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Saudi Aramco IPO

Last week, the world’s largest corporation got listed on the Riyadh Stock Exchange at last, after significant delays in the last few years. On its second day of trading, Aramco reached the valuation of $2 trillion that has been coveted by Prince Mohammad bin Salman (MBS). 

This IPO is so bizarre on a variety of fronts. To begin with, the buoyancy of the Aramco share price in the first few days of trading ran counter to lackluster performances of in energy companies with long track records as public companies, in the developed world or else. The global energy sector in general has not been much higher than their five year lows. Aramco’s IPO valuation at $1.7 billion is considered widely as already somewhat overvalued. Some investment bankers did not value Aramco much higher than Apple’s $1.2 trillion. It doesn’t give a strong logical reason for its share price to rally immediately after the IPO.

Aramco lacks a large investor base. Saudi Arabia is not a part of the MSCI World or All Country indices, of course, and has just got promoted to the MSCI Emerging Market index this past summer. Not being a part of the developed world gives global investors little reason to invest in a company that they consider overvalued. How MSCI treats Aramco is yet to be known, but Riyadh Stock Exchange caps the company’s weight at 15% in order to limit its outsized effect. Otherwise, the Aramco effectively becomes the market itself.

Aramco earns $111 billion in profits after tax. At $2 trillion valuation, this would give a price/ earnings ratio of 19 times. It looks expensive, especially considering the long-term future of the business of drilling fossil fuels. From a different perspective, however, it may not be outrageous compared to Exxon-Mobile that is trading at 20 times. A cyclically-depressed industry can be granted a high P/E ration at its bottom, already looking into profit upturns in the near future. Aramco says it pays out $70 billion in dividends, and this gives a dividend yield of 3.5%. To anyone who cares about dividends, Exxon-Mobile that yields 5% is a better alternative.

Since the investor base in the developed world don’t care about Aramco. IPO offerings have been taken up largely by sovereign wealth funds in the Gulf states, in addition to local Saudi Arabians who lack accesses to investments outside their country. They are captive investors who can’t go elsewhere. To those who can go elsewhere, Aramco probably doesn’t matter. This limited investor base could stand in the way of efficient pricing of the company.

Whether Aramco’s valuation is $2 trillion or else, the company has sold only 1.5% of its shares to the public, with the remaining 98.5% in the hands of the government of Saudi Arabia. In contrast Apple, with a $1.2 trillion valuation, is 88% free-float. Which company has a truly greater value? The vast majority of state-owned enterprises in general offers only a limited percentage of their shares as free-float. Telecom operators and energy companies are often more than 50% owned by the government, either in the developed or emerging world. Limited free-float shares give those Monoliths bloated valuations. The world’s first ever trillion company was PetroChina amid a spectacular commodity boom when crude oil was traded well in the north of $100 per barrel, PetroChina hit the trillion mark. However, it didn’t stay up there very long. It’s share price fell precipitously as the market saw no further upside in crude oil. A dozen years later, it is traded only at $140 billion.

Morgan Stanley Capital International that supplies a variety of global indices takes this free-float factor seriously not only because of liquidity but also of shareholders’ ability to influence the direction of the company. MSCI stresses the number of shares that global investors have accesses to. In its global equity indices, the markets whose dominant portion in the hand of the government are not treated nicely. That is why China’s weight is a tiny fraction of the U.S., the most liquid market by far, in its All Country index, though China is the largest market in the emerging market index.

Unlike index weighting of these monoliths, such bloated valuations cannot be checked effectively in mergers and acquisitions deals. Artificially high share prices can still be used as strong currencies when a bloated SOE buys companies in the developed world. Aramco may not have a plan to buy assets that are considered strategic in the west, but China and other developing countries has done it more than several times in the past in North America and Europe. Some foreign players are playing different games of state capitalism on the same capitalism rule that was devised in the west, and has aroused warnings in the developed world. In the U.S., the Committee on Foreign Investments in the U.S. (CFIUS) scrutinizes investment proposals by foreign entities and blocks the deal if necessary. Europe still has little effective defense on the state capitalism’s intrusion but is finally waking up on this issue. 

About the author: Ichiro Suzuki, CFA, is an Advisory Group member at Richard A. Mayo Center for Asset Management of Darden School of Business, University of Virginia. He has retired as Senior Portfolio Manager/ Global Equity Strategist at Nomura Asset Management. Suzuki graduated with B.A. from Waseda University and MBA from UVA's Darden School of Business. Aramco IPO has dug Saudis an even deeper hole What does the Aramco IPO tell us about Saudi reforms? Saudi Aramco shares soar in debut, closing in on the kingdom’s coveted $2 trillion valuation

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