Summary: Saudi Aramco’s IPO faces significant hurdles related to valuation, oil price and yield.
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3 thoughts on “Saudi Aramco: Yield is the key”
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Yesterday’s launch of the IPO underlined the lack of interest among non-domestic investors, albeit without telling us much which was new. However, one snippet I did find new and interesting, ie that the IPO roadshow will not be going to either Japan or the US.
Together with China, Japan is the biggest Asian buyer of Saudi oil. And the US is, of course, a close Saudi ally. I wouldn’t want to read too much into their omission from the roadshow as there is, of course, a world of difference between inter-government relations and private investor perceptions. But it is still geopolitically interesting, in my view, especially since Aramco and its bankers are reportedly concentrating on Chinese and Russian de facto sovereign funds in their quest for non-domestic investors. In short, the focus appears to be on countries which are looking to build closer ties with the Kingdom and therefore have reason to buy which goes beyond just return on investment. Shifting sands indeed.
This being said, as the comment published yesterday on my 11 November article for the Newsletter makes clear, the vast majority of the take-up is clearly going to have to be domestic.
Looking farther out, I think it fair to assume that MbS will be very determined to ensure that Aramco is seen as a good investment in the weeks and months after the IPO in the hope of floating more of the company in the not too distant future and, this time, pulling in more foreign capital. If I am correct, it is going to be very interesting to see how this impacts on Saudi policy in Opec+ at a time when it is clear that the percentage of the world’s oil being produced by Opec itself is in, probably long-term, decline.
Now that Aramco has lost its chance for any kind of float outside KSA and dropped all plans to sell shares abroad, everything is taking place inside the country. But even there the government has had to introduce special measures so the IPO can go ahead.
Several of the most important conditions the Tadawul normally imposes on any company that floats have been waived. For example, the standard listing rules state a company must offer at least 30% of its shares to the public to gain a listing on the main market – but not in this case. An exemption has also been issued so that non-resident institutional foreign investors can subscribe.
Despite its size – the Arabic version is 806 pages and the English one about 658 pages – the Aramco prospectus lacks substance making it hard to condense it even into a meaningful 3-page summary. It clearly states you cannot sell your shares for 6 months and even after that there is no guarantee the ban will be removed. It could be extended for another 6 months.
Besides relaxing the regulations on Aramco, to boost the IPO banks are being forced to raise their credit limit from 85% to 90%. Banks are being forced over the 90% barrier as there is insufficient liquidity in the whole country to buy even 2% of Aramco. Current liquidity in the market is in the range of USD $50 bn. If the people are forced to buy shares in a 2% IPO this will consume $40 bn. When this money ends up in some account in Switzerland or the Bahamas where will the liquidity come from to run the country? How could USD $10 bn be enough?
Banks have also been forced to retrieve dead loans by settling with whatever debtors can offer – even as little as 10%. So for example someone indebted to Al Rajhi bank for SAR 1 bn can pay just SAR 100 bn and the bank will scratch their debt completely. People with large outstanding loans at the bank have been contacted and informed if they have any cash available the bank is willing to settle. ‘Give us whatever you have and we will scratch your loan’. I have spoken to people who were offered this, they accepted it, and their debt was wiped.
MBS is of course extremely keen the IPO will succeed and so the campaign to encourage people to invest is immense. The regime is using all its tools to force or mislead people in order that they buy shares. Even intellectuals and writers with no connection to Aramco are encouraging people to invest and warning them that if they do not their patriotism is open to question. Any day now Saudis are expecting the Council of Senior Religious Scholars to issue a fatwa saying it is every Muslim’s religious duty to buy Aramco shares!
What is curious is how normal all this has become. Mujtahidd was the first to mention that MBS is coercing Saudi businessmen to buy Aramco shares and that otherwise they would end up in the Ritz. Now everyone is saying it – the WSJ, Bloomberg, FT – and so this has become common knowledge. But just like people have become used to Trump lying everyday, so people are growing used to MBS using force to get what he wants. Such behaviour has become normalised, it no longer even raises eyebrows. Western media reports MBS’s extortion matter of factly, just another piece of business news.
There is no poll to tell us what Saudis think about all this but Twitter – which remains the best available means for judging Saudi public opinion – indicates scepticism is dominant and that there is widespread doubt about the government’s narrative. In my opinion, what will happen is that MBS will decide at the end of November whether to proceed based on the reports he receives from his agents about whether they will be able to collect the 2% cover from the business community or not. If he can guarantee that a sufficient number of big businessmen will buy 1 or 2% he will go for it. But if this cannot be secured even by force and manipulation, I think he will cancel the IPO.
A few comments about the Aramco IPO:
– At this valuation, the only hope the Saudis have of attracting foreign investors is if there’s a broader political angle to the investment. Reports last week that Chinese government-linked firms are looking to invest fit this model. Purely private firms would only be willing to invest, in my view, if there’s some benefit to them in currying favour with the Saudi government.
– The restructuring of the royalty/tax treatment of Aramco revenue lowers the tax assessed by the sovereign when oil is below $70pb but raises it above this threshold. Thus investors are giving up most of the upside for higher dividends if oil rises significantly. It’s hard to see the value of buying an equity if most of the equity upside has been taken away.
– I fail to see how $1.5tn became the ‘consensus’ estimate for international investors’ valuation of Aramco. Many credible, thoughtful analyses written before the IPO news that I’ve seen were closer to $1.0-1.2tn. Several back-of-the-envelope attempts I made came up with figures in this range. I suspect the $1.5tn figure was a messaging campaign, possibly with support of stakeholders, that somehow got picked up by the media and echoed.
– Traders often complain of a price spread so wide you could ‘drive a lorry through it’. As Alastair points out, the recent valuation spreads put forward by analysts from the underwriting banks are so wide you could park Sweden’s economy in them. It seems that in most cases, the lower ends of these estimates were low enough to retain credibility among international investors, while the upper bounds were high enough to avoid attracting the wrath of the Saudi government. It strains credulity that a properly informed, qualified analyst would be unable to pin down the valuation without such a wide margin for error.
– I’m confident that the Saudi government will be able to place shares domestically (plus a few international placements to ‘strategic’ investors) at a price range in the recently touted $1.6-1.8tn range. What is more uncertain is how the implied valuation will change once the shares float. The Saudis must be very cognisant that a significant decline in the share price after flotation will damage their credibility in the eyes of foreign investors – which will hurt the chances of selling a second tranche of shares on international markets (which they need to attract foreign capital, which was the point of this exercise to begin with). I think the prospect of a Saudi-led OPEC cut should be seen in this context – not as an attempt to push the spot oil price up a few dollars per barrel, but to reduce the downside risks to the oil price in the months following the Aramco sale.
– Don’t forget that the Saudi government has been leaning on banks to lend to retail investors who want to buy the shares with borrowed money (and ensuring adequate liquidity in the system to permit such activity). Several times in the past Gulf governments have bailed out citizens who purchased shares with leverage on local exchanges only to see share prices tank. If Aramco shares tank shortly after the IPO, the Saudi government will face the double whammy of pressure to bail out citizen shareholders and buying back Aramco shares from what would be deemed a failed placement.