Run, Do Not Walk, Away from the Aramco IPO

Nov. 18, 2019
Bob Adelmann

Even before becoming the crown prince, Mohammed bin Salman (MBS) had big dreams. If he could raise $100 billion, he might be able, if he moved swiftly enough, to keep his kingdom from becoming irrelevant.

He posited the idea in 2016: sell five percent of the government's only asset – Aramco, officially the Saudi Arabian Oil Company – to unsuspecting investors who think that it's worth $2 trillion. In 2018, he began to draw up plans to redirect the country's total dependence upon oil revenues towards real estate development, tourist destinations, industrial parks, improved transportation, and other infrastructure improvements. He called it his "Vision 2030."

His path became twisted, slowing the initial offering of shares. He met resistance from inside the kingdom, so he had to do some housecleaning. There was the murder and dismemberment of Washington Post journalist Jamal Khashoggi last October, which MBS denied any knowledge of, but which forced Fitch Ratings to downgrade the government's credit rating. And then there were the attacks on the company's oil fields in September, letting all the world see just how vulnerable those facilities are in a highly volatile and explosive Middle East.

Nevertheless, Aramco, MBS's "crown jewel" announced on Sunday that it is only offering 1.5% of itself for sale in December, at a price far less than MBS had hoped for. And if things don't meet even those minimum, now greatly reduced expectations, he could pull the offering altogether before it goes public in December.

Analysts looking through the 600-page prospectus that was released last week on the deal aren't impressed, with many suggesting a much lower valuation, perhaps as low as just $1 trillion. That could turn MBS's dream into a nightmare. If the offering goes well, he might receive $25 billion. If it doesn't go well, it might generate nothing at all, leaving behind bad press and a warning to investors to stay away from such offerings in the future.

There are many risks investors face if they decide to provide the funds needed to pay for MBS's dream, including the company's recently declining profits as oil prices have dropped. Now there's the risk that the offering won't take place at all.

The company's "road show" or "book building" tour across the globe apparently hasn't gone well, according to the Wall Street Journal: "International investors have so far signaled that a $1 trillion to $1.5 trillion valuation would be more reasonable [number] for them to consider investing."

The company is undertaking a massive marketing effort to sell shares to Saudi's citizens, with billboards touting the offering, talk show hosts talking up the "opportunity," and even Islamic officials "approving" the purchase of shares for the common folks. MBS himself is pressuring some of the country's richest individuals (many of whom he recently investigated and temporarily incarcerated over charges of corruption) to "invest" in his company, with the clear implication that if they don't, he could revisit their alleged illegal activities. That's not an investment; that's blackmail.


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It's increasingly unlikely that any of the funds raised will ever help MBS reduce his country's near total reliance on oil for its budget. In April, the Saudis entered the bond market for the first time, raising $12 billion in the process. This was necessary to help fund the country's enormous and increasing annual deficit spending. In 2018, revenues fell short of spending to the tune of $36 billion, with a similar shortfall likely this year. Next year the country's finance minister expects that the country's deficit will widen to $50 billion. So, as large as the potential IPO might be (if it happens, it would be the second largest in history), the proceeds will quickly be absorbed by the government to cover its excessive welfare state spending. MBS's Vision 2030 will remain just that: a vision.

The initial offering would provide the company with a measure of just how hungry investors are to holding a share of Aramco in light of a declining world economy and soft oil prices. The idea is that if the offering goes well, a second much larger offering would come, reflecting the initial offering's price. But money managers were leery that the price of such a small initial offering could be manipulated to make it appear that the company is worth more than it is.

Accordingly, Aramco has announced that there won't be a second offering.

A key giveaway is that, buried deep inside the 600-page prospectus that MBS hopes few will read, is this nugget:

The government may direct the company to undertake projects or provide assistance for initiatives outside [of Aramco's] core business, which may or may not be consistent with the company's immediate commercial objectives or profit maximization.

One doesn't have to read Arabic to conclude that the government (which presently owns 100 percent of Aramco) considers the oil company its own private piggy bank, and may just decide that it has better uses for the $25 billion that might come from the IPO than investing it in real estate projects, tourism centers, or manufacturing facilities. It may just decide to use the money to pay off some of its enormous debt.

That leaves investors holding a piece of paper promising large dividends and a share of the world's second largest proven reserves of oil that might never gain in value. Remember that this is not a typical free market IPO, but an attempt to sell off a tiny sliver of a state-owned and controlled oil company in order to help its owner pay its bills. The value of that piece of paper will be subject not only to governmental decrees and future changes of "direction," but the long-term price of oil, which has clearly trended downward. In June 2014, the West Texas Intermediate (TWI) price of oil was over $105 a barrel. On Friday the market closed at $57.93 a barrel.

A relevant question would be: why would anyone invest in a company owned and controlled by a thug like MBS, even if the numbers looked good, which they don't?

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Sources:

The Wall Street Journal: Saudi Aramco IPO Price Range Values Company at Up to $1.7 Trillion

The New American: Saudi Arabia's Aramco IPO Fraught With Danger for Investors

The New American: Aramco IPO Plans Pushed Forward Before Oil Prices Drop Further

CNBC: Saudi Aramco's IPO is set to value the oil giant at up to $1.7 trillion

Reuters: Saudi Aramco will not market IPO in the United States: sources

Yahoo: Aramco declares $1.71 trillion valuation in blockbuster IPO

USNews: Eager Saudis Prepare to Snap up Stakes in 'Crown Jewel' Aramco

Background on Saudi Aramco

Chart of crude oil price (WTI)

Background on Mohammed bin Salman (MBS)

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