Aramco offers high risk, but huge rewards
The launch of Saudi Aramco’s IPO on Sunday will begin a fortnight of feverish debates and valuation discussions among investors and banks. But Aramco is not just an investment in an oil company: it is an invitation to be a junior investor in the state of Saudi Arabia — with all the dangers and upside that entails.
Many factors will make Saudi Aramco’s flotation on the Saudi Stock Exchange unique.
The float’s size, at up to $2tr, and profile have made it the most talked about transaction in investment banking for two years. And Aramco is the world’s most profitable company, having made $111bn of net income in 2018 from $356bn of revenue.
But Aramco’s IPO will be one of the riskiest investments for years, if not the riskiest.
While buyers will commit huge funds, they will — even collectively — own next-to-nothing of Saudi Arabia’s national oil champion. While it may be the largest holding for many investors, they will be minority shareholders with little to no say in how the company is run.
Investors will also be committing huge sums to Saudi Arabia, at a time when the kingdom faces a crisis. In September, forces directly linked to Iran, or to the Iran-backed Houthi rebels Saudi Arabia is fighting in Yemen, attacked two Aramco facilities with drones, temporarily halving Saudi oil production.
The reason for the attack was not just that Aramco is an oil company — it is a crown jewel of the Saudi state.
The company is responsible for Saudi Arabia’s wealth, so investing in it will be akin to investing in a government.
Investors buying into Aramco must consider the risks of war, the potential for international condemnation — such as that which followed the murder of journalist Jamal Khashoggi last year — and domestic political turmoil, including growing calls for civil reforms and respect for human rights. There is also the environment.
Oceans of money
Nevertheless, as in so many instances where doing business with Saudi Arabia is concerned, for some the sheer quantity of money available counters the risks.
Aramco’s remarkable dividend policy may be generous enough to make investors forget all the complications surrounding the company.
Saudi Arabia has committed to guaranteeing the dividends paid to Aramco’s new shareholders for the next five years, by giving external investors priority over the government in receiving dividend payouts. That makes the dividends almost as secure as government bond coupons.
The level of dividend has been fixed at $75bn for the whole company. Aramco’s dividend yield will therefore range from 7.5% at a $1tr valuation to 5% at $1.5tr and 3.75% at $2tr.
Because of the predicted enormous size of the IPO — Saudi Arabia originally wanted to float 5% of its capital — investors will have an opportunity to place huge orders. What policy the kingdom and its lead managers will adopt towards sizing and pricing the deal and allocating stock remains to be seen. But the state could, if it wished, fill investors’ boots. That would enable them to put very large sums to work, for a guaranteed annual cash return. Add in the possibility of coming into the deal as a privileged investor, and the option looks particularly tempting.
The global coordinators are certainly open to taking interest from cornerstone investors, which would come in at the beginning of the deal, with an order good throughout the price range. In return, cornerstones would normally get a full allocation. Another option is an anchor order, which comes in early and in size, but can have a degree of price sensitivity.
Other stocks might have higher yields, but can an investor put $1bn — or $5bn — into them?
However, investors must accept that an investment in Aramco is not like any other emerging market company, where there is a plausible separation between the company and the actions of its home government.
Investors might be happy to commit funds to the kingdom, given Crown Prince Mohammad bin Salman is seen as a moderniser. Nevertheless, everyone must go in with the knowledge that investing in Aramco will come with controversy.
An investment in Aramco is a minority equity investment in Saudi Arabia itself, with all the risks that entails.
But for many investors such a large pool of guaranteed cash might be enough to tempt them to back the deal.
Strip away the razzmatazz, hype, politics and gossip, and this is a simple case of risk and reward. Just one on a gargantuan scale.