Frank Franklin II/AP
Barneys New York in 2004.

Dubai’s Possible Sale of Barneys Reflects Reduced Oil Wealth, Retail Slump

January 29, 2009 01:02 PM
by Anne Szustek
Dubai governmental investment wing Istithmar is considering selling Barneys New York, less than two years after acquiring the high-end department store to diversify its portfolio.

Sale at Barneys?

Istithmar, an investment branch of the emirate of Dubai, is reportedly mulling the sale of its entire stake of Barneys New York, the luxury fashion department store it picked up in September 2007 for $942.3 million from Jones Apparel Group.

As was the case with other governmental investment funds based in the United Arab Emirates, Istithmar’s foreign-asset shopping spree was tempered by the current global economic crunch. The multibillion-dollar investment fund was one of seven operating out of the Persian Gulf region to lose a total of 15 percent in value.

Istithmar’s struggles with Barneys are multifaceted. On the consumer end, sales in the U.S. luxury fashion segment were down 27.6 percent year-on-year from December 2007 to 2008, according to statistics supplied in a MasterCard report cited by The New York Times. Barneys’ sales margins have suffered as fashionistas have gone recessionista. Rather than maxing out their credit lines, Upper East Side and Rodeo Drive grand dames are opting for items more affordable and practical than $300 t-shirts, prompting Barneys to have markdowns of as much as 75 percent.

Meanwhile, the shrinking profit margins are weighing on Istithmar’s own debt lines. The investment wing took out significant loans to buy Barneys, expecting that sales would quickly recoup the interest payments. This credit crunch comes on top of global economic conditions that saw a sapped real estate market and sluggish hydrocarbon prices, two of the UAE’s main stocks in trade.

Thus the potential sale of Barneys reflects not only the struggling retail market stateside but also the diminishing petrodollars of oil-based economies like Dubai’s.

According to The New York Times, sources with knowledge of Istithmar stress that any potential sale is “fluid.” Istithmar chief executive David Jackson declined comment when asked by the Times if the store may go for a steep discount.

“If they’re in a hurry and need the cash right now, they will have to pay the price,” Armando Branchini, vice president of Intercorporate, a Milan-based luxury consulting firm, told Bloomberg. “If Istithmar can be patient, they’ll get the pay-off.”

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Background: Decline in UAE sovereign wealth funds

Sovereign wealth funds, also known as SWFs, are an investment tool used by governments to preserve investment funds. They have been in use since the 1950s as a way to hedge national coffers against economic downturns. According to the International Monetary Fund, among the world’s largest users of SWFs are the UAE, Norway, Saudi Arabia, China, Kuwait and Russia, which all have significant oil wealth.

Oil economies, particularly those in the oil-based economies of the Gulf, eager to diversify their investments, have been buying up assets of Western companies. The two richest of the UAE’s seven emirates—Abu Dhabi and Dubai—as of last summer had some $5 billion a week to spend on foreign investments thanks to their sovereign wealth funds.

Case in point: what was, as of last year, the world’s largest SWF, the Abu Dhabi Investment Authority, bought a $7.5 billion stake in Citigroup in November 2007. Riding high on $120-per-barrel oil, the ADIA, dubbed the “Masters of the Oil Universe” last summer by BusinessWeek, was flooding its funds into American hedge funds, real estate—including 75 percent of New York’s iconic Chrysler Building—and private equity funds.

Fast forward a few months to January 2009. Oil is hovering in the $40 range. Morgan Stanley purchased a 51 percent stake in a joint venture with Citigroup to take over the latter’s Smith Barney, Smith Barney Australia and Quilter units for $2.7 billion.

In Dubai, in addition to the plummeting oil prices, the credit crunch has sapped the real estate market, which now constitutes the core of the emirate’s wealth. In fact, the move into real estate was largely to hedge against oil markets. Building from its infrastructure wealth, Dubai governmental investment arms have purchased major stakes of foreign companies, including a 1 percent stake of technology manufacturer Sony on Nov. 26, 2007, Barneys New York, British hotel chain Travelodge and U.S. hedge fund Och-Ziff Management.

But as with much of the global economy, SWFs, especially those with heavy holdings in financial institutions, have been walloped in this recession: during 2008, assets of Gulf-based sovereign wealth and foreign-reserve funds lost 27 percent of value, or $350 billion, according to research by the Council on Foreign Relations’ Brad Setser and RGE Monitor’s Rachel Ziemba, published in The Economist.

The two economists predict that if oil were around the $50 per barrel mark, Persian Gulf countries will probably need to have zero purchases of foreign assets after domestic spending is factored in. Should oil dip to some $25 per barrel, Gulf states will likely be forced to begin to divest foreign holdings.

Reference: United Arab Emirates

The United Arab Emirates (UAE) is a federation of seven independent sheikdoms. While each emirate is semi-autonomous in civil and investment law, they function together for purposes of foreign policy and defense. Oil was first discovered in the area in 1958, and forms the base of the country’s enormous wealth.

Before oil was discovered in the UAE, the local economy relied primarily on pearl diving and fishing, the BBC explains. When it started to export oil, this Gulf nation’s coffers and society were rapidly transformed. Sheik Zayed al-Nahyan, then ruler of Abu Dhabi, the largest emirate, ensured that the hydrocarbon revenues were reinvested in social infrastructure such as education and health care, as well as immovable investments such as real estate. In the past decade the emirates, particularly the two richest of the seven, Abu Dhabi and Dubai, have divested their petrodollar earnings into overseas financial holdings.

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