The Fuse

In the Face of Risks and Questions, Saudi Aramco Presses Forward with IPO

by Nick Cunningham | October 30, 2019

After multiple delays, Saudi Aramco plans on moving forward with initial public offering in the next few weeks.

The partial IPO of Saudi Arabia’s state-owned oil company remains a key objective for the kingdom, as well as for the crown prince’s long-term plans to diversify the Saudi economy. But the multi-year saga is not over, and plenty of hurdles remain.

The on-again off-again IPO
There have been multiple delays to the public offering, a plan that was originally revealed to the world nearly four years ago. A persistent glut in the oil market delayed the offering, and so too did the unexpected complexity of selling off a part of the secretive state-owned company.

Crown Prince Mohammed bin Salman (MbS) has made the partial sale a top priority. More details will be revealed on November 3, but press reports indicate that the subscription period for investors will begin on December 4, and trading on the Saudi stock exchange, the Tadawul, a week later.

How much should the valuation of an oil company be discounted if it is vulnerable to major attacks?

The most recent setback to the IPO came from the Abqaiq attack in September, which overnight slashed Aramco’s production dramatically. Worse, it revealed a vulnerability that had largely not been taken into account. Pricing in geopolitical risk to the company’s valuation presents enormous questions. How much should the valuation of an oil company be discounted if it is vulnerable to major attacks?

There are other questions that differentiate Aramco from most publicly-traded companies. To what degree is there government interference? To what degree will Aramco be responsible for propping up other parts of government spending? Also, how will Aramco’s operations be affected by Saudi Arabia’s role in OPEC+, which currently includes production curtailments?

But the biggest sticking point has been the valuation. For years, Saudi officials have claimed that Aramco should be valued at $2 trillion. A 5 percent public offering of the company could raise around $100 billion, and the proceeds could be invested in any number of priorities that the government sees fit. Similarly, if the kingdom chose to sell 3 percent of the company, it would raise $60 billion, based on the valuation that MbS is seeking.

However, the problem is that almost any analyst that has looked under the hood does not think that Aramco is worth nearly that amount. The IPO has been delayed several times as Saudi officials seek to muster up support for the $2-trillion-dollar figure. Aramco has hired several hundred bankers around the world trying to sell the deal, Bloomberg reported.

Even if Aramco was somehow able to obtain a valuation of $2 trillion, it would increase the likelihood that the share price would then fall sharply after it begins to trade publicly. Such a decline could destabilize the entire Saudi stock exchange, the Tadawul, sources told the FT. For those that bought in, they would be nursing huge losses. The FT reports that the government is pressuring wealthy Saudis to invest, some of whom were ensnared in the crown prince’s infamous 2017 crackdown at the Ritz-Carlton. Some banks in Riyadh are also reportedly lending to investors so that they can buy shares.

The transaction price is expected to be announced on November 17, although the date could slip once again if the crown prince’s valuation target is not met, according to the FT.

“At first, 1%-2% of the company is to be floated. Given the company‘s targeted valuation of $2 trillion, $20-40 billion would need to be drummed up, which seems ambitious given the lack of interest among international investors,” Commerzbank said in a note. “The Royal Family’s original plans to list the company’s shares also on international exchanges such as New York or London have already been dropped.”

A fork in the road
The Aramco IPO comes at a pivotal time. The Saudi economy is growing at a lackluster rate. Globally, the crown prince’s standing is severely diminished. After seeing the red carpet rolled out for him by American media, politicians, CEOs and investors just 18 months ago, MbS became something of an international pariah in the wake of the failed war in Yemen and the brutal murder and dismemberment of Saudi journalist Jamal Khashoggi.

Saudi Arabia is hosting the Financial Investment Initiative (FII) this week, often likened as “Davos in the Desert.” The Kingdom is desperate to make it a success, and it comes one year after the Khashoggi murder. While major investors spurned the FII last year, many have returned this time around.

Saudi officials are aiming to overcome these hurdles and turn the Aramco offering into a success. Aramco just told financial analysts working on the IPO that it earned $68 billion in the first nine months of 2019, a figure that makes it by far the most profitable company in the world, according to Bloomberg. Last year, the company earned $111 billion.

While many of its problems are short-term in nature, a larger question for Aramco – and thus, for the company’s valuation – is the prospect of peak oil demand. Forecasts run the gamut, but many oil market analysts see demand hitting a peak over the next decade or so, after which consumption enters decline. It doesn’t take demand falling to zero for there to be substantial upheaval in the market. As coal-fired power plants continue to shutter, particularly in OECD countries, coal producers have been tossed into bankruptcy, even as coal remains a significant source of electricity around the world.

Aramco is not at risk of going out of business anytime soon, but persistently low prices will put a strain on government budgets

It’s not clear if the same will play out in the oil market, but the prospect of slowing and an eventual peak in demand means that oil prices will struggle to return to the heights seen prior to the 2014 meltdown. As a low-cost producer, Aramco is not at risk of going out of business anytime soon, but persistently low prices will put a strain on government budgets. Saudi Arabia needs oil prices to trade at about $86.60 per barrel for its budget to breakeven, according to the latest estimates from the IMF.

There is no danger of Riyadh running into an imminent budgetary crunch, but the longer oil prices trade below that mark, the more pressure there will be to cut output to boost prices or divert revenues to the government for other objectives. Needless to say, while these are long-term risks, they are completely relevant questions to Aramco’s upcoming IPO.