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The Saudis are hoping to take a slice of the company public at a valuation of $2 trillion, but investors may find that price too high. 

https://www.bloomberg.com/news/articles/2019-10-10/aramco-s-long-delayed-mega-ipo-is-finally-set-to-hit-the-market?srnd=premium-europe

Crown Prince Mohammed bin Salman had only just started his rise to global notoriety when he stunned the global business community in early 2016 by promising to sell shares in the Saudi Arabian Oil Co, the state oil producer. Now, after several false starts, the initial public offering of Saudi Arabia’s crown jewel—Aramco, which pumps 10% of the global crude oil supply from abundant fields under the kingdom’s desert—is finally going ahead.

The government is set to make a formal announcement in late October, and the superlatives are likely to follow thick and fast: the biggest-ever share sale, the world’s most valuable company, the largest dividend payments in history. While details of the offer haven’t been made public, people involved in the transaction say about 2% of Aramco may be sold at a price that would value the entire company at $2 trillion, raising $40 billion and outstripping the $25 billion raised in 2014 by Chinese e-commerce giant Alibaba Group Holding Ltd. “Aramco is ready for listing whenever the shareholder makes a decision to list,” Chief Executive Officer Amin Nasser said last month. “It’s going to be very soon.” Beneath the hype, the sale isn’t quite the exercise in free-market liberalization the prince first suggested. For one thing, there’s no plan to list in a global financial center such as London, New York, or Hong Kong. For now, the shares will trade only on Riyadh’s stock exchange, the Tadawul.
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A local listing—albeit one marketed to international investors, too—will give the government significant input into who buys the stock. The kingdom’s richest families, including some who had members held in Riyadh's Ritz-Carlton hotel during Prince Mohammed’s crackdown on corruption in 2017, have been invited to become anchor shareholders. It’s an offer they may find hard to refuse. The offering will also be pushed to Saudi citizens through a countrywide advertising blitz, with banks encouraged to lend money so retail investors can participate, according to people briefed on the plans who asked not to be named before the details are made public. Moreover, Saudi authorities traditionally intervene in the weeks after a share sale to support the price and ensure the offering is considered a success. Outside Saudi Arabia, bankers on the deal are concentrating on pitching the offering to sovereign investors in Asia and the Middle East, who may have long-term economic and political reasons to cement strong ties with Riyadh. 

What could be in short supply is interest from the world’s money managers, who see reasons to stand on the sidelines: a weak oil market, concerns about the strength of the global economy, and last month's attack on Aramco’s most important crude-processing plant. Investors are already demanding a premium to hold the country’s debt, downgraded in October by Fitch Ratings Ltd. “Aramco is simply the best oil and gas asset on the planet,” says Danilo Onorino, who runs fund manager Dogma Capital in Switzerland and has invested in Aramco’s bonds. “But there are problems. Saudi Arabia’s cost of capital is relatively high, the oil price isn’t where you want it to be, and there are issues with transparency.”

Investors are worried about corporate governance, as well. The IPO won’t bring independence from the Saudi state, which has never suggested selling more than 5% of the company. Aramco’s tax payments and dividends will remain the biggest source of government income, and Saudi Arabia is the most important member of the OPEC cartel. So oil production policy will likely remain a political decision. In early September, Khalid Al-Falih, Saudi Arabia’s energy minister and Aramco chairman, was dismissed. He’d been considered relatively skeptical about prospects for the share sale. One of Prince Mohammed’s half-brothers was made oil minister; the chairmanship of Aramco went to Yasir Al-Rumayyan, head of the kingdom’s Public Investment Fund, the sovereign wealth manager that will be handed the proceeds of the IPO.

“Aramco operates some of the lowest-cost assets in the world,” says Rob Thummel, a senior portfolio manager at Tortoise, an investment firm. “The biggest concern around Aramco is governance. If governance challenges can be solved, then investor interest will be high.” Valuation is another concern. The crown prince has always insisted that Aramco is worth more than $2 trillion, almost twice the market capitalization of Microsoft Corp. and Apple Inc., the world’s most valuable companies today. There’s little doubt Aramco deserves a stratospheric valuation: The company pumps almost 10 million barrels a day, more than double its largest American rival, Exxon Mobil Corp., and posted an annual profit of $111 billion last year. But $2 trillion still looks aggressive compared with other major oil producers.

Aramco recently promised to pay a base dividend of at least $75 billion in 2020, significantly higher than the $58 billion it paid to the Saudi government in 2018. That’s equivalent to about $20 for every barrel the company produces and more than the dividends paid by Exxon, Royal Dutch Shell, and Chevron combined. The Saudi government also tweaked Aramco’s tax structure to allow more scope for shareholder payments, cutting the royalty paid on every barrel to 15% from 20% as long as oil prices stay below $70 a barrel. (It’s currently below $60.) It even went as far as promising that minority shareholders would be paid dividends before the government if oil prices were to crash.

Even so, at a valuation of $2 trillion, Aramco’s dividend yield will equal just 3.75%. That looks like a healthy return in a world of zero interest rates, but it’s less than holders of the company’s 30-year bond are getting. Today, Exxon’s dividend yield is about 5%. The number for Shell, a company that hasn’t cut its dividend payments since World War II, stands at more than 6%. For Aramco to match Exxon’s yield, its market value would have to be closer to $1.5 trillion.

Another concern for potential investors is the outlook for demand. Aramco was built in an era when oil demand would reliably rise year after year as hundreds of millions bought cars and took to the road. That’s starting to change. Global automakers such as Volkswagen AG are investing billions in electric vehicles, and some analysts expect gasoline demand to peak within the next decade. The oil market faces more immediate challenges, too. The U.S.-China trade war is denting the outlook for energy demand, and inventories are ample by historical standards. The International Energy Agency sees a potential mismatch between supply and demand early next year of more than 1 million barrels a day. Aramco argues that having the lowest-cost fields in the world means Saudi Arabia will be drilling for many decades, but investor attitudes toward the industry are changing. The government could decide to compromise on valuation to ensure the sale’s success, but Prince Mohammed is willing to pull every lever to get as much cash as possible for another of his key causes: the Public Investment Fund, the body charged with spearheading the kingdom’s economic transformation beyond energy. 

BOTTOM LINE - The long-delayed IPO of Saudi Arabia’s Aramco, which pumps 10% of global crude oil, may need to value the company at less than the expected $2 trillion.

A natural gas facility in Aramco’s Shaybah oil field. 

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Edited by DayTrader

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