INSEAD Case study

INSEAD Case study

Markus Giebel (Giebel) looked out the window of his office at the gleaming Dubai skyline, pondering his options.  Giebel had been brought in to lead Deyaar Development PSJC (Deyaar) after the previous CEO, Chairman and other members of the senior management team departed under controversial circumstances. Upon his appointment as CEO in August 2008, the seasoned German executive had to bring the firm out of a period of unprecedented turmoil. One of his first actions, in fact, had been to reduce the size of this very office, as a symbol of his new approach to managing costs. Within a few months, he had recruited a crack executive team and had begun to restore confidence in the battered enterprise.
Now, however, in early 2009, new dangers lurked on the horizon. A financial crisis that many originally thought would be limited to the US spread rapidly around the globe. Because many key players in the Dubai real estate market were highly leveraged, concern began to turn into panic. The seventh annual Cityscape event in Dubai the previous October had been conducted in a glum mood, in sharp contrast to the frothy optimism of the previous two boom years. Clearly further action was required to sustain confidence in Deyaar and ensure its survivability in the face of an economic tsunami. Giebel believed that fear of failure could paralyze the organization, making failure more likely. What should he do, he wondered, to safeguard Deyaar, sustain motivation as its turnaround continued, and focus people on pursuing a bright future together?

Boom and Bust: The Impact of the Global Financial Crisis on the Dubai Property Market

The discovery of oil in Dubai in 1966, had led to extraordinary period of economic growth in the Emirate. A wave of foreign workers descended upon the city state resulting in its population tripling in size between 1968 and 1975.  Revenues generated by oil allowed the city to quickly expand infrastructure, including schools, hospitals and roads, to meet the increasing demands of Dubai’s swelling population, and saw Dubai establish itself as a regional business and tourism hub.

Recognising the need to diversify its economy away from its dependence on what it knew to be limited oil reserves, Dubai focused on becoming a regional business centre and the largest re-exporting centre in the Middle East.  In doing this it drew upon its strategic location, long trading history, excellent infrastructure and liberal government policies to attract international businesses to the Emirate. The success of this policy was reinforced when, in the 1990s, unrest in neighbouring countries such as Kuwait, Iran and Bahrain saw a growing number of foreign companies establishing headquarters in the Emirate.

At the same time, the Dubai government made a strategic decision to develop the Emirate as a major international tourism destination leading to significant investment in tourism infrastructure. This strategy was very successful, bringing an increasing number of visitors to Dubai, as well as an influx of expatriates relocating to the Emirate to work. 

In 2002, a government decree allowing foreigners to hold freehold title to property led to a subsequent boom in the Emirate’s real estate sector. The level of construction activity increased rapidly to keep pace with what seemed an insatiable demand for property investment in the Emirate. However, as the global 

financial crisis that had started in the US began to unfold in the second half of 2008, questions began to arise as to the likely impact it would have on the local economy, and in particular on what many market observers at the time saw as an overheated property market.

As credit problems and economic contraction spread to the Middle East, it seemed nowhere was immune to the fallout of the crisis. Liquidity in the credit market dried up almost overnight, business and consumer confidence fell sharply, the level of bankruptcies and job losses mounted rapidly, and a flight of capital occurred as investors shifted away from investments in emerging market economies such as Dubai. The consequent collapse in the Dubai real estate market caught many investors and property developers by surprise. Property prices tumbled sharply and the number of property sales, especially off-plan, fell to close to zero.

Markus Giebel Takes the Helm at Deyaar

Established in 2002, coinciding with a government decree allowing foreigners to hold freehold title to property in Dubai, Deyaar had in the ensuing six years become one of the largest publicly listed property developers in the United Arab Emirates (UAE). The company’s development activities were focused on mixed-use property developments across the Emirate, including locations in Business Bay, Dubai Marina, Dubai Waterfront, Jumeirah Lake Towers and Downtown Jebel Ali. On the back of Dubai’s booming property market Deyaar had become one of the fastest growing property development companies in the region and had consistently recorded double digit profit growth.

In March, 2008, Deyaar CEO Zack Shahin (Shahin) was detained on charges of embezzlement and accepting bribes. Deyaar lost some investor confidence by failing to disclose Shahin’s arrest to the Dubai Financial Market for 21 days. The chief operating officer, chairman and vice-chairman resigned at the end of the month, and three other arrests were made during the next few weeks in connection with the case. When His Excellency Nasser Bin Hassan Al Shaikh was appointed as Deyaar’s new non-executive chairman, he called Markus Giebel, CEO of Dubai-based investment boutique Vedera Capital, and asked if the German executive would take over as CEO. (See Exhibit 1 for Markus Giebel’s biography.) Giebel recounted:

“I said I had a company already, Vedera Capital, so I had no time.  We talked, and I eventually said, ‘Let’s make a gentleman’s agreement: call me if you don’t find someone in three months.’  Three months later, he called again and I asked, ‘Did you look?’  He said, ‘I have no one,’ so I accepted the position with no salary negotiation. The leadership element was important — if you have a good leader you respect and trust and he asks you for something, your motivation rises. The man who offered me the job is someone I wanted to be associated with. Also, the market and economy were booming, so joining a publicly traded real estate company made sense to me.”

On his first day at work, Giebel recalled:

“I was taken up to my office, which was the size of a basketball court. An entire 15,000 square foot floor housed two people: the CEO and the COO. My secretary came in at 1 pm to tell me lunch was ready. I thought they would bring me lunch in my office, but she ushered me to a separate room where a three-course meal was served on a tablecloth. I said right then that the spending spree is over; this is unjustified and wastes shareholder value. I told my secretary I wanted a salad or a sandwich I would eat while sitting at my computer.”

It seemed to Giebel that his palatial office had exemplified the culture that had grown up during the boom times. When the property market was strong, business was easy for Dubai developers such as Deyaar: they acquired land, drew up plans, sold properties off-plan, built them, and raked in profits. Noted Giebel, “The company was driven by “quick” profit, and long term sustainability didn’t matter as much.” As a symbolic first gesture, Giebel reduced the size of his office by 2/3 and created office spaces near his for other executives to share the floor.

Giebel spent most of his first months as CEO listening. He went to every floor and met every employee, including the tea servers. He shook hands, introduced himself as the new CEO, and asked each employee what was their role. That sent a strong signal to employees, who were used to two powerful individuals making all decisions behind closed doors. Giebel commented:

“It was a little bit of a personal touch with everyone who works in the company. I didn’t make any decisions the first month unless they were absolutely necessary. I gave a small speech to the company saying that I was going to institute an open-door policy: anyone could see me as long as his or her supervisor was informed. I started coffee clubs, gathering 10-15 staff at a time to meet in my office and ask any questions they had.”

Giebel soon found that the company was paralyzed with fear and indecision. “The CEO had been detained and there were auditors everywhere,” he explained. “The chief operating officer disappeared and the chief financial officer and vice president of marketing had left.” The remaining management team found it difficult to move forward under the shadow of suspicion into which the company had been cast. “Everything was stagnant — with the auditors around, people thought ‘It’s better if I don’t do anything than if I do something wrong,’” Giebel remarked.

Giebel also found that basic facts were difficult to come by. The company had no clear dashboard, no single place where it was possible to view the big picture of what was happening. He decided that his top priority would be to hire a new CFO and understand where the money was going. Through a consulting company that had been engaged with Deyaar before Giebel’s arrival, he located a strong candidate, Sundaresan Krishnamurthy (Krishnamurthy), a Senior Vice President of Finance within the Dubai Investment Group. (See Exhibit 2 for Krishnamurthy’s biography.) Said Giebel:

“I learned something important when I hired Krishna. The first time I met him, we had a good conversation but I wanted a firmer handshake from him. I said to colleagues after the meeting that he had good subject matter expertise but his handshake put me off a bit. Paying attention to that would have been a huge mistake — we couldn’t have fixed the company without him. The story to learn is that little things can put unjustified uncertainties in your mind, and you have to pay attention to what matters most.”

Beginning a Turn-around

Krishnamurthy joined Deyaar on October, 9, 2008. He was on board only two days before his predecessor left, so any handover was minimal. He recalled:

“I had a lot of sleepless nights at first. IT, financial and accounting teams reported to me, and I spent a lot of time understanding what they were doing, what problems they were facing, and how to get over them. We had to take stock: we didn’t know where we were. The job of the first fifteen or twenty days was to get the basic facts right: profitability, project status, what project payments are due, and so on. It took me about 45 days to understand the balance sheet thoroughly: what numbers were good, where were the problem areas, and what we had to focus on. Going deep into the information sources was a good thing to do: once we knew where we were, it was simpler to make an action plan.”

While Krishnamurthy was gaining control of Deyaar’s numbers, it became increasingly clear that the global financial crisis would have a heavy impact on Dubai. Giebel made an unusual decision for a Dubai property development company: he decided to create a strategy office. If a financial crisis was going to sweep over the Dubai market, he reasoned, two things would matter most: strategy and communications. He needed a financially savvy chief strategy officer to stress-test Deyaar’s cash flows under different assumptions. He turned to one of his co-founders at Vedera, Dimitre Michev (Michev), and persuaded him to join Deyaar in November, 2008 as Vice President of Strategic Planning. (See Exhibit 3 for Michev’s biography.) Michev recounted:

“At the Cityscape event in 2008, it became very obvious that there would be a crisis. Morgan Stanley predicted that property prices would drop 10% between 2008 and 2010 in their base case forecast (Morgan Stanley Research, MENA – Property Winners and Losers in MENA Property, August 4, 2008).  Cityscape was a quiet event — there were hardly any transactions. Markus came to me and said ‘Deyaar has no strategic planning, no business plan, and no proper analysis of the company. We don’t know to what extent our receivables are exposed to default risk. I need you to join me full time to take Deyaar from where it is to being one of the strongest companies in the market.’ ”

Richard Imran Ding (Ding) (see Exhibit 4 for Ding’s biography), VP Legal and General Counsel of Deyaar had been with Deyaar since 2005 and kept Giebel, Krishnamurthy and Michev updated on the issues facing the company and the crippling effect of indecision. The fear of making decisions was profound and Deyaar was going to suffer the consequences of inaction. Richard kept the team updated also on the legal issues being faced, in a constantly evolving legal environment, and how legal was keeping a control on things – at least in some way - to keep things moving. Ding said:

“The effect was profound. Nothing was moving. When Markus came on board, it was important that he knew that things were stagnating. I had some discussions with him on some of his ideas and plans and knew that he and the new management team that will come forward, would be good for Deyaar. Shareholder and investor confidence would be restored and Deyaar would shine again. In this respect, I knew I could help and it was imperative that Markus, Krishna and Dimitre who were new in Deyaar be given the facts so that they could hit the ground running.”

Once Krishnamurthy and Michev were on board, Giebel communicated to employees that there would be no mass firings. He explained:

“As soon as we had the best CFO and strategist on board, I was confident nothing much could happen to us. If you hire the wrong people at the beginning of a turnaround, the stability of the company is jeopardized. If you fire the wrong people, it is a disaster. You have to get the pillars of the company right before you make big people moves. Reducing payroll was not going to make or break the company, so we decided to hold on until we understood how big the crisis was and put our key pillars in place. We would have time later to top grade the work force.”

Added Michev:

“Most companies in a turn-around situation just fire people. Our profit was 1.1 billion dirhams in 2008, and our payroll was 100 million dirhams, so what do you achieve if you fire everybody? If you fire the wrong person, you can really be in trouble.”

Giebel made one exception to this policy, disbanding Deyaar’s brokerage department. This operation had not performed financially, and Giebel believed that if it couldn’t make money in a boom market, it had no chance in a downturn. Noted Michev:

“When the crisis started, other companies started mass firing, but we only let the brokers go.  They were paid by commission, and it was obvious that without transactions, they couldn’t survive. We offered to relocate some of the best to other positions, but most didn’t want to do that.”

Added Krishnamurthy:

“We took a strategic stake in a brokerage company, so we had to ask why we needed 30 people doing that for us who could only make money when prices were good. We placed a couple of good ones into the brokerage company, and were generous with terminal benefits for the rest.  We gave them three months’ severance in addition to end-of-service benefits, and we protected their visas to stay in Dubai so they could find other jobs. We held 1:1 meetings with each person to explain the process and to suggest what they were good at and where they might want to upgrade their skills. Very few companies say ‘thank you’ and take extra time with people to help them move forward.”

Having made key people decisions, Giebel’s two priorities were charting a turnaround strategy and communicating it clearly, both internally and externally. “In those difficult days, strategy and communication were the two most important things,” Giebel recalled. The new team’s greatest advantage was its ability to assess the situation objectively. Said Michev: 

“In November 2008, people were still saying there was no crisis. Things would be fine by National Day (in early December). Then they kept advancing the date — things would be fine by the New Year, or in the spring. We said there was definitely a crisis, and we had to stress-test our cash flows, see what would happen if you continued with this portfolio or that one.”

Added Giebel:

“Doing this analysis with no emotions was the most important thing. We are not attached to buildings because they are beautiful. The biggest problem people face is that they get emotionally attached to projects. Each project becomes someone’s baby. The people who run projects have great reluctance to do cash flow analysis. But if there is resistance in top management, you can lose hundreds of millions by letting projects continue too long.”

The new management team had to shift Deyaar’s mindset away from pursuing profit growth at any cost. The company had always focused on steadily increasing profits with little regard for a long term outlook. “We shifted the paradigm from profit to cash, where debt matters a great deal,” Giebel said. “That had direct implications for how we dealt with vendors, architects, and so on. All the other developers asked first what the customer wanted them to do. I said the right question is what is your strategy — look at the portfolio and ask what is best for both of us.”

Turning Crisis Into Opportunity: Deyaar’s Turnaround Strategies

As the impact of the financial crisis spread and economic conditions deteriorated, a dramatic change in the fundamentals underpinning the Dubai property market became apparent. Job cuts and a lack of liquidity in mortgage markets saw the demand for properties fall sharply, driving a decline in property values. Deyaar’s leadership team built models using worst-case scenarios based on the 1997 crash in Hong Kong and Singapore, where in ten years the market recovered to 70% of peak values. (See Exhibit 5 for a forecast of Dubai property market dynamics produced by Deyaar.)

The results were frightening: cash flow would become negative if property prices dipped by more than 20%. (See Exhibit 6 for a graphical depiction of the analysis.) If prices fell by 50% and management did nothing, 60% of customers could be expected to default. Deyaar had some 30 buildings at various stages of development. The management team put each project under a microscope, with a ruthless focus on cash flow. Explained Krishnamurthy:

“We knew what projects we were going to do, so we analyzed cash flow project by project: how much cash will we need and how much are we likely to get. This focused us on how to save cash and ensure each dirham was wisely spent. We analyzed our cash flow needs for the next year to ensure that we would not spend more than we could obtain in bank financing. We did a complete analysis of inflows and outflows so the cash we had would stay with us during the crisis.”

Building a business plan based on this analysis required more data that was not easy to obtain. Commented Michev:

“In investment banking, you call someone and the documents you need show up right away by email. Here, I had to sit with each key executive to get a handle on what Deyaar was, so we could prepare a business plan and budget for 2009. With the sales people, we looked at our portfolio to see what percentage of customers were speculators and what percentage were end users. We looked at each property we were managing and each project under construction. It was a lot of work, but it allowed us to create a business plan that showed the banks and our employees exactly what the situation was and what we were going to do about it.”

Basic data on customers was missing. Explained Giebel:

“We didn’t know them. We didn’t know which were investors, which were end users, and how much debt they had. I said ‘let’s talk to the customers,’ but we had 7400 active customers and we couldn’t find phone numbers or addresses for 1000 of them. Three different groups of people interacted with customers: project managers, facility managers, and sales people. They were in three different locations and none of them talked to each other. We brought them all into one place and created a new customer service center. During the crisis, we hired 20 people to staff that center, building it up so we could monitor anything.”

Deyaar’s most urgent need was to keep customers from defaulting. Only by preserving payments and cash flows could the company safeguard itself and preserve options for future growth according to the 2015 vision. Commented Krishnamurthy: “The biggest challenge was to collect money from customers. Anyone who had paid 10% down would not pay the other 90% once the market dropped by 30%.” Working proactively with customers to help them avoid default was essential. Customers who had a portfolio of assets were most likely to default on properties held by developers who did nothing more than demand payment.

The management team’s project-by-project, customer-by-customer analysis suggested that three main factors would govern the default rate in the portfolio (See Exhibit 7). Location was the first. Projects experiencing significant delays in installing infrastructure (e.g. electricity, water and roads) would likely produce high default rates. Price was the second. Projects priced at the peak of the market were expected to generate high default rates. Cash flow was the third. Even projects with good locations and good prices could experience defaults if customers faced liquidity problems.

By December 2008, Giebel was ready to present to the board his team’s projections and proposed transition strategy. The business plan for turning around the company and then resuming growth toward a new vision was approved by the directors, then shown to Deyaar’s banks. Giebel believed that if it managed cash properly and safeguarded the business, Deyaar would emerge from the crisis stronger than its competition. Then, by top grading the company’s human capital, it could implement Blue Ocean strategies to achieve a vision for 2015. This three-phase approach (See Exhibit 8) was the cornerstone of the business plan Michev was in charge of developing. Explained Giebel:

“In any turnaround situation, you have three big blocks of activities. First, you have to safeguard the company, usually through some form of financial engineering. Second, you have to get the right talent and fire people who are not A players. Third, you have to communicate a five year vision. You must do these three things in any turnaround, and the first is the most important.”