIC RESEARCH Research and Advisory Inside this Report Executive Summary 2 The Merger Talks 4 through the Years Here and Now: The Current State of the 5 Exchanges The Inevitable Benefits of a Merger 6 Will a Merger of ADX Consolidation 7 and DFM Make Sense? What Could Hinder a 10 Merger? Annexes Background on UAE 12 Markets Precedence from the 13 World Stage Sources and Citations 14 Contacts and Disclaimer 15 Monday, October 1, 2018 Let the Merger Ensue... After several years of hibernation, talks about a potential merger or consolidation of UAE’s primary exchanges: Abu Dhabi Stock Exchange (ADX) and Dubai Financial Market (DFM) have become rife again. Since the last time that such an event was thought to have materialized (ca. 2013-2014), much has already happened—including the UAE now categorized as an Emerging Market. Perhaps this time, a merger could finally come into fruition. One Country, One Exchange has a nice ring to it; certainly makes a lot of economic sense and strengthens Brand UAE. The Time Is Golden for the Emergence of a Single Market with Brand UAE As this report is written, both the ADX and DFM have protractedly seen thin volumes of trades. The combined markets’ 1H18 monthly average turnover was ca. AED18bn, more than 20% lower than the monthly average turnover of 2017. Markets’ Operating Margins and Sustainable Growth Rates as represented by DFM’s data have been under pressure in the past few years. The need to counter falling margins and rationalize costs is a strong driving force behind any merger and one that should be heavily considered. The latest market valuations of both markets are lower compared to their historical averages— making it opportune to reach a compromise valuation for a potential unification. In the meantime, economic prospects for 2018 and beyond are healthier compared to the past year. As such, there is no better time than at present to seriously engage and work towards a unification process. Succession of Events Could Indicate that a Merger Would be Pushing Through Recent events have drawn further on a history of collaboration between the emirates of Abu Dhabi and Dubai. Most recently, there have been reports that flagship carriers, Etihad Airways and Emirates Airlines are supposed to be having exploratory talks on combining their operations. Months before, the two airlines have extended their ties as Etihad has allowed its pilots to take up opportunities in the Dubai-based carrier for as long as two years. Prior to that, a Joint Venture between mega developers, Aldar and Emaar came to light. And previously, there was the mega-merger of Dubai Aluminium and Emirates Aluminium which is now known as Emirates Global Aluminium or EGA. In early June 2018, the Chief Executive of the Securities and Commodities Authority (SCA), Dr. Obaid Al Zaabi, announced that the UAE Central Bank has assumed the role of Settlement and Clearing for ADX and DFM1. The members of the investment community, led by regulators are reported by the general media to be in full support of a potential consolidation of the exchanges. A stronger and bigger unified market will also be important in SCA’s endeavors for the UAE to further develop the financial markets. 1 Source: https://www.reuters.com/article/emirates-regulator/uae-central-bank-assumes-role-of-settlement-and-clearing-agent -idUSL8N1TD3A3 Thematic Research UAE: One Country, One Exchange Page 2 Let the Merger Ensue... An Exchange Merger Would Mean ... A merger of the exchanges is an event that could help energize the UAE’s financial markets— as a uniform and potentially more efficient exchange could make it easier for investors to trade across markets, leading to a more stimulating trading activity and eventually encouraging better inflows of foreign and institutional investments. Benefits are seen on many layers: on the exchange, among the listed firms and among the investors. For the Exchange: A singular market offers opportunity for more diversified products and services. Further opportunities could arise from synergies and less complexities. There is also the potential for an increased presence in the global stage. Take the case of Southeast Asia’s Philippine Stock Exchange: two bourses became one in 1992, following a presidential decree. Post-unification of its exchanges, the Philippine market saw market capitalization expand by 355%, value of transactions surged by 385% and the foreign portfolio investment expanded by nearly 300% between 1992 and 1994 (Ho and Odhiambo, 2015). For the Listed Companies: A unified exchange could potentially provide the listed firms cost reduction, better liquidity and increased foreign and institutional participation. For the Investors: A merged exchange could potentially provide the investors greater access and overall better economic outcomes as well as risk reduction. Mind the Caveat While there may have been a growing set of indicators pointing to a merger happening this time around, we need to be mindful of the following that could derail the process, once again: Valuation consensus of the exchanges and the dynamics of the consolidation could hinder a potential merger process. Control aspects remain key for such an event to materialize. Should a merger proceed, timing is quite important to generate the desired momentum. Thematic Research UAE: One Country, One Exchange Page 3 The Merger Talks Through the Years This year, 2018, marks the 18th year of birth of both the ADX and DFM. A few years into the markets’ existence, whispers of a potential unification came up. However, it was only after the Global Financial Crisis of 2008 that merger speculations intensified as exchanges around the world scampered to find liquidity. Below are the highlights of the published accounts of public discourse on the merger of ADX and DFM: Various experts’ opinions were culled by an Argaam.com article. Benefits to a 2007 merger between the two exchanges were shared by prominent business figures. Based on published reports from various dailies, in 4Q10, Goldman Sachs as commissioned by the Emirates Investment Co. (which was reported to have been 2010 in charge of a merger back then) completed a study on the merger of the two exchanges. Abdullah Al Turaifi, then chief executive of the Securities and Commodities 2011 Authority (SCA) signified support for a potential unification of the exchanges. Bourse merger proposal was revived. Prior merger talks were halted reportedly due to differences over how to value the exchanges, and because of competing public priorities such as the aftermath of Dubai’s 2009-2010 corporate debt 2013 crisis. Abu Dhabi reportedly hired J.P. Morgan Chase and FGB to advise on the merger. Investment Corporation of Dubai, the flagship holding company which owns stakes in many of Dubai’s top entities, including DFM’s parent, Borse Dubai, had hired Citigroup. Once again talks bogged down on the proposed merger, mainly due to the issue of valuation. The valuation of DFM, the Gulf’s only listed bourse, had increased significantly since the advisers were first appointed, as trading increased during a bull run which saw the value of Dubai’s benchmark index jump nearly 60% 2014 between 01 January and 06 May 2014. Based on a valuation of around 20x EBITDA used under the merger plan, DFM’s value rose from around AED2bn at the end September 2013 to AED4.64bn at the end of March 2014. The merger plan valuation, conducted by Goldman Sachs, according to two of the sources, put ADX at about 10-12x EBITDA. Dr. Obaid Al Zaabi, then acting CEO of SCA, was quoted in a report saying that 2017 the decision of merging ADX and DFM lies with the management of the two markets. In May 2018, Al Khaleej newspaper reported that the settlement of ADX and DFM’s transactions has been assigned to the UAE Central Bank in May. Many see this as a preparatory procedure before the potential merger. 2018 In June 2018, Dr. Obaid Al Zaabi, the current CEO of SCA, announced that the UAE Central Bank has assumed the role of settlement and clearing agent for market transactions. Thematic Research UAE: One Country, One Exchange Page 4 The Current State of the Exchanges Long-drawn Out Thin Volumes in the Markets Both the ADX and DFM have protractedly seen thin volumes of trades. In the past two years, the combined turnovers of ADX and DFM traded below the normalized 5y average (see chart to the left). For 1H18, monthly average turnover was ca. AED18bn, more than 20% lower than the monthly average turnover of 2017. Overall listings this year, so far, have been constrained with no IPOs versus at least two in 2017. There have been announcements of planned IPOs such as UPP’s ServeU, DIC’s Emicool, Bloom Holdings and Emirates Aluminium. However, these are just announcements at this stage and Emirates Aluminium already disclosed that its IPO shall be delayed to 2019. This is not surprising, given that market conditions are not conducive at the moment for listings. Nagging Pressure on Margins and Sustainable Growth As there is no current access to ADX’s financial statements, we look at the fundamental data of publicly-listed DFM and use them as proxy to check for the UAE markets’ fundamental health. Operating Margins, as represented by DFM’s margins, have been under pressure in the past three years. The exchange, as it currently stands, could not offset the weakness in business volume. As the YTD volumes continue to be moving in a similar weak trend, we expect further pressure on operating margins. Another issue of note is that with the exception of the year 2014, the annual sustainable growth rate of DFM has been negative.