Bankers working on the initial public offering of Saudi Aramco have delivered their financial recommendation: that investors valued Aramco at well below $2 trillion. In turn, Saudi officials scrapped plans to market shares directly in the United States, Europe, and Asia. Aramco will float 1.5% of its shares on Riyadh’s Tadawul stock exchange for the time being. The subsequent IPO will target Saudis and foreigners licensed to invest in the kingdom – with some limited hope reserved for state investment vehicles in neighboring Gulf states and Asian countries.
The scaled-back listing and uncertain investor interest outside of the kingdom concede a contradiction at the heart of the Aramco IPO: Saudi efforts to convince investors of Aramco’s value are fundamentally at odds with simultaneous plans to diversify the country’s economy away from its dependence on hydrocarbon revenue. The Saudi government does not see a viable, long-term future in oil and gas but continues to hope that investors will measure the country’s crown jewel differently.
Adjusting Expectations
Since plans for an Aramco IPO were announced in 2016, the contradiction between the company’s valuation and long-term future has been reconciled with the notion that all of the parties participating in the IPO could benefit financially. It is now clear that the various stakeholders must adjust their expectations of a financial windfall. The Saudi government wanted to receive $100 billion by selling 5% of a $2 trillion company. Yet Aramco set its offer price range between 30 and 32 Saudi Arabian riyals ($8-$8.53) per share, suggesting a valuation of between $1.6 trillion and $1.7 trillion. Listing 1.5% of Aramco shares at this price could generate as much as $25.6 billion. This sum would exceed that of the record-setting Alibaba IPO in 2014 but still falls far short of initial expectations set by Saudi officials.
Indeed, much more investment is needed to power Saudi Arabia’s ambitious economic diversification agenda. The McKinsey Global Institute estimated that a “productivity-led economic transformation” in Saudi Arabia would require around $4 trillion in investments. The costs of National Transformation Program initiatives are projected to reach around $119 billion over five years, according to Al Tamimi & Co., with the government expected to shoulder the majority of spending. Moreover, these National Transformation Program estimates do not include expensive development initiatives, such as Neom, Qiddiya, and the Red Sea Development project.
Global banks involved in the IPO stood to capture more than $200 million in fees, had they met the Saudi government’s ambitious targets for the IPO. However, many international investors placed Aramco’s valuation somewhere between $1.1 trillion and $1.6 trillion, which constrained the banks’ ability to both meet the financial expectations of Saudi officials and facilitate a profitable intermediation. Banks involved in the Aramco IPO will likely receive closer to $90 million, whereas Alibaba paid an estimated $300 million in fees during its 2014 listing in New York.
Retail and institutional investors benefit if the value of purchased shares rises and upon receiving dividends. The high valuation initially sought by the Saudi government would have left little room for shares to rally. Aramco also promised an annual dividend of at least $75 billion over the next five years, which equates to a dividend yield range between 4.4% and 4.8%. This yield is lower than Exxon Mobil’s 5% or Shell’s 6.4%. Aramco will prioritize dividends for nongovernment shareholders on a prorated basis even if the company’s profits dip. The short-term focus on dividend yields portrays the deal as more of a bond issuance, wherein lenders often receive fixed interest rates, than an offering of shares in a company with genuine growth potential.
Balancing Demand
Beyond guaranteeing dividends, Aramco has sought other ways of shaping the short-term investment dynamics in the IPO and preventing the stock from tumbling after trading begins. Saudi citizens will receive one free share for every 10 shares purchased, provided that they hold on to investments for 180 days. The country’s central bank permitted domestic banks to double their standard lending limits to accommodate retail investors seeking to purchase Aramco shares.
Other high-profile IPOs, albeit not in the energy sector, have fared poorly this year: The stock prices of Lyft and Uber tumbled in the first days of trading and ultimately proved disappointing. A follow-on offering of Aramco shares after the lock-up period – a stage wherein issuance of additional shares is prohibited and internal shareholders are unable to sell the stock – could exert downward pressure on share prices and trigger a sell-off by investors. Aramco also established a share plan that will provide share-based incentives and restricted share units to retain executives, management, and other employees over the long term.
With around 0.5% of shares reserved for retail investors, Aramco must raise another 1% – around $17 billion – from institutional investors. The cancellation of Aramco’s international roadshows increases the relative importance of funding from neighboring Gulf countries as well as Russia, China, and other Asian countries. Aramco plans to host investment meetings at Dubai’s Ritz Carlton Hotel and the Dubai International Financial Centre on November 24. For their part, Russian Direct Investment Fund officials dismissed rumors that the sovereign wealth fund would make a major investment in the IPO but confirmed that the Russia-China Investment Fund is “working to attract Chinese investors into [the] Saudi Aramco IPO.” Malaysia’s Petronas and Russia’s Lukoil have declined to participate in the IPO.
Finding a Silver Lining
Few doubt the profitability of Aramco today. The company’s net income in 2018 reached $111 billion, and its cost of production for a barrel of oil, at $2.80, is the lowest in the world. The company produces around 10% of global oil, pumping some 10.3 million barrels per day in addition to natural gas. With 297.7 billion barrels of proven oil reserves as of 2018, Aramco estimates that it can keep its pumps going for over 50 years. It is a complex firm that combines deep expertise in the energy sector with rapidly expanding refining and downstream capabilities. Reports that Aramco booked $19.5 billion of retail and institutional orders after five days reflect the strength of the company today.
However, the ability to bring hydrocarbon commodities to market and the price they will fetch over the next five years remains uncertain. The risks are many: regional insecurity; fluctuations in oil prices; reduced demand for Saudi crude owing to the introduction of new technologies and regulations; and changing perceptions of the oil and gas industry as a result of climate change. The Vision 2030 strategy to transform Aramco into a “global industrial conglomerate” may mitigate some of these threats, but it will inevitably introduce new risks.
The completion of the Aramco IPO could reinvigorate the country’s broader – but currently stalled – privatization program. Saudi officials had hoped privatization initiatives would generate up to 40 billion riyals (approximately $10.7 billion) in government proceeds and result in 35 billion riyals (around $9.3 billion) in net government savings by 2020. These proceeds could be reinvested effectively in strategic, non-oil sectors, such as technology, tourism, and entertainment. Yet little progress on privatization initiatives appears to have been made by the time the Aramco IPO unfolded.
It is unsurprising, then, that Saudi authorities have launched new efforts to promote greater private sector investment in the country’s non-oil economy. On November 19, the government gave each Vision 2030 Realization Program Committee 90 days to prepare an action plan for the Strategic Committee at the Council of Economic and Development Affairs on how to better involve the private sector in high-impact initiatives. While these plans are being formulated, the government will continue to rely heavily on taxes, dividends, and royalties from Aramco – these totaled nearly $160 billion in 2018.
The underwhelming trajectory of the Aramco IPO has revealed a cold, hard truth: An IPO of the world’s largest oil producer may not be the best path toward financing a diversification of the economy away from an overreliance on hydrocarbon revenue.
