Saudi Arabia’s Aramco IPO Is a Bad Buy

Aramco is the world’s largest oil company. It is also currently the most profitable company in the world, and based on the 2019 listing by Fortune, the company’s profitability is almost double that of Apple. As a private organization that produces about 10% of the world’s crude oil, Aramco’s revenue for the financial year 2018 was at an eye-popping US$224 billion (£174 billion; RM929 billion).

Its net profit alone was a whopping US$111.1 billion, easily outstripping American giants such as Apple Inc. and Exxon Mobile Corp. In fact, Aramco’s net income was more than Apple, Google and Exxon combined. But all these guarded secrets were only revealed after the Saudi Arabia’s most precious company was forced to raise cash from the international financial market.

After the initial IPO of Aramco was postponed last year, the kingdom had to disclose its financial data to raise debt to pay for the acquisition of 70% stake (worth about US$69.1 billion) in domestic petrochemical group Sabic (Saudi Basic Industries Corp). Surprisingly, despite its jaw-dropping profit, Aramco doesn’t generate as much cash per barrel of oil as other oil companies like Royal Dutch Shell Plc.

That’s because for decades, Aramco has been the ultimate cash cow which Saudi Arabia milks every year. It pays a staggering 50% of its profit to Saudi in the form of income tax. The kingdom’s dependence on the company to finance social and military spending, as well as the lavish lifestyles of thousands of princes and princesses, places a heavy burden on Aramco’s cash flow.

As a result, both Fitch Ratings and Moody’s Investors Service rated Aramco the fifth-highest investment grade, the same as Saudi sovereign debt. In essence the ratings of “A+” from Fitch and “A-” from Moody’s, which were lower than oil companies such as Exxon, Shell and Chevron, means the kingdom’s sluggish economy will put pressure on Aramco’s cost of borrowing.

Thanks to the stubborn low price of crude oil, the situation is more desperate than ever for the Kingdom of Saudi Arabia to raise cash through the initial public offering (IPO) of its state oil company. David Petraeus, the former Director of the Central Intelligence Agency (CIA), revealed to CNBC – “It’s a fact that Saudi Arabia is gradually running out of money.”

General Petraeus, who is currently chair of the KKR Global Institute, said the Saudi’s sovereign wealth fund has been substantially reduced to below US$500 billion currently. The budget deficit of the kingdom would need between US$40 to US$60 billion of cash yearly, depending on the price of the Brent crude oil.

He said – “The bottom line is that they need the money, they need that outside investment that is crucial to delivering ‘Vision 2030’ which cannot be realized without outside investment, this is just one component of a number of different initiatives that they’re pursuing to try to attract that outside investment.”

Yes, Saudi is being forced to go public for money by selling their cash cow, something that they had reluctant to do. But not only they have to sell a small portion of Aramco, they have to make sure the IPO is a success as it desperately needs to attract outside investment. The company is due to go public next month, with state reports suggesting it could be December 11.

The IPO will, for the first time ever, open up ownership of the government-owned Aramco to public investors. After a few false starts, the Aramco shares will only be listed on Saudi Arabia’s own Tadawul exchange. The IPO offer period or book-building period is from November 17 to December 4 for institutional investors and November 17 to November 28 for individual investors.

However, the valuation of the company from international banks indicates a wide range of price targets – between US$1.2 trillion and US$2.2 trillion. At US$2 trillion valuation, the sale of shares is expected to bring in US$40 billion to the country’s coffer, easily breaks the record-holder for the biggest IPO in the world – Alibaba’s 2014 listing which brought in US$25 billion.

But most analysts have pointed out that there are some major issues with the company’s finances and its valuations. Aramco’s IPO prospectus has raised some threats which were not seen in most analysis previously. The recent drone attacks aside, the new risks included the impact of flattening oil demand growth, as can be seen currently.

Other serious risks which had been overlooked comprise potential legal repercussions if listed on Western stock exchanges and the potential lack of interest from U.S. and European institutional investors. Obviously, foreign investors would be less interested to put their money in the local stock exchange as compared to New York Stock Exchange, for example.

Congress in September 2016 had voted overwhelmingly to override a veto by then-President Obama for the first time, passing into law a bill that would allow the families of those killed in the Sept. 11, 2001 terrorist attacks to sue Saudi Arabia for any role in the plot. Effectively, American courts could seize Saudi assets to pay for any judgment obtained by the Sept. 11, 2001 families.

In July 2016, the U.S. government released 28 pages of documents from a congressional inquiry detailing links that the FBI found between the perpetrators and Saudis based in the U.S. The kingdom has been under tremendous pressure ever since it was revealed that 15 out of the 19 hijackers in 9/11 terror attacks which killed nearly 3,000 people were Saudi citizens.

The possibility of investing in an oil company that could be sued for so-called terrorism may be new but lawsuits against major oil companies had happened before. Investors have seen several court cases and class action lawsuits against mega oil corporations such as Shell, ENI, Total and BP. When listed, Aramco will not be a private company anymore, but a “normal” public listed company.

As a public listed company, Aramco will be scrutinised from all angles including environmental issues. Last year, the company produced 128 million metric tons of carbon dioxide in extracting, refining and marketing its products – the third largest behind Russian gas-giant Gazprom and Chinese producer Sinopec. The Saudi would be pressured to cut back on its carbon emissions as part of the Paris accord.

In a scenario where the Aramco IPO attracts mostly Asian and non-Western institutional investors, who don’t really care about global warming or climate change problem, Saudi will face other problems. As the de-facto leader of OPEC, Saudi’s Aramco could be caught in an awkward situation where its OPEC agenda would clash with the interest of the investors.

New shareholders of a publicly listed Aramco will be upset if Aramco’s production volumes are determined by the oil cartel’s members, which has been the tradition and the agenda of the OPEC for decades. On the other hand, if Aramco decides to follow the desires of the foreign investors, Saudi obviously would not be able to comply with OPEC, making the cartel powerless.

While Aramco is the richest company on planet Earth, its reliance on global oil prices are spectacular. In 2016, when the price of Brent crude plunged to average US$45 a barrel and OPEC cut production, the company actually struggled to break even. Net profit for the full year was just US$13 billion and free cash flow was merely US$2 billion. Zero dividend was given that year.

Therefore, the dividend is not a sure thing. Currently, Aramco pays out US$75 billion in annual dividends. At the company’s desired US$2 trillion valuation, that’s a dividend yield of just 3.75%. When compared to the average 5.7% dividend yield offered by Western oil companies and the average 6.3% yield offered by other emerging oil majors, clearly 3.75% is not enough to entice foreign investors.

Saudi Arabia’s autocratic Crown Prince Mohammed bin Salman, whose reformist credentials were tarnished by the gruesome murder of journalist Jamal Khashoggi, might face “interrogations” by investors if most of the money raised is diverted to fund mega-projects such as NEOM, a US$500 billion futuristic mega city planned in the northern Red Sea coast, which officials say will have flying taxis and talking robots.

It is worth to note that 5 of the 11 board directors are government ministers, though another five are independent. Even after the IPO, the kingdom will remain as the biggest stakeholder with more than 96% of the shares. They could still bulldoze to undertake wasteful projects that may not be in the interest of the minority shareholders.

Source: Finance Twitter