(Alisha Gragya & Taiga Nakamura)
Beginning January 2016, the Saudi Crown Prince Mohammad Bin Salman publicly declared that he intended to sell 5 percent of Saudi Aramco, a government-owned oil and natural gas company based in Dhahran, Saudi Arabia, in the face of a widening economic deficit and depleting foreign reserves. The government planned to reinvest the receipts from Aramco’s initial public offering to fund Saudi Arabia’s ambitious economic projects aimed at diversifying its economy away from oil. Investor expectations were high for this oil giant, which is responsible for 10 percent of the global oil production and contributes $111 billion on average to the country’s economy every year. A well-established supply chain network, domination over the oil market and strong company financials made Aramco a profitable prospect for financiers across the globe.
The sale of shares, accounting for 1.5 percent of the company’s valuation, took place in a globally conducted initial public offering (IPO) on Tadawul, Saudi Arabia’s stock exchange, on 11 December, 2019. The IPO registered a record as Aramco continued to become the world’s largest and most profitable public company, easily surpassing China’s tech giant Alibaba. A massive $26 Billion was raised by the enterprise (Samantha Gross, 2020). The valuation techniques adopted, though, were subject to great debate worldwide.
Mystery looms over Aramco’s Valuation
When the Crown Prince Salman announced that the company was valued at over $2 trillion, it stunned the world. Eventually, more than a dozen investment banks were brought on board to facilitate the smooth performance of the IPO in global capital markets. However, Investors and investment banks, across the world, balked at the startling revelation and casted doubts primarily because the company faltered on the requisites for listing on the world’s significant stock exchanges.
Uncertainty looms over Aramco’s $2 trillion valuation due to a couple of reasons- high political exposure, low oil prices, geopolitical regional tensions and climate change concerns. Global investors valued Aramco between $1.2 and $1.7 trillion, far below the Crown Prince’s coveted valuation (Wald E., 2020). The reduced IPO forecast, predicted due to decline in the demand for oil and geopolitical jitters, shattered the Kingdom’s dreams of an immense international IPO. The dissatisfied Aramco Management was completely unwilling to sell stakes in the company at the low-priced valuation estimates. Subsequently, the company withdrew the stakes from the global capital markets and decided to list the firm on the Saudi Arabian stock exchange. Through strong political support in the country, Aramco hired local investors and analysts who managed to inflate Aramco’s valuation as per the Kingdom’s wishes at $1.7 trillion, which was considered to be the most optimistic and far-fetching valuation figure.
Despite worldwide dubiety of the correctness and transparency adopted in the valuation methodology, the enterprise received enormous funding from government officials, wealthy Saudi families and regional allies. The local investors were incentivized through concessions and preferential loan rates to purchase Aramco shares. Even till date, a combination of patriotic and political factors is driving the share price of the company.
Determining True Value
One important aspect to factor-in when evaluating Saudi Aramco is to note that this is no conventional company. It is certainly not one whereby shareholders are capable of influencing major corporate decisions at annual general meetings nor elect the board of directors. The nature of the state-owned company with a 98.5 percent controlling stake by the government implies that shareholders are more of a capital provider purchasing a bond rather than equity. But also, the uniqueness of this IPO listing means that while Saudi Aramco can certainly be compared to its comparable companies, including Exxon Mobil Corporation, Royal Dutch Shell Plc and Chevron Corporation, its valuation must be discounted largely on political risk and country risk. Bernstein analysts Neil Beveridge and Oswald Clint highlighted that many of emerging market oil majors trade at a discount to its developed Western comparables by 30-40 percent (Salzman, 2020), and Saudi Aramco should be no exception.
On a cash flow basis, Aswath Damodoran, professor of finance at the Stern School of Business at New York University provided a thorough Dividend Discount Model valuation to assess Saudi Aramco’s intrinsic value. Upon applying valuation adjustments including political risk, upside limits and an increased influential role on setting oil prices, the professor obtained a figure around $16.5 trillion. One reason for quoting the above independent valuation is due to the fact that figures presented by investment banks are a pricing rather than a true ‘valuation’. The figures usually presented on the news and quoted by public investors are judgments on the price the investor clientele would be willing to pay, rather than the material value of the company. To assess whether the opening price of the IPO has been an overvaluation, from an academic standpoint, would require such an independent opinion. Upon a simple comparison, it becomes evident how the current share price at 33 Saudi Riyal has been inflated through extensive advertisement and political assistance. Since the market is known to correct itself to reflect true value, there is certainly the risk of following the path of WeWork and Square if and when their shares reach Western Stock exchanges.
Regardless, even when considering the above, listing the valuations quoted by investment banks in a graphical format provides a clearer picture but also a warning to potential investors with regards to the approximate $2 trillion Crown Prince Mohammad Bin Salman claims the company is worth. Especially given that this figure is not a valuation, nor a pricing, but rather an ideal figure once promised by investment banks prior to the 4 years of delay and disruptive events. However, Saudi Aramco’s shares could be a solid investment for domestic investors, provided the investor recognizes that the primary returns are from the dividends, and as pointed out by Professor Aswath Damodoran (Damodaran, 2020),
Financial Highlights Post COVID
Each Aramco share was traded at $8.52 in December, 2019, when the company was listed on Tadawul. Despite inventory losses, declining crude prices and falling refining margins, the company witnessed a strong financial output in the first quarter of 2020, due to favourable trends in the working capital. With strong financial statements in hand, the company announced dividends worth $18.75 billion in the first quarter, the highest for any publicly listed company. However, the math behind the dividend announcement seemed incongruent as Aramco’s finances were a testament of a 25 percent reduction in the first-quarter net profits. Financiers believed that this extra mile was risked to enhance investor confidence in the company. According to the company’s authorities, the dividend payments were a part of the company’s shareholding and investor benefit plans.
Beginning 2020, a dampening crude oil demand caused due to the global pandemic and highly dynamic business environment is forecasted to affect Aramco’s full year earnings. Under challenging market conditions, Aramco traded below its IPO price at $8.24 on 8 March, registering a 6.36 percent decline. This was a result of the tensions between Saudi Arabia and Russia, two major oil producers, after OPEC’s pact with Russia to limit oil supply fell apart. In totality, share price was reported to fall by 15 percent since the IPO in 2019.
In fact, investors must pay close attention to the soon-to-be-announced Q2 earnings reports to assess the extent to which the current pandemic has negatively affected the company’s profitability. It seems, however that the financials may not look particularly well, especially due to the overproduction and reducing prices of oil sold to Asian countries during April, which inevitably required Saudi Aramco to cut its production in May and June.
(UPDATE: 11/08/2020) As expected, earnings reported last week suggests Saudi Aramco earnings to have fallen by 73 percent compared to last year (Reed, 2020) due to the widespread pandemic. Dangerously, Saudi Aramco must pay a quarterly dividend of $18.75 billion, three times its cash flows, as part of the commitments promised during the run-up of the IPO. With this information, investors must be wary of the ability of Saudi Aramco to continue such large dividend payments as the decline in oil demand continues to damage the company’s financial health.
Despite faring pretty well on the Saudi Arabian stock exchange, Saudi Aramco’s IPO dashed the Kingdom’s ambitions. The Crown Prince Mohammad Bin Salman’s primary objective was to diversify the economy from its overdependence on oil and bring in foreign investment via this IPO. The operation appears to have missed such aim. The overwhelming response by local investors brings in the question of long-term sustainability. Moreover, the $26 billion is still far from the initially anticipated $100 billion, which would have contributed to the Vision 2030, and absence of global diversification seems to widen the gap even more! Superficially, the IPO seems impressive, but on a closer look it raises questions pertaining to the resilience of the company to market and political headwinds.
Adoption of correct valuation standards, distance from political influence, stronger crude trade agreements and appropriate economic reforms to uplift the hurt economy might be the way ahead for Saudi Aramco. The company would see an improvement by opening itself to several prominent stock exchanges of the world, after adhering to the listing standard requirements.
Initial Public Offering (IPO)- The public sale of equity shares by a company to raise capital for its expansion, diversification or funding of further investments.
Dividend Discount Model Valuation – A method of company valuation based on the key assumption that the share price of the company reflects all future dividend payments made, discounted to the present.
Overvaluation – Occurs when the current share price is not justified by the earnings outlook of the company.
Vision 2030 – Framework implemented in Saudi Arabia to make efforts in diversifying the economy away from oil and develop other key sectors including health, education and infrastructure.
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