The upcoming float of Aramco is dividing market opinion. The listing of such a large firm, with a unique business model and numerous political peculiarities, is certainly a one-off. The analysis templates just don’t fit the situation. Also, in some ways, the IPO is catching the zeitgeist of the investment community. On the one hand, it’s the most profitable company in the world, on the other its future prospects are challenged by changing consumer tastes. A lot will come down to the price level at which the shares are listed, but a premium might tempt investors in to taking a position. Not least because digging down into the nature of oil demand raises an argument that Aramco might fare better than its peers as the markets see a general move away from oil.
The first problem for analysts is getting to grips with a firm of such a size. Although only about 1% of the firm’s shares will be publicly listed through this first IPO, suggestions are that the IPO will value the entire firm at somewhere between $1tn–$2tn. As Wall Street Journal’s James Mackintosh said, at the low end of the valuation, Aramco “will still be worth more than all Brazilian stocks, and the top valuation would make it worth more than Korean, Australian, Swiss or German stocks.”
Source: The Wall Street Journal
Then there is the question of the 1%. Any investors will be minority shareholders in a stock listed on the Saudi stock exchange the Tadawul. The majority shareholder will be the Saudi royal family, the figurehead of which is crown prince Mohammad bin Salman Al-Saud (MBS). A due diligence analysis of ‘key staff’ would pick up that recent news coverage of MBS centres around his alleged involvement in the murder of journalist Jamal Kashoggi. Another measure of the situation is that MBS plans to build a resort on the Red Sea coast called Neom, which will include flying taxis and be staffed by robots. Reports from Bloomberg suggest that work has already started on this ‘land of the future’ and that two Saudi construction firms have been awarded contracts to begin building housing for (human) workers.
The key question for many is that if the owner of the business is looking to scale down their exposure to their own business, then why might other investors want to pick up the pieces?
The simple answer is that making money never went out of fashion. Once listed, Aramco will become the world’s most profitable publicly owned company. It will have the world’s greatest known reserves and lowest per/barrel extraction costs. In terms of hard numbers, 2018 saw it generate $111bn in net income and some $86bn in free cash flow.
The plan is that the profitability of the firm manifests itself as a yield to shareholders of approximately 5% p/a. According to the summary prospectus, Aramco intends to pay out an incredible $75bn in cash dividends in 2020. Putting this into context reveals this number is approximately 30 times more than the $2.6bn Apple distributed to investors in 2018.
Investors willing to hold their nose on the way to the bank may be willing to take a position in what is essentially a non-voting preference share, which will likely hold a yield one or two percentage points higher than the peer group. It will be interesting to see how many rotate out of existing oil positions and into Aramco. There is even talk of it being a test of ‘loyalty’ for some institutional investors. Saudi investors make up a large part of the global investment industry, and shunning the IPO might be politically risky and even bring about redemptions from funds.
Some appear willing not to take up the opportunity to invest. Pavel Molchanov, director and energy analyst at Raymond James flagged up the governance issues as being a concern. CNBC reported him as saying:
“The biggest issue with Aramco is that everything about this company is controlled by the Saudi royal family — shareholder opinions, your board votes, none of that makes any difference.”
Ironically, whilst being bad news in absolute terms, the trend away from carbon fuels may offer Aramco a competitive advantage against its peer group. Green issues will be an increasing challenge for all the firms in the sector. The pressure will, however, be greatest on those with a higher cost base. With capital flowing out of the sector, firms such as Aramco, which have a secure capital stream, could reinvest rather than have to rely on a dwindling pool of global investors still willing to invest in oil. The Saudi regime is also much less tolerant of public demonstrations. Extinction Rebellion will get more bang for their buck protesting at the offices of the Western producers.
The price of oil can be expected to rise as other producers struggle to navigate the ‘green’ issues. The Saudi firm will be less exposed to direct political pressure but able to benefit from any associated price rise.
It’s completely understandable that the Saudis are looking to reduce their exposure to the family firm. Despite his wealth, even MBS has bills to pay. The IMF reports this year that the kingdom’s budget deficit has widened further to around 7% of its gross domestic product (GDP).
The ‘Risks’ section of the summary prospectus includes some big red flags. There is the very real risk of terrorist activities and all-out war. Governance issues are also worth noting, as is the political risk of product prices being largely dependent on OPEC. On the other hand, the ‘old-school’ political structure in Riyadh makes the firm more likely than its peers to be able to work around and possibly even benefit from the increasingly important ecological concerns of consumers and investors.