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An investment gone sour for Abu Dhabi Investment Authority

In one of our previous articles we discussed the impact of global financial crisis on Sovereign Wealth Funds (SWFs). Similar to other institutional investors, fortunes of SWFs have also tumbled much to the dismay of sponsoring governments. They continue to remain highly exposed to financial and real estate sectors and some appear to be in dire need of diversification. Against this backdrop, the ongoing dispute between Abu Dhabi Investment Authority (ADIA) and Citigroup causes little surprise.

Established in 1976, ADIA is a SWF wholly owned by the government of Abu Dhabi. Total assets under its management is not exactly known but is estimated to be some $600 billion, thus making it the largest SWF in the world. Much of its funding comes from the Abu Dhabi National Oil Company (ADNOC) and its subsidiaries which pay a dividend to help finance ADIA and its sister fund Abu Dhabi Investment Council (ADIC). Following the sub-prime bailout, ADIA owns 4.9% of Citigroup and Citi is one of its largest holdings.  

ADIA made a $7.5 billion investment in Citigroup in November 2007 in the latter’s attempts to improve its fast deteriorating capital base. In fact, much of the proceeds were expected to be treated as Tier 1 capital for regulatory capital purposes. These equity units are defined as mandatorily convertible securities consisting of a contract to purchase stock at different purchase dates, and an undivided beneficial interest in trust preferred securities.

The conversion will take place in four settlements between March 15, 2010, and September 15, 2011at prices ranging from $31.83 to $37.24 per share. Each settlement date is subject to an extension of up to one year. These equity units prior to conversion carry a fixed annual payment rate of 11%, payable quarterly; almost double the interest carried by the Citigroup bond at that time. Citi’s current share price is well below the lowest settlement price band of $31.83 in the agreement and accordingly, ADIA is required to convert its equity units and receive 235,627,500 shares of Citigroup at a conversion price of $31.83 per share. Given Citi’s current share price of $3.34 per share, this translates to a hefty conversion premium and a massive loss to ADIA.

In an attempt to avoid potential losses from the deal, ADIA has filed a claim against Citigroup under international arbitration law, alleging fraudulent misrepresentation over the investment. ADIA seeks rescission of the investment agreement or damages in excess of $4 billion. Citigroup reckons that the allegations are entirely without merit and has stated its intents to defend against them.

Whatever the legal verdict may be, the incident shows growing dissension among SWFs over their investments particularly in banks and real estate projects. It also indicates their reluctance to have further exposure at least to the banking sector. ADIA already has considerable exposure to the banking sector through its investment in Citi as well as its approximately 70% holding in the National Bank Abu Dhabi. Its other large holdings in companies in the financial sector include Macquarie International Infrastructure Fund Ltd and Egyptian Financial Group, Hermes Holding Company.

Attempts by SWFs to reduce their exposure to banks have already started in earnest. For instance, Kuwait’s SWF Kuwait Investment Authority (KIA) has sold its approximately 5% stake in Citigroup for $4.1 billion in less than two years after acquiring preference shares. KIA reportedly has made a handsome profit of $1.1 billion from the deal. Qatar Holding LLC, an arm of Qatari SWF, Qatar Investment Authority (QIA), has sold its stake in Barclays plc at a profit of ₤615 million a year after its investment. Similarly, the Government of Singapore Investment Corporation (GIC), a SWF sponsored by the Singapore government, has sold its stake in Citigroup also at a profit. Clearly, the deal ADIA has struck with Citi has been less than profitable.

ADIA’s contention stems from what appears to be an apparent disparity of terms in its own agreement with Citigroup vis-à-vis those between Citi and other institutional investors. According to ADIA sources, GIC, also invested in Citigroup at a lower dividend of approximately 7% but had the option to convert preferred shares into Citi ordinary shares at any time without any mandatory timelines or prices. This has apparently enabled GIC to renegotiate those terms with Citi and also sell its investment at a profit. ADIA feels short changed over its terms and hence the allegations of fraudulent misrepresentation.

ADIA’s ability to wriggle out of the agreement at this time remains questionable as there is little provision for such manoeuvres. The “Purchase Contract Reset Adjustment” section of the agreement states that if “Citi issues in excess of $5 billion of equity or equity-linked securities at a sale price below $31.83 per share, or additional Upper DECS Equity Units with a payment rate higher than 11% or a conversion premium below the conversion premium of this security, during the one year period following the issuance of the securities, the maximum conversion price may be reduced, but not to less than $31.83”. However, one year has gone by since the time Citi and ADIA struck the deal thus leaving what could be a window of opportunity for ADIA to renegotiate terms.

Be that as it may, we stand by our previous comments that SWFs will seek to reduce their exposure to the banking sector. We also stand by our argument that SWFs may seek increased exposure to the natural recourses sector particularly mining. China’s SWF, China Investment Corporation (CIC) has already started making strategic investments in mining companies. After its 17% stake in Teck Cominco (TSX: TCK.A and TCK.B, NYSE: TCK), CIC invested $500 million in Toronto listed South Gobi Energy Resources (TSX: SGQ). Similar investments by other SWFs in mining companies are expected.  

It is interesting to note that ADIA’s investment in Citi at that time was a matter of considerable concern to many in the West. Despite ADIA’s refusal to take up the board position that was offered, some even viewed the investment as a potential threat to the US banking industry and the much hallowed Wall Street. Indeed, the deal appeared to be extremely attractive to ADIA at that time as 11% dividend on equity units was well above the then prevailing interest rates. With markets having gone against ADIA leading to massive conversion premiums on Citi, those who were drawing daggers then appear to have gone silent now.

Sources & Acknowledgements:

Sovereign Wealth Fund Institute, Council on Foreign Relations, The Economist, Individual Sovereign Wealth Funds including ADIA

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