How does the Iranian bombardment impact a company's valuations in Dubai?

While working for years in consulting, I used to value every single step I made. Any recommendation or any move shall have a clear and explicit answer to the questions “why”, “how”, “when”, and “what impact it’s going to have”. When there were no answers to any of these questions - well, it requires another coffee, problem-solving, and sleepless nights. It was mandatory to think through the problem to get from a client a round of applause and “a-ha” moment. 

Now, as I am growing our M&A activity track record at Alex Bond Capital, I face similar challenges, but on a much broader scale. As we are actively looking for the acquisition of a Dubai SME, we have raised a question: how does the conflict impact the valuations of Dubai companies? And if there is any systematic and well-balanced approach to value the impact? Well, let’s try to use it. 

Let’s draw a formula to analyze the discount/premium of a business operating in a country experiencing the horror of a military conflict. Let’s use 5 dimensions: industry, scale, flexibility, duration, and the conflict’s output (whether a country has won or lost). Please note that the following split could be further developed into more narrowly defined factors, including the competition, client base, etc.

1. Industry. The most important aspect is industry. It’s objectively clear that some of the businesses (i.e., HoReCa or apparel) may instantly collapse due to the conflict, while others (i.e., wholesale food supply, metal construction production, or even escort services) could thrive. Typically, the affected country's leadership tries to derail the current economy and shift it to self-sustainability and self-sufficiency, covering the major economic veins and protecting it from bottlenecks. This is what has happened previously (in Napoleon's time in France, WWI, WWII) and recently (in Ukraine), and that’s what is expected to happen in the future. To find an answer in the industry, it is important to judge the demand carefully. For example, I do believe that when we talk about kindergarten or the healthcare industry in Dubai, the demand may drastically fall by -30 -60% (at least within the first 3-9 months). At the same metal works, businesses and military supply may double in size. 

2. Scale. This one is quite obvious: it depends on the size of the business, its production capacity, and international exposure. A particular country or region could lead to just a minor decline in the revenue of the larger holding group if its daughter companies spread across the broader region. Otherwise, if the business is in the epicenter of the conflict, it may be stressed out enough to lock its doors forever, regardless of the budget on hand. No compromises here. For example, on the day of the Russian attacking Ukraine, McDonald's Ukraine has temporary shot down all its restaurants. While in 6 months they have returned to operations, and in 4 years from the emergence of the conflict, the food chain opens new restaurants (mostly regained its popularity). 

3. Flexibility. Whether the leadership of a firm is ready to adjust its regular working conditions to the new reality is also important to judge. After COVID-19, many owners became more flexible; however, the question became the sliding performance of remote workers. During a conflict, some companies may require their staff members to show up in the office, while others are allowed to stay at home/shelter. To understand if a military conflict has direct negative consequences on a company’s performance, one needs to study the current compensation and infrastructure of a firm: how people are getting paid, how far they live, whether they are independent enough to deliver the real value remotely, or require constant supervision. Can the manufacturing facility be reassembled (if needed) and moved from the impacted area to another place where it’s safer? Can the business transition naturally into another market segment with the same capabilities it has now? When it’s life-threatening and hard to continue any operations, it’s flexibility that matters.  Although it is important to support those who were affected by the conflict, when a business starts supplying without returning the productivity or an output, it’s a way to nowhere. Some businesses (like b2b services) are inherently more flexible than others (i.e., heavy machinery production facilities or mining assets).

4. Conflict duration. It’s not a secret that a fight becomes less exciting when it lasts longer than expected. The reason is that instead of spending 2-4% of the annual budget on military, affected countries shall scale it up to 25-40%. This is another reason that some of the companies, which previously fit the general economy in almost a day, become obsolete. It’s not only B2G suppliers, but also a wide range of supporting producers, like paint manufacturers, etc.

5. Conflict’s output. Businesses in the same industry in attacking and defending states/countries demand different approaches for valuations. For example, if an aggressor pays reparations to the defeated party, the defeated party may massively increase its expenses in all construction-related industries, as it shall be physically rebuilt. Hence, players who provide services, like MER, will also experience demand. At the same time, if the defeated party pays reparations to the aggressor, its construction industry is expected to shrink, as the country will need to tighten its belt more rigidly and delay potential construction spending for “better times”. 

So, well, how then shall we use this approach? Well, here is where the true value of a strategic value-based investor comes on stage. And that’s where one may act boldly: either double down or step away from the countries affected. As for Dubai, it will be rational to assume a certain discount to be provided to the acquirers of the businesses within a range of -20% to -50% to pre-conflict valuations. And the more discounts, the heavier the businesses are affected by the current events. At least that’s what we have seen across the world during various military conflicts of recent years. And, as we like Dubai and aren’t afraid of events, expect us to double our efforts in buying great companies there. 

Example: 

A dental company that serves kids. 

Initial pre-conflict valuation: 11x. 

Impact of the conflict:

1. Industry: the dental industry massively relies on the locations, staff availability, and physical clients’ visits. -1x.

2. Scale: mainly the customers are locals and tourists, with revenue of Dubai accounting for c. 30% of the total group. We expect that the demand will fall in the emirate by 50% in the next 9-12 months and will not recover within the next 3 years. -1.5x.

3. Flexibility: the locations can’t easily be transferred or placed in shelters, hence -0.5x.

4. Conflict duration: 1.1 for 3+ months, 1.4 for 6+ months, 1.7 for 9+ months, 2x for 12+ months.

5. Conflict output: If Dubai wins the war, we expect a large population to return with their families to regain the pre-conflict demand within the next 3 years. However, no extra growth stimulus is expected. Impact = 0x.

Results: 11x -1x - 1.5x - 0.5x =9x (at max, without duration factored) and 11x - 3x*1.1 = 7.7x, 11x-3x*1.4 = 6.8x, 11x-3x*1.7 = 5.9x, 11x-3x*2=5x (with a duration).