Most companies would be thrilled to raise $25.6 billion in an initial public offering… especially for the biggest IPO in history – like Aramco, Saudi Arabia’s state-controlled oil company, did earlier this month.
But Aramco isn’t like most companies. And Crown Prince Mohammed bin Salman, the de facto ruler of Saudi Arabia, has good reason to be disappointed with what was one of the biggest IPO flops ever.
Aramco’s IPO wasn’t doomed from the start… Bankers who were willing to state the obvious – the analytical equivalent of “the sun is big and hot” – could have prevented the stench of failure from being forever attached to Aramco. And it would have helped if MBS, as bin Salman is sometimes called (though probably not to his face), didn’t have a predilection for murder and mayhem.
The 800-Pound Gorilla
On the surface, Aramco’s IPO looks like a smashing success. The company instantly became the world’s biggest public company, with a market capitalization of $1.7 trillion. (Apple (AAPL) comes in at No. 2 with $1.2 trillion.) It’s the most profitable company in the world, with a 2018 net income of $111 billion. That’s twice the net income of Apple… and five times more than global oil major Exxon Mobil (XOM).
Aramco is the world’s largest energy company. It accounts for an incredible 10% of global daily oil production. (The entire U.S. produces 18% of the world’s oil). It has more reserves than Exxon Mobil, Chevron (CVX), Royal Dutch Shell (RDS-A), BP (BP), and Total (TOT) combined. When Aramco sneezes, the world’s energy market – which dictates how much it costs to fill your gas tank, heat your house, and transport anything you use – catches pneumonia.
And Aramco matters to Saudi Arabia – at the fulcrum of stability in the volatile Middle East – like air matters to humans. Aramco provides more than two-thirds of total Saudi government revenues. The company’s revenues are equivalent to more than half of Saudi Arabia’s total GDP. By comparison, the revenues of the largest American company by sales, Walmart (WMT), is about 3% of U.S. GDP. If Aramco catches pneumonia, Saudi Arabia does too…
Aramco’s oil wealth helps keep the 15,000-strong Saudi royal family – with an estimated total net worth of more than $1.4 trillion – comfortable in their Maseratis and Rolexes. And Aramco helps keep the peace by providing for the other 99.95% of the population of Saudi Arabia, including the 20% that lives in poverty. If Aramco falters, all of the authoritarian dictates and steel-toed boots of the Saudi government under MBS won’t be able to keep things under control.
Not Enough Golden Eggs
The problem facing Prince Mohammed when he first floated the idea of partially privatizing Aramco in January 2016 was that the golden goose of Aramco wasn’t delivering enough rose petals to the family or rice to the people.
The International Monetary Fund says the country will post a budget deficit equal to 7% of GDP. That makes the U.S., at around 4% last year, seem downright frugal. MBS was concerned about the economy’s “oil addiction,” and wanted to reduce Saudi Arabia’s dependence on the oil price. His economic diversification program, called Saudi Vision 2030, required even more golden eggs.
The initial plan was to sell a 5% stake in Aramco for $100 billion – valuing the company as a whole at an incredible $2 trillion. An offering that size on the New York or London exchange would have been four times bigger than the previous record holder, Alibaba’s (BABA) 2014 IPO. By the extravagant standards of the hyper-rich Saudi leader, it would have been an appropriate coming-out party for Aramco and Saudi Arabia… and of course for MBS himself.
The Small Matter of… Valuation
But you can only sell something if you have a buyer. And if the buyer doesn’t want to pay the price the buyer is asking, there’s no sale.
The banks that help the buyer and seller find common ground in an IPO earn a percentage of the total sum raised. So bankers trying to get into the deal had every reason to pitch a high valuation to MBS – so that they could make more money themselves (those Cybertrucks aren’t going to pay for themselves).
That… and also, it’s never a good time to try to tamp down the expectations of an early-30s autocrat with a hazy understanding of how markets work, and a penchant for chopping people into bits.
While MBS was plotting Saudi Arabia’s emergence onto the global capital markets stage, he was also behind the notorious October 2018 death of U.S.-based journalist Jamal Khashoggi. After getting under MBS’s skin by criticizing the regime in columns for the Washington Post, Khashoggi was strangled and his body was cut into pieces by Saudi agents at the country’s consulate in Istanbul. The CIA concluded that MBS ordered the killing.
MBS had already shown his true colors in November 2017, when he detained a few hundred fellow Saudi royals, business leaders, and others in the Riyadh Ritz-Carlton for months – ostensibly as part of a crackdown on corruption. Being a prisoner at a fancy hotel isn’t as bad as sitting in a small room with bars… But many of the Ritz prisoners were hospitalized for physical abuse. Some of them were forced to turn over money, real estate, and shares, without any legal process.
It was MBS’s way of showing – Game-of-Thrones-in-the-desert style – the royal family, and the country’s 33 million people, who was boss.
So… bankers had plenty of reasons not to disappoint MBS. As the Financial Times put it in November 2017, “Valuation is another troubling issue for the kingdom… [Mention a valuation of $1 trillion] to MBS only if you are prepared to leave the room quickly. In Riyadh, the accepted figure is double that.”
Numbers Don’t Lie
MBS’s autocratic stranglehold in Saudi Arabia – unfortunately for Aramco’s valuation – doesn’t extend to the portfolio-allocation decisions of international investors. For Aramco to sell $100 billion of shares, household-name global mutual, pension, and hedge funds – the Fidelities, Vanguards, and Bridgewaters of the world – would have to buy in in a big way.
But during the early stages of marketing the deal in November, it became clear that international investors weren’t interested at the price level (that is, total company valuation) that MBS wanted. Foreign investors indicated they might be interested in buying shares at prices that would put Aramco’s value in a range between $1.2 trillion and $1.5 trillion. That’s a lot… but it’s a long way (a few Exxon Mobils) from $2 trillion.
Rather than reduce the price of his crown jewel deal, MBS cut the international portion of the offering. Selling a 1.5% stake of Aramco for $25 billion on Saudi Arabia’s Tadawul stock exchange to mostly local and regional buyers was a huge comedown… It was a Motel 6 instead of the Four Seasons. Not only would Aramco get less cash – but there would also be no CNBC coverage of MBS ringing the closing bell at the NYSE on the first day of trading.
A Question of Valuation
The bankers who helped MBS fuel his $2 trillion fantasy were excited for what, at a $100 billion deal size, would have been around a $350 million payday. Even shared among two dozen or so banks, that’s a lot. A smaller deal that didn’t include many international investors meant a much smaller payoff for Goldman Sachs, Morgan Stanley, and other big banks.
But with some basic math and common sense – and just a bit of insight on MBS’s prior behavior – the fancy Western bankers should have seen it wasn’t going to work.
The easiest way to value a company is by comparing its price (market cap) with its earnings, better known as the P/E ratio. Based on Aramco’s 2018 net income, at a (fairy tale) $2 trillion market capitalization, the company would have been valued at a trailing P/E ratio of 18. At a market cap of $1.7 trillion, which is where the company went public, it’s at a P/E of 15.
That compares with a 2018 P/E ratio for Exxon Mobil of around 14. Rivals BP and Royal Dutch Shell are valued at 2018 P/E multiples of 13 times and 11 times, respectively.
Would it make sense for an investor to pay a higher price, in terms of valuation, for Aramco than he’d pay for a major global oil company that’s been around for decades? It’s the question that any investor who’s looking to buy into an IPO asks – is this new company more attractively valued than what he can buy on the secondary market now? The answer, at least at the market capitalization that MBS wanted, was a resounding no.
The Problems With Buying Aramco Shares
Why did international investors see Aramco as too expensive? First, there’s the question of corporate governance – that is, whether small shareholders in Aramco could expect to be treated fairly and receive their fair share of profits. Maybe they would… but as the Financial Times pointed out, “Any ruler who arrests his relatives will not listen much to minority shareholders.” (And the Khashoggi incident suggests that MBS doesn’t take a shine to complainers.)
On another front, Aramco’s assets – that is, its oil fields – are all in one place: Saudi Arabia. That makes production a lot easier and cheaper. It costs Aramco $2.80 to produce a barrel of crude oil… which it sells today on the global market at around $60/barrel. But it’s also a lot riskier… In September, a drone attack on two big Saudi oil facilities (widely blamed on Iran) cut the company’s crude oil supplies by more than half. The price of oil spiked as much as 20%, and it took weeks for Aramco’s production to come back on line.
By comparison, ExxonMobil and many other major global oil companies have operations in dozens of countries. It would take a lot more than a few guys with a vendetta and some flying explosives to take out their frustrations on energy companies that aren’t as concentrated as Aramco.
What’s more, in terms of political risk, Saudi Arabia is a lot closer to Russia and Turkey (also run by murderous megalomaniacs) than it is to Switzerland. So Aramco shares should be valued more closely to energy companies traded in those markets, than oil companies in safe and predictable countries where the rule of law actually works. A better comparison for Aramco would be Gazprom, the world’s largest natural gas company. It’s majority-controlled by the Russian government and shares trade at a P/E ratio of around 4.
Aramco at a P/E of 4 would suggest a total market cap of around $450 billion. Let’s be generous and say that Saudi Arabia’s Aramco is twice as safe as Russia’s Gazprom… But even $900 billion would earn you a hard spanking (or worse) from MBS. Somehow, Aramco found buyers at nearly twice that level for its IPO.
How the Deal Got Done
Actually, it’s not that much of a mystery. Following some intense arm-twisting by MBS, domestic institutional investors – Saudi fund managers, state-controlled funds, and other pools of capital linked to the government – bought heavily into the Aramco offering. Around 4.9 million Saudi retail investors did too… urged on by religious leaders and supported by interest-free loans provided by friendly local banks. And you can bet a lot of members of the Saudi elite (remember the Ritz?) gave until it hurt.
Regional investors like state-backed funds in Kuwait and Abu Dhabi were also encouraged to buy in to the deal as a show of support. In the end, international investors – buying through the Saudi exchange – accounted for just around 10% of total shares sold in the offering.
The deal got done. But its execution was terrible… The planning was worse… And everyone was left with a farm full of egg on their faces.
What’s next for Aramco? With around 15% of the Saudi population owning shares directly (many of them having bought with leverage), a sharp decline in the share price would be bad news for political stability – and for MBS. In coming months, Saudi Arabia – which, as the most powerful member of oil cartel OPEC, has a lot of sway in the matter – will do whatever it can to keep the price of oil steady.
The oil price aside, Aramco shares face very stiff headwinds – even though after the offering, MBS urged more buying by his “friends” to push the market capitalization closer to his dream $2 trillion level. In coming months and years, MBS will want to sell more shares – remember, he was aiming to sell 5% and only sold 1.5%. But in the meantime, investors will be wary of buying shares if they’re anticipating a huge wave of new shares hitting the market.
Also, Aramco is already the world’s biggest company. It’s worth more than the five next-biggest oil companies combined. How much bigger can it get? This isn’t a share that’s going to double over the next year – if ever. Aramco promised investors a $75 billion dividend… which equates to around a 4.4% dividend yield at the IPO price, which is less than what you’d earn if you held shares of almost any other big energy company. So Aramco’s dividend promises aren’t going to draw in buyers either.
A Long-Term Peak for Oil
And in the bigger picture, the fact that Saudi Arabia is selling Aramco at all is a bad sign. Saudi Arabia is the ultimate insider in global oil markets. When insiders sell, it often means that they think that the next direction for the share price is down.
The writing is on the wall for oil… In the coming years, it will face increasingly stiff competition as the prices of alternate energy sources continue to fall. It might take decades, but oil is going the way of fax machines, hard-copy pornography, and snail mail. I think we’ll look back on the Aramco IPO as the long-term peak of the oil market. And that’s enough to concern even MBS – to say nothing of small Aramco shareholders.
Kim Iskyan is an editor at large for Stansberry Research, and has written about investing in a wide range of frontier and emerging markets. Until recently, he was the publisher of Stansberry Research’s Asian affiliate, and he lives in Singapore.