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Saudi Arabia

Aramco IPO delay (again): Delays adviser fees more than Saudi diversification

    Hasnain Malik
    Hasnain Malik

    Strategy & Head of Equity Research

    Tellimer Research
    18 October 2019
    Published by

    Saudi Aramco has delayed its IPO again, according to press reports. The impact on the timing of fees for the company's financial advisers is likely greater than on the timing and funding of the country's diversification ambitions. 

    The funding for those ambitions remains primarily from the government's dividends from Aramco as opposed to the sale of a small percentage stake in Aramco. Dividends in the first-half of 2019 alone are larger than the potential proceeds from a 2% IPO (even at a US$2tn valuation). 

    We prefer Saudi to the other large GCC oil exporters but, for us, it (and the GCC) ranks relatively low in the wider emerging and frontier universe. 

    Below we briefly consider the risks, which any valuation of Aramco should reflect, the importance of the IPO to Vision 2030 and the position of Saudi in emerging and frontier portfolios.

    Scenarios for Aramco valuation and IPO proceeds, using listed oil major dividend yield benchmarks

    Source: Bloomberg, Tellimer Research

    Aramco equity investment case risks

    Aramco is the largest and lowest cost producer of oil, and the scale of spare capacity still makes it uniquely strategic in the global oil market. However, the risks associated with Aramco equity investment case are multiple: Some are generic to the entire oil major sector, some are generic to state-owned oil companies and some are unique. 

    1. Alternative oil major equities in developed markets are easier to access (no need to set up Saudi trading access), have a long history of disclosure and alignment of majority and minority shareholder interests, transparent ownership, greater free float in percentage terms, longer-standing top management, and diversification across multiple countries and assets.
    2. Oil price outlook: Against a backdrop of anaemic global growth, oil prices remain low despite OPEC Plus output restraint, sanctions disruption to Venezuela and Iran, an unprecedented attack on core Aramco assets, attacks on oil tankers off the coast of the UAE and in the Gulf of Oman, risks to output in Iraq and Libya, China build-up of strategic oil reserves, and more debate over the sustainable growth in US shale output.
    3. Majority government shareholder versus minorities: Tax rates, dividend stream, acquisitions and capex are all effectively determined by the largest shareholder, the government, which may prioritise value created for the broader Saudi economy and citizen population over the value created for minority shareholders.
    4. Aramco bears the burden of OPEC Plus output restraint: Saudi compliance with output targets has not always matched the rest of OPEC Plus.
    5. Security: Costs of defence (for Saudi in general and Aramco specifically) are likely to escalate as the US gradually reduces its military commitment to the region (or at least, continues to adopt a more transactional approach to providing that security).
    6. Aramco is owned by the Saudi government, which, in turn, is the royal family and that (similar to some of the other GCC national oil companies) links Aramco to risks associated with royal family succession.

    These risks, of course, do not prevent a listing of Aramco’s shares, but they do impact the valuation that active institutional investors, who under no compulsion to invest, are prepared to pay. 

    Aramco IPO is a one part, not the central piece, of Saudi’s non-oil diversification

    The transaction is important for Saudi because it will provide capital to invest in the diversification plans laid out in Vision 2030. But this should be put into context: Even if the proceeds of the listing amount to as much as US$20-40bn (ie based on a 2% stake at a US$1-2tn valuation range), it is unlikely that this would immediately be invested in diversification projects. Furthermore, the cash flow required from investment in diversification is still likely to be sourced mainly from the government’s dividend from Aramco (which totaled US$46.4bn in H1 19 alone, split between a US$26.4bn “ordinary” dividend (flat yoy) and a US$20bn “special” dividend (a 233% increase yoy). In other words, we do not believe that any diversification project will be held up specifically because the Aramco IPO is delayed. 

    A temporary reversal of the side-effects of the IPO on local equities and liquidity

    The delay may also, albeit temporarily, reverse some of the effects of such a large transaction on the local equity market and banking system.

    1. Local investors, who may previously have mobilised funds to participate in the IPO by selling a portion of their existing equity holdings, reinvest their cash back into the equity market. The local Tadawul equity index is down 5.3% (in total return terms) to date in October (at one point down c7.5%), compared with GCC peers, which are flat at 2%.
    2. The delay may also allow for other, much smaller, IPOs of local companies to proceed (now that they will no longer be crowded out).
    3. Liquidity in the local banks may divert back to lending for local businesses, as opposed to lending for local investors, to finance their purchases of Aramco shares. Loan growth yoy is very low – year-to-date and in August, it was merely 3.2% and 2.8%, respectively. 

    We remain relatively unenthusiastic about Saudi equities

    We prefer Saudi to the other large GCC oil exporters but, for us, it ranks relatively lowly in the wider emerging and frontier universe. Local consumer confidence is recovering, the social liberalisation and legal reforms necessary to enable non-oil diversification (eg in entertainment and tourism) are proceeding, and price/book valuation of the Tadawul index is a few percent below the 5-year median. 

    This is enough for us to prefer, within the GCC, Saudi over Abu Dhabi, Kuwait and Qatar, which are all more expensive (relative to history). In the cases of Abu Dhabi and Qatar, they have less low-hanging fruit from non-oil diversification, and in the case of Kuwait, it has less political will for non-oil diversification. But relative to the broader emerging and frontier universe, Saudi (and the GCC) ranks fairly lowly. Passive funds inflow related to EM index inclusion are fading, oil price remains subdued, Saudi output remains restrained (to meet OPEC Plus targets), security risks have increased (both for the broader region and for core Saudi oil assets), the US rate cycle is no longer providing a tailwind for Saudi bank earnings (geared to investment in government securities), and FX rate pressures are not acute enough elsewhere in emerging and frontier markets to push portfolios towards US$-pegged markets.

    Saudi equities, Aramco bond, sovereign bond recent performance

    Source:  Bloomberg

    Screen of Saudi stocks for liquidity, performance and valuation

    Source: Bloomberg, Tellimer Research