Complex Made Simple

Saudi Aramco’s IPO valuation and the global crude oil market

Saudi Arabia plans to accelerate the IPO timetable for Saudi Aramco, the kingdom’s flagship state owned oil and gas monopoly that happens to be the world’s most profitable company. Saudi Aramco will be the world’s largest IPO ever if it lists on the London or New York stock exchange in early 2020.

The Saudi Aramco IPO plan, all but shelved in 2018, reappeared on the kingdom’s agenda after the company floated a $12 billion new issue last April in the Eurobond market that was wildly oversubscribed, with $100 billion in bids. Lead managed by J.P. Morgan, the international banking syndicate included the crème de la crème of Wall Street, the City of London and European finance. Why would an oil company with $110 billion in 2018 net profits raise $12 billion in Eurobonds in the global capital markets at spreads even lower than the Saudi sovereign bond issue? The answer is obvious. The kingdom is obviously preparing the world of high finance for an imminent Saudi Aramco IPO.

Saudi Arabia has been the ultimate petro-economy since Chevron geologist struck an oil gusher in a Dammam salt dome in 1937 and changed the history of Arabia forever. If ever there was an ultimate prize in the global provinces of black gold, the kingdom of Saudi Arabia is it. With 260 billion barrels of proven reserves, Saudi Aramco is the only oil company in the world that can produce up to 12 million barrels a day with drilling costs estimated at $9 a barrel, the lowest in the world. Saudi Arabia also anchors the Saudi kingdom’s power and influence in the global energy markets since its 1 million barrels a day spare capacity enables Riyadh to act as the “swing producer” in OPEC.

The oil crashes of 1986, 1999 and 2014-15 were all triggered by Saudi Arabia’s decision to temporarily abandon the role of “swing producer” to punish free riders and quota cheaters in OPEC as well as preempt shale gas exports from the Permian Basin in West Texas. Despite five decades of attempted economic diversification, oil revenues are still 90% of both the Saudi government budget and exports. Saudi Aramco’s petrocurrency bonanza has enabled the kingdom to become the financial superpower of the Middle East, the largest economy in the Arab world, the architect of “riyalpolitik”.

The valuation of Saudi Aramco at is IPO will be set by the world’s fund managers, though the Saudi Crown Prince Mohammed bin Salman has argued it is worth $2 trillion, a figure not accepted by most oil and gas sector analysts in London and New York. The coming IPO means Saudi Arabia will do its best to keep crude oil prices in a bullish uptrend, even if it means bearing a disproportionate share of the OPEC/Russian output cut pact. The price of crude oil has been hugely volatile in the past five years – from $128 Brent in October 2011 when Libyan dictator Colonel Gaddafi was lynched amid a NATO bombing campaign and $110 in June 2014 (the month Daesh terrorist seized the Iraqi city of Mosul) to as low as $28 in early 2016 after an epic oil price crash. Oil prices have been on a rollercoaster range from $43 – 85 since 2018. Brent crude trades at $58 now.

Energy stocks have been the worst performing sector in the S&P 500 index in the past decade and in 2019. Wall Street has derated the valuation of oil and gas stocks as recession fears have hit global petroleum demand estimates. Even Saudi Aramco net profits for the first six months of 2019 fell 12% to $46.9 billion. Depending on the outlook for oil prices and Saudi oil production/exports, the Saudi Aramco IPO could value the company anywhere from $800 billion to well above $1.4 trillion, above the market caps of Microsoft and Apple on Wall Street.

Unlike the bond holders, the buyers of Saudi Aramco IPO must remember the majority shareholder (the kingdom plans to sell only a 5% stake to the public) is a sovereign Arab government that may choose to cut oil production for national security/OPEC “swing producer” role reasons, not a share-holder value maximizing economic enterprise. This will necessitate a valuation discount at a time when Shell, BP and Total offer dividend yields as high as 6.5%.

Saudi Arabia also provides concessional oil exports to key allies in the Middle East, such as governments of Bahrain, Jordan, Morocco, Pakistan and Egypt. US law could also make Saudi asset in New York vulnerable to class action lawsuits. There is no real transparency on corporate governance or capex policy in most state-owned oil and gas companies, the reason Brazil’s Petrobras IPO was such a colossal disaster.

Saudi Aramco’s deal to buy a 70% stake in SABIC, the kingdom’s petrochemical complex, for $69 billion, will also raise alarm for Western fund managers as it was motivated by Saudi public finance imperatives, not a classic shareholder value maximization rationale. Since the Saudi state owns both Aramco and SABIC, this was a related party transaction, anathema to Western fund managers. Petrochemical analysts argue Saudi Aramco may also overpay for a 20% stake in India’s debt laden Reliance Industries at an enterprise value of $75 billion.

Saudi Arabia could face financial headwinds if the trade war triggers a global economic slump. After all, Saudi Arabia’s trillion-riyal 2019 State Budget was the most expansionary in the modern history of the kingdom, Neom could cost $500 billion and the Uber IPO, the Softbank-Saudi PIF’s $100 billion Vision Fund’s flagship deal, has been a flop on NASDAQ. The IMF estimates the Saudi budget deficit will reach 7% of GDP in 2019 and the kingdom’s budget breakeven price for Brent is $80-85.

This macro data will unquestionably impact valuations of the Saudi Aramco IPO. The recent spasm of risk aversion has gutted the valuations of oil and gas supermajors to 10-year lows and energy is a mere 4.7% of the S&P 500 index, down from 13.4% in 2008. This is not the optimal time to invest in the ultimate oil and gas mega-IPO, though the world could be entirely different at the time of listing in 2020. My call? Aramco’s 2019 net revenues could be $104 billion. I estimate a 10 times valuation multiple reflects the myriad risks of the business and Saudi Aramco could thus be valued at a market cap of $1.04 trillion on the New York or London stock exchange. This will be a historic moment for Saudi Arabia and the world financial markets if it happens.

Opinions expressed in this piece belongs to the author and do not necessarily reflect the opinions or beliefs of AMEinfo.