Do as I say, not as I do

When Peninsular and Oriental Steam Navigation Company (P&O) shareholders approved Dubai Ports World’s bid to buy the company for $6.8 billion on February 13, no one could have imagined the transaction would become a fork in the road for the Republican Party, but with mid-term elections but eight months away, the ‘ports’ deal, as it has come to be called, has occasioned the first outright clash between President Bush and Congressional Republicans since Bush came into office in 2000. At issue, claim the Congressmen, is the security of six American ports (New York, Newark, Baltimore, New Orleans, Miami and Philadelphia), the operation of which has been carried out by P&O, a British concern, for a few years now. Since DP World is controlled by the al-Maktoum clan (in other words, the Government of Dubai), many—if not most—Congressmen sense a danger in having an Arab government administrate US ports; however, to date, not one stitch of compelling evidence has been presented to demonstrate how security at the affected ports would be compromised. When P&O operated the ports, the local US authorities were still responsible for security, and this would not change now that DP World has bought P&O.

Never the less, powerful forces are gathering to squash the transaction. Congressman Jerry Lewis (R-CA), head of the House Appropriations Committee, introduced yesterday a bill to block the ports deal, saying, “This is a national security issue, this is a national security bill. We want to make sure that the security of our ports is in America’s hands. My amendment blocks the deal by prohibiting Dubai Ports World or any entity controlled by DP World from taking control of U.S. port operations.” Someone should explain to Chairman Lewis that the ports’ security have always been in “America’s hands.” Or, if he persists in believing otherwise, one could point out that a foreign entity has operated the ports for some time now—where was all this vitriol before?

It should be clear by now that all this outrage has very little to do with US national security, and given the mid-term elections in November, it is easy to see Congress’ behavior as a form of points-scoring in districts back home. It would be far easier, however, to demonstrate this had the Bush Administration been more thorough in its review of the deal. Since 1975, all such cross-border deals must be reviewed by the Committee on Foreign Investment in the United States (CFIUS), which resides in and is chaired by the US Treasury Department. As one would expect of bureaucracy, the full Committee does not meet as often as one would think, especially so given the level of foreign direct investment that pours into the US annually. In its defense, most deals do not warrant a great deal of scrutiny and can pass muster without a lot of fuss. The DP World transaction, obviously, is not one of those deals, yet the Committee handled it much the same as it would an acquisition in the cat food or garden supply industry. It is difficult to tell if the Committee’s laziness was “purchased” or simply a small part of the general incompetence of the Bush Administration, but greater scrutiny up front would have headed off the Congressional chorus of windbags.

Was the $100 million gift from Government of Dubai to the United States for Hurricane Katrina relief merely a magnanimous gesture, or a cynical attempt to curry favor ahead of the ports deal’s announcement? Was the January appointment by President Bush of David Sanborn, a DP World executive, to become the administrator of the Maritime Administration in the US Department of Transportation connected to the soon-to-be-announced ports deal? These are valid questions, but they are also fairly representative of the unctuous lubricant that greases the wheels of commerce on a daily basis. If these events did have some bearing on the ports deal, they would rate as ‘petty’ on the sliding scale of corruption; however, a failure of CFIUS to properly execute its delegated duties begins to resemble something far more serious—and worthy of investigation.

Opponents of the deal—and at this point, they are legion—have been fond of citing the role Dubai played in the 9/11 attacks, acting as a hub for transport and financing. Also, the United Arab Emirates, the collection of mini-states to which Dubai belongs, was one of three governments to recognize the Taliban regime of Afghanistan. While explaining away recognition of the Taliban is difficult, the connection between Dubai and 9/11 is a tenuous one. Dubai is a hub for many things in the Near East; it is the Arab world’s version of Switzerland, Wall Street, and the Cayman Islands all rolled into one neat package. Given the formerly lax rules in place to regulate capital flows, it comes as no surprise that part of the monies used to fund terrorism flowed through Dubai, but that of itself is hardly indicative of anything. Westerners, too, used Dubai as a money-laundering center pre-9/11.

One of the more successful efforts of the US and its allies in its conflict with militant Islam concerns financing. The US has been fairly successful in making it much more difficult for terrorists to use the international banking and financial system for their nefarious purposes, and this success would have been hard—if not impossible—to achieve without the active support and cooperation of governments around the world, including the Emirates. Increasingly, Dubai has yoked its future prosperity to the globalization sponsored by the US-led international financial community, as it develops enviable financial services and tourism industries. Its few oil reserves will run out in a little over a decade, and the city-state has moved aggressively to diversify its economy. Oil now accounts for only 7% of GDP. Put another way, Dubai has powerful, compelling reasons to play ball and in no way wishes to become a pariah state out of favor with the West. Since 9/11, Dubai has cooperated on virtually every initiative, from better monitoring of capital flows to hosting US warships at its strategically located port.

It seems clear that some Congressmen are looking to sink the DP World deal by impugning Dubai. Those who simply wish to delay the deal in order to carry out a more thorough investigation are, I believe, acting well within the bounds of fairness, but in today’s environment, it is difficult to distinguish between those who simply want due diligence and those who want to score political points back home by subverting free trade. Other than slinging a little mud in the direction of Dubai, such as the kind mentioned above, no Congressman has had the temerity or intelligence to cite publicly, chapter and verse, what specific security concerns are implicated by the deal.

What, exactly, would DP World be responsible for? According to a release from the U.S. Department of Homeland Security, DP World would operate a total of 11 terminals at six ports and would have some stevedoring duties in Norfolk, VA. The actual port facilities are not being sold, and responsibility for the ports’ security is—as has always been the case—that of the US and its enforcement agencies. Some Congressmen, particularly those in the opposition party, have used this occasion to sound off on the lousy job being done to secure American ports, and while that would seem to be an accurate assessment, it is a horrible pretext for blocking a corporate transaction and is close in nature to mere grandstanding.

When the news story regarding the deal first broke, I admit to having some reservations about the deal, mostly because I could not see the business case for investing in the operation of US ports. It is an extremely low-margin business, and given the litigious nature of the American marketplace, there is significant exposure to liability should something truly awful happen involving one of our port facilities. After all, if there were real money to be made from operating the ports, American private equity firms would have swooped in long ago. If the investment of significant capital can’t be rationalized on a commercial basis, it leaves itself open to other explanations. Perhaps it’s merely a ‘vanity’ purchase, along the lines of robber barons buying European castles or Japanese corporations of the 1980s buying movie studios. Or perhaps there is a malign intention behind the purchase.

For me, establishing the business case was important. First, the debate concerning this transaction will ultimately come down to the ‘character’ of DP World more than anything else. Rest assured, had the purchaser been a French, Canadian, or even Singaporean company, none of the current hysteria would have occurred. We have long had commercial relationships with these countries; they are familiar to us. But an Arab company, owned by an Arab state? This is something else altogether, and one feels certain there is also a fair amount of racism involved in perceiving an Arab acquirer to be, de facto, shady.

However that may be, for me the failure to see any investment thesis whatsoever that squared with commercial reality gave me reason to pause. Why spend $6 billion for flea-market assets? After discussing this with a friend of mine who has traveled throughout the Emirates and is familiar with the place, it became clear to me that my failure to see the business strategy behind the purchase had more to do with a certain American commercial parochialism. I was viewing the transaction as a private equity firm would. In PE, the strategy has always been to target undervalued assets whose latent value can be unlocked with better management and cost cutting, whereupon the assets can then be resold for many multiples the original purchase price. Private equity investors expect high returns, and PE firms never enter an investment without knowing where the exit door is; the time horizon for these investments is rarely more than a few years.

Looking at the DP World transaction in this manner, as my friend explained, misses the point. Since DP World is controlled by private interests—in this case, the Government of Dubai—time is not of the essence. The company has all the time in the world; there are no rowdy activist shareholders to please, no private-equity sponsors to coddle. As for the underlying strategy, the operation of ports worldwide is an extremely fragmented industry suffering from an overall lack of investment in technologies that could enhance productivity. This type of underinvestment is endemic to low-margin businesses depending upon high volumes to make suitable profits. For example, the bills of lading, manifests, and assorted paperwork documenting the coming and going of cargo is still trapped in the 1950s, with much of it recorded with pen, paper, and carbon copies. Digitizing this content could yield significant gains in productivity, but since there is no one player in port operations with adequate resources or scope to make this a reality, it has not occurred widely to date. Implementing seemingly small initiatives such as this could move the margins ever so slightly, and in the maritime business, given the huge volume of stuff shipped annually, a small gain in productivity could reap huge rewards. The goal of DP World, then, is to acquire enough scale to ram through such productivity-enhancing initiatives. It will take time and patience, however—something most investors in the West lack.

Once I understood the business logic behind the purchase, I felt much more comfortable with the acquisition, although I see no harm in allowing Congress and the White House to conduct their investigations. I would be highly surprised if something material to ‘national security’ turned up. More than likely, the investigation will center upon the ‘fitness’ of DP World as a commercial enterprise. A quick glance at the company’s executive team should dispel the notion that the company is merely a corporate hang-out for royal sycophants. Its CEO, Mohammed Sharaf, is an American-educated veteran of the shipping industry; its COO, Edward Bilkey, is a US Navy veteran and graduate of Yale and the Fletcher School of Law and Diplomacy.

Amid the truly disgusting displays of economic nationalism from European governments of late, it would be severely injurious to the international business community if the US government squashes the DP World transaction when no proper evidence has been produced to substantiate its fears regarding national security. While I will always dislike the idea of foreign-government-owned entities buying a private business, we have allowed other state-owned entities to purchase American assets in the past; therefore, we have an obligation to play by our own rules and precedents and allow this deal to proceed.

Update: DP World announced minutes after this blog was posted that it had decided to divest the American assets acquired in the P&O transaction, thus putting the matter to bed, but perhaps leaving potential future investors in the US with a poor impression of our commitment to free markets.