Three massive transactions in the Gulf states over the past few weeks have highlighted different paths for the regional economy. Uber paid $3.1 billion for competing ride-hailing firm Careem, Saudi state oil giant Aramco agreed to pay $69.1 billion to buy the Public Investment Fund’s 70 percent stake in petrochemical company Saudi Basic Industries Corporation, and Aramco then issued a prospectus to raise $10 billion or more in bonds to help pay for SABIC.
Careem is the Middle East’s standout technology startup success. Yet, along with online shopping portal Souq, acquired by Amazon in 2017, it is the exception that proves the rule. Truly technologically innovative, export-oriented startups are in short supply in the region.
In contrast, the “back-to-basics” economic strategy now underway in the region represents a partial retreat, or at least a refocusing, from the ambitious diversification goals of past years. It aims to create more value, government revenue, and employment from the core natural resource sector, in which mining, metals, and a greater focus on gas slightly vary the theme of oil dependence.
A degree of future-proofing is intended by expanding refining and petrochemicals, both at home and in fast-growing Asian markets. More specialty chemical production generates greater employment and export sophistication. The Gulf national oil companies have not yet moved as far as the European majors – particularly Shell, Total, and Equinor – in building post-oil businesses that may encompass renewables, batteries, retail electricity, and hydrogen.
Buying SABIC takes Aramco a lot closer to its strategic petrochemical goals and avoids competition between the two giants. But it does not add much to the kingdom that it did not already have, other than perhaps some cost savings.
The long delay in finalizing the combination appears to reflect disagreement over the price and Aramco’s concerns over SABIC’s staffing. Aramco wanted to pay less, but the Public Investment Fund held out for the market value as reflected on the Tadawul stock exchange when the deal emerged in July 2018. Aramco did at least secure the concession that it would pay for most of the deal in instalments over two years, with $10 billion up front financed by a bond. SABIC boosts its enterprise value by about 5 percent, but its employee roster by half.
Financially, the SABIC deal just moves money from one pocket to another. The government could have achieved the same effect by having Aramco issue debt, pay a special dividend, and then allocate it to capitalize the Public Investment Fund.
To make the deal more than a bookkeeping exercise, and to boost its value closer to the aspired $2 trillion for any eventual initial public offering, Aramco will have to generate benefits from its erstwhile rival. This can include operational synergies, but more interesting would be to leverage the two companies’ research portfolios, their cooperation on converting crude oil directly to chemicals, and in general the integration of Aramco’s refineries more closely with petrochemical plants. This will be complicated while 30 percent of SABIC remains with public shareholders, and there are no plans to buy them out. Aramco may sell off some parts of SABIC that do not coincide with its core business, such as the steel (Hadeed) and fertilizer divisions.
The bond prospectus, meanwhile, emphasizes Aramco’s strengths, the key one being its enormous, low-cost oil resources handled by a capable, technologically savvy organization. Its financial position is very strong, with annual revenue of $356 billion, profits of $111 billion, $48.8 billion cash in hand, and only $27 billion of debt. Its credit rating is constrained by the sovereign: It would rate AAA, the highest possible, on its own merits, but Fitch gives it A+, the fifth-highest rating, equivalent to the country. It is clear that the Saudi government has full discretion to dip into its coffers by raising royalties, taxes, or dividends or by requiring further purchases of other state assets.
Aramco’s bond has reportedly attracted interest of over $100 billion, and it eventually chose to up the offering from $10 to $12 billion, at even lower interest rates than Saudi government debt. Borrowings at this level are readily sustainable, but the issuance is part of a growing trend for Gulf state oil companies to take on debt. Petroleum Development Oman issued $4 billion in a loan secured by oil exports in 2017, and Abu Dhabi Crude Oil Pipeline, a subsidiary of the Abu Dhabi National Oil Company, floated a $3 billion bond in November 2017. This partly reflects a sensible optimization of capital structure. But the funds raised have to be used productively, not simply as part of propping up government finances, while Oman and Saudi Arabia in particular continue to run large deficits.
In August 2018, the Public Investment Fund took out an $11 billion loan. The Vision Fund, heavily backed by $45 billion from the Public Investment Fund, and $15 billion from Abu Dhabi’s Mubadala, borrowed $3 billion from banks in March. There is an obvious danger when a large sovereign wealth fund becomes a leveraged venture capitalist.
The Public Investment Fund owns an indirect 6.2 percent in Careem via Saudi Telecom and is on the other side of the deal via 5 percent of Uber. Other very partial hedges against a possible future of declining oil demand include 4.9 percent in Tesla, $1 billion in competing electric car maker Lucid Motors, and the Vision Fund’s plans for massive solar power investments.
The sale of SABIC reduces the Public Investment Fund ’s weight in the domestic economy, but it remains prominent in oil services, electricity, water, mining, tankers, ports, railways, tech and industrial incubators, banks, telecoms, and the stock exchange – the Tadawul. Several of these firms are also partially owned by Aramco and/or SABIC, as well as by private Saudi investors. Despite the upgrade of the Tadawul to the MCSI Emerging Market index, foreign ownership of stocks is still very small, just over 5 percent.
The state hand in the Saudi economy is already too heavy. Attracting foreign direct investment has proved increasingly difficult in recent years, with net inflows barely 1 percent of gross domestic product from 2013 onward, plunging to 0.2 percent in 2017 (a total of just $1.2 billion for the year), although picking up somewhat in 2018. The planned privatization program has hardly advanced. The Saudi Electricity Company has been restructured in advance of a planned part sale, but Aramco’s IPO has stalled, ostensibly because of the SABIC deal.
The government needs to decide which of its direct holdings are genuinely strategic and essential; which could do better in the hands of another state entity, such as Aramco’s acquisition of SABIC; and which could be divested entirely or at least sold down. Then it needs to determine how successful international Public Investment Fund investments could be leveraged to benefit the domestic economy, without squashing local private initiatives.
This is just part of a wider conundrum: how to raise government revenue and exports, increase taxes, create well-paid citizen employment, boost the economy’s technological level, reduce dependence on oil, and cut subsidies, all over the next decade. Building on the very real strengths of Aramco and SABIC is the easy part. The hard part is to create the conditions for the next Careem, not crowd it out.
