Aramco – IPO of the century or a risk too far?

The world's most profitable and valuable company, the world's largest oil producer, the biggest initial public offering (IPO) in history – superlatives abound when it comes to Aramco, Saudi Arabia's giant state oil company. Eagerly awaited for many years now, the company is seeking a valuation of up to $1.7 trillion in its upcoming IPO, which would see it easily replace US technology giant Apple as the world's most valuable publicly traded company.

Aramco’s IPO commands investor attention given the sheer scale, profitability and dividends of what Bernstein analysts aptly describe as a “monster oil” company. It was easily the most profitable company in the world last year, recording net income of $111 billion – almost double that of Apple, its closest rival in terms of profitability.

Lower oil prices and production problems will hurt profits in 2019, although the numbers – $68 billion in profits in the first nine months of the year – remain eye-popping. Those profits aren’t going to dry up any time soon.

Armaco possessed the equivalent of 260 billion barrels of oil at the end of 2017 (more than 10 times as much as fellow oil giant Exxon Mobil), with those reserves having an estimated life of 54 years. Not only that, Aramco extracts oil for just $2.80 per barrel; that’s a fifth of Exxon Mobil’s extraction cost and far cheaper than all of its oil rivals.

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Aramco has promised a minimum annual dividend of $75 billion over the next five years – almost five times greater than the world's biggest dividend payer, Royal Dutch Shell, which paid out dividends of $15.7 billion last year.

Valuation concerns

Huge profits mean a huge market capitalisation although there is a similarly huge range of opinion as to how high the company should be valued.

“While we’re used to valuing Big Oil, Aramco is Monster Oil”, so determining fair value isn’t easy, Bernstein analysts said last month. Although Saudi Arabia crown prince Mohammad bin Salman had long put a $2 trillion valuation on the firm, scepticism from the international investment community meant those ambitions had to be scaled back, with Aramco now seeking a valuation between $1.6 and $1.7 trillion.

Bernstein reckons the firm is worth between $1.2 and $1.5 trillion, but other analysts arrive at far greater valuation spreads. Goldman Sachs has estimated Aramco to be worth between $1.6 and $2.3 trillion; Bank of America says it could be worth as much as $2.4 trillion or as little as $1.2 trillion; Royal Bank of Canada’s estimates range between $1.3 and $2.2 trillion; three separate valuation models used by Morgan Stanley suggest a spread of at least $1 trillion, Bloomberg recently reported, with the bank’s estimates ranging from as low as $1 trillion to as high as $2.5 trillion.

Overall, however, the consensus among money managers has been more downbeat than upbeat; a Bloomberg survey of money managers found more than 40 per cent estimated the company to be worth between $1.2 and $1.5 trillion, with another 25 per cent valuing it at $1.1 trillion or less.

For all the talk of the aforementioned $75 billion dividend, a 5 per cent dividend yield – the same as Exxon Mobil – would suggest a valuation of "only" $1.5 trillion. The initial talk about securing a valuation closer to $2 trillion would have meant a dividend yield notably lower than Western oil giants.

Risks

That seems problematic, to say the least, and many strategists caution that the various risk factors associated with Aramco necessitate it be valued at a discount rather than a premium.

Some of the risks Aramco faces are common to all oil companies. Increased concern about climate change is reflected in the growing number of funds stating they will not invest in oil companies, Nomura noted recently.

According to documents seen by the Wall Street Journal, Aramco’s growth assumptions and dividend package are based on Brent crude prices at or above $65 a barrel, but oil prices are volatile; they have ranged from $44 to $85 over the last three years, averaging $63 during that period.

Oil demand will start to contract as early as 2035, according to an IHS Markit assessment included in Aramco’s IPO prospectus, or possibly even within the next 10 years depending on the pace of the move towards renewable energy. Then there are the Aramco-specific risk factors. Investors were reminded of the geopolitical risks following drone attacks on the company’s oil processing facilities at Abqaiq and Khurais in September, attacks which forced Aramco to slash more than half of its daily oil production.

More serious, perhaps, is the fact that investors are being offered a minority stake in an oil company owned by the Saudi state. The Saudi government is free to raise tax rates in the future, Bernstein cautioned last month. His concern was echoed by Raymond James energy analyst Pavel Molchanov, who said the “biggest issue with Aramco is that everything about this company is controlled by the Saudi royal family – shareholder opinions, your board votes, none of that makes any difference”.

In the past, the monarchy has used Aramco to finance its own projects and the firm’s prospectus admits the government “may direct the company to undertake projects or provide assistance for initiatives outside the company’s core business” and which “may not be consistent” with commercial objectives.

Similar concerns have long bothered investors in other state-controlled oil giants such as Brazil's Petrobras and Russia's Gazprom and Rosneft, all of which consequently trade on much lower valuations than their Western counterparts. Aramco's continued secrecy will also concern institutional investors.

The company’s prospectus didn’t reveal bankers’ fees, a price range, a date for the listing or the total percentage of the company to be sold. Just 10 of the 658 pages in the prospectus are devoted to third-party certification of its oil and gas reserves, noted Bloomberg columnist Liam Denning, who contrasted this with the 135-page third-party certification published in Rosneft’s 2006 prospectus.

Despite wanting a valuation 15 times Rosneft’s current enterprise value, said Denning, Aramco chose to publish “an upstream assessment that looks like a pamphlet in comparison”. Profitable as it is, international investors might argue the risks associated with Aramco warrant a decent discount to its Western rivals, but the Saudi government appears to think otherwise.

Aramco has chosen to list only on the Tadawul stock exchange in Riyadh, where wealthy Saudi families are under political pressure to invest and where Saudi banks have even been issuing loans to ordinary investors to buy stock. However, with marketing roadshows in the US, Asia and Europe having been cancelled, it’s clear that persuading global investors to buy into the issue has proven to be a much trickier task.