Hubris

ARAMCO GIVES BANKERS NEW SCOPE FOR SAUDO-MASOCHISM

Hubris

BY GEORGE HAY

Investment bankers are bracing for another extended round of what’s best called “Saudo-masochism”. Saudi Aramco’s stalled $100 billion stock-market debut is showing signs of life, eliciting the sort of frenzy that accompanied initial pitching of the deal in 2017. Yet with the first team of advisers set to change, the question is whether being jettisoned is a good thing.

Of the original leading counselors to Aramco, Wall Street boutique Evercore and mega-bank HSBC may have their roles reduced, Reuters reports. Whether this is the result of bankers briefing against rivals to a thin-skinned client, or mere Aramco caprice, is unclear. If true, it would still leave JPMorgan, Morgan Stanley, Moelis and Michael Klein on board. But they might look more like gluttons for punishment than masters of the universe.

Assuming a late 2020 listing at the earliest, banks would have to maintain teams in the kingdom. That’s a big cost commitment, especially given the probability that underwriting fees will amount to a fraction of the top rate, some 7%, normally paid in U.S. deals. Efforts to secure listings in New York or London, alongside Riyadh, led to investor pushback and political complications. That’s before vectoring in the outlandish $2 trillion valuation Crown Prince Mohammed bin Salman envisages for the absolute monarchy’s primary cash generator.

Adding to complexity this time around is whether the murder of journalist Jamal Khashoggi by Saudi agents last October has sapped institutional appetite for a piece of an entity closely entwined with the crown. The ease with which Aramco in April sold a $12 billion bond, and a prospectus that showed it earned $111 billion in 2018, may not guarantee support for overpriced stock in an ESG-focused investment climate.

Both Evercore and HSBC featured in the top five for 2018 Saudi investment banking fees, according to Dealogic, while HSBC leads this year. Either way, the point of enduring current thin gruel from Aramco is the hope of riches later, when Saudi opens the gates to foreign direct investment to achieve the crown prince’s 2030 economic vision. Yet Reuters reported in June that only one big foreign firm, theme-park operator Six Flags Entertainment, had so far committed to supporting such projects. If the bonanza proves to be a trickle, bankers’ toils will look thoroughly masochistic.

First published July 19, 2019

(Image: REUTERS/Maxim Shemetov)

NEW ARAMCO CHAIR BEARS SMALL PLUS AND BIGGER MINUS

Hubris

BY GEORGE HAY

The Saudi Arabian equivalents of Kremlinologists have something new to get their teeth into. Saudi Aramco is replacing its chairman, Energy Minister Khalid al-Falih, with the man who runs the country’s $300 billion sovereign wealth fund, Yasir al-Rumayyan. For Western investors pondering whether to buy into the oil giant’s stalled initial public offering, that brings a plus and a potentially bigger minus.

The good-ish news is that Aramco is flipping the script. Reflecting its role as a department of the kingdom, the group’s chair and the energy minister have always been the same person. Replacing Falih in one sense therefore creates welcome daylight between company and ministry. Having been a banker and at the core of the Public Investment Fund’s various investments in Uber and the SoftBank Vision Fund, Rumayyan may also be a fitting figure to lead a foreign listing.

Yet the move could exacerbate a bigger problem for foreign investors: the fact that Aramco’s strategy, along with nearly everything else in Saudi Arabia, is ultimately set by Mohammed bin Salman, the crown prince, who has been a controversial figure since the murder last year of journalist Jamal Khashoggi by Saudi agents – if not before. The PIF is central to the crown prince’s Vision 2030 agenda to diversify his country away from fossil fuels, and Rumayyan is a key ally. Hence if anything the links between the company and the centre of power are now tighter.

Non-Kremlinologists might say the changing of guard is irrelevant given MbS, as he’s known, calls the shots anyway. Aramco was, for example, recently obliged to spend $70 billion of its own money acquiring the PIF’s 70% stake in chemicals group SABIC, which was more about creating cash for Rumayyan’s fund to spend than any merger rationale. Still, Aramco’s decision to pay in installments implied some sort of independence, given it could have afforded the whole lot in one chunk. The scope for even such mild resistance looks even narrower now.

First published Sept. 3, 2019

(Image: REUTERS/Hamad I Mohammed)

SOME ARAMCO IPO BANKS LOOK MORE EQUAL THAN OTHERS

Hubris

BY GEORGE HAY

All Saudi Aramco’s listing advisers are equal, at least in name. The oil giant has hired nine banks to lead its revived initial public offering and given them the grand-sounding title of global coordinator, Reuters reported on Wednesday. That means they all get bragging rights. But they will not all be doing the same thing.

Hiring a boatload of investment banks is not unheard of, and with a market capitalisation of $1 trillion to $2 trillion Aramco will almost certainly become the world’s largest listed company. But that was the case back in 2017, when JPMorgan, Morgan Stanley and HSBC were the leading players. Now Bank of America Merrill Lynch, Goldman Sachs, Credit Suisse and Citigroup have been added to the roster, along with Saudi Arabian lenders National Commercial Bank and Samba Financial.

In practice, however, the three lead banks will have done most of the work already. It will be surprising if JPMorgan, whose Saudi relationships go back decades and which has comfortably topped Dealogic’s list of investment-bank revenue generators so far this year, does not remain the de facto top dog.

That said, there could be tweaks to the IPO pecking order. First time round, HSBC’s role was weighted towards the local Saudi listing rather than wherever Aramco will be listed abroad. Its first-tier crown could be taken by Goldman, whose pitch has been burnished by representatives such as Dina Powell, who served in U.S. President Donald Trump’s administration before returning to the Wall Street bank last year. Goldman also has history with the Public Investment Fund, whose boss Yasir al-Rumayyan last week became Aramco’s chairman.

BofA, Citi and Credit Suisse are wildcards. Citi’s departure from Saudi Arabia in 2004 is still remembered there, while the other two lenders have had good relations with Qatar, a Saudi foe. Still, both BofA and Citi have lent money recently to the PIF, while the Swiss bank’s efforts are headed by Hazem Shawki, who until recently was a regional bigwig for Goldman.

All nine of Aramco’s banks remain equally burdened with what’s likely to be a tortuous listing process – starting on the Riyadh bourse and going international later – with a demanding client for minimal reward. In other respects, some will prove more equal than others.

First published Sept. 12, 2019

DRONES DETONATE SAUDI ARAMCO’S RENEWED IPO HOPES

Hubris

BY GEORGE HAY

Saudi Aramco’s best-laid IPO plans just suffered a drone strike. In the last few weeks, the world’s biggest oil producer had seemed to be getting its stalled listing back on track by identifying a new chairman and naming a squadron of investment bankers to oversee a Riyadh stock offering. Saturday’s air attacks by Iran-aligned Houthi rebels, which knocked out over half Saudi’s national oil output, upend that.

The strikes on Aramco’s Abqaiq and Khurais facilities are a major escalation of previous Houthi drone launches, which were mostly directed at Saudi energy infrastructure and airports. Abqaiq alone processed 50% of the company’s 10 million barrels per day crude oil production in 2018. Aramco’s maiden international bond prospectus in April identified the facility as critical for its financial condition.

The world’s oversupplied oil market has some scope to absorb a short-term shock. Developed economies’ oil stocks are above five-year averages, and the combination of a global economic slowdown and increased output by other countries means the Organisation of the Petroleum Exporting Countries is currently set to produce 1 million barrels per day more than is required to balance the market in 2020, Morgan Stanley analysts reckon. Even before the attacks, the cartel had faced pressure to consider deepening production cuts in place since 2016.

Yet while Saudi might welcome a coordinated reduction, it certainly won’t like Saturday’s massive and involuntary unilateral disruption, which Reuters reported on Sunday could take weeks to fix. Aramco might have to draw on the Kingdom’s 188 million barrels of reserves to maintain exports of 7 million barrels per day that mostly go to Asia.

The best case is that Aramco’s vaunted operational efficiency enables it to restore full production rapidly. In that scenario the $10 a barrel spike in oil prices that consultant Rystad expects might even help bump up the company’s stock market value, which Breakingviews calculates will fall well short of its desired $2 trillion. Yet the latest dramatic evidence of Aramco’s vulnerability, and the possibility of regional reprisals by the volatile Crown Prince Mohammed bin Salman, make it almost certain that international investors will apply a higher discount rate to its future earnings. That could make renewed impetus around the IPO look premature.

First published Sept. 16, 2019

(Image: REUTERS/Hamad I Mohammed)

ARAMCO IPO CAN CHOOSE EITHER PRICE OR CREDIBILITY

Hubris

BY GEORGE HAY

Saudi Aramco has gone further than it ever dared before. The oil giant on Sunday kicked off a long-awaited initial public offering for the world’s biggest crude producer. The relationship between valuation and credibility is more complex than it might look.

Crown Prince Mohammed bin Salman has long wanted to sell 5% of Aramco at a $2 trillion valuation. He also wants to attract top-tier global investors. A listing in London or New York is out for now. The company will initially sell a sliver of just 1%-2% on the local Tadawul exchange, including an offering for Saudi retail buyers.

Aramco is keen to tout its financial might. It produces 10 million barrels of oil per day, generated net income of $111 billion last year, and earned a 41% return on average capital employed. These measures put it miles ahead of the five major oil companies – Royal Dutch Shell, Exxon Mobil, Chevron, BP and Total – it regards as stock market peers.

Those listed companies trade on an average dividend yield of 5.6%, based on Refinitiv estimates of their expected payouts for next year. Aramco is promising to distribute at least $75 billion to shareholders in 2020. At the hoped-for $2 trillion valuation, its shares would yield just 3.8%.

In reality, international investors will probably demand a substantial yield premium to buy into a company which saw half its production knocked out by rocket attacks in September. With a dominant state shareholder and a small free float, Aramco looks more like Rosneft, whose shares yield a hefty 8.3%.

Aramco is not subject to the international sanctions which hang over its Russian peer. But even a more modest yield of, say, 6% would imply a market capitalisation of just $1.2 trillion.

Dividends are not the only valuation benchmark. A Breakingviews model which values Aramco on the basis of discounted cash flows, and incorporates new lower royalty payments to the Saudi government, spits out a price of close to $1.6 trillion. But with a potential demand-led oil glut next year, active institutional investors will remain wary.

Accepting a valuation well below $2 trillion might look like a defeat for MbS. But setting the price too high would force Aramco to lean on rich Saudis and retail investors to get its IPO underway. The credibility of the country’s attempts to diversify away from oil may depend on it accepting a lower price.

First published Nov. 4, 2019

ARAMCO’S INTREPID INVESTORS ARE HEDGED IN TWO WAYS

Hubris

BY GEORGE HAY

Saudi Aramco’s listing represents a tough task for its bankers. Their job is to sell a minority stake in a state-run entity with structural challenges to international investors who usually expect a proper say in the companies they own. Even so, the latest initial public offering documentation suggests buyers have two hedges.

On the face of it, foreign investors that take the plunge and invest in the 1% to 3% Aramco is selling – worth $15 billion to $45 billion assuming a $1.5 trillion valuation – are ordinary shareholders. That small say could make them vulnerable if oil prices collapse. The Saudi government, which will still own over 90% of the shares, could try to recoup lost revenue by taxing Aramco more. Yet international shareholders are subtly different from two other classes.

The first is the Saudi government itself, and its attitude to the $75 billion in minimum annual dividends Aramco is pledging though 2024. If a plunging oil price obliges it to pay out less, Riyadh will sacrifice its own share of the dividend to keep other shareholders whole. On the assumption it sells 3% of the company, Aramco’s free cash flow would have to fall below $2.3 billion for private investors’ dividend to be at risk. In 2018, free cash flow was $86 billion.

Subordinating the state and effectively turning other investors into preferred shareholders may help attract hedge funds, by making the stock easier to borrow against. Assume a fund used debt to fund half of its stake and borrowed at 3%. It could then make a juicy and predictable 7% annual return, according to Breakingviews calculations.

The other class is domestic Saudi investors. They are getting a sweeter deal in the IPO than international peers, with an extra share bonus for each 10 they hold for half a year. But that too may be good news: the bigger the presence of domestic retail investors, the stronger the incentive Riyadh will have to manage Aramco fairly. A nosediving share price might undermine the regime.

Neither of these two hedges are fail-safe. Riyadh could find ways to hurt Aramco, while helping domestic investors, say through lower taxes. And as recently as 2016, falling oil prices meant Aramco only generated $1.6 billion of free cash flow. Still, fund managers strapping themselves into the IPO roller coaster do at least have two credible airbags.

First published Nov. 4, 2019

(Image: REUTERS/Hamad I Mohammed)