Saudi
Aramco, the world’s most profitable corporation priced its long-awaited IPO at
the high end of the target range on Dec 5, raised $25.6 billion at a valuation
of $1.7 trillion. This will be the world’s biggest IPO (BBC, 6 Dec 2019).
Aramco
priced its initial public offering at 32 riyals ($8.53) per share, surpassing
the $25 billion raised by Alibaba when it debuted on Wall Street in 2014. The
sale of 1.5% of Aramco was oversubscribed 4.65 times, according to Aramco. In
other words, there was $119 billion of investment funds bidding $25.6 billion
worth of shares. The stock sale was first announced in 2016 with expectation to
raise as much as $100 billion from the sale of up to 5 percent of the company.
Saudi
Arabia is dependent on oil dangerously. In 2018, the petroleum sector
contributed 87 percent of the government’s budget, 90 percent of export
earnings, and 45 percent of GDP. The IPO is a strategy to reduce this oil
dependency, by providing funds for other nonenergy investments.
However,
various risk factors associated with Aramco that investors should consider
before investing in this company. According to Ram Shivakumar, professor of
economics and strategy at Chicago Booth, Aramco is facing two megatrends challenges:
The
first megatrend is the additional supply of oil and gas from non-OPEC members. Due
to innovations in hydraulic fracturing and horizontal drilling, there has been
a five-fold increase in the production of shale gas in the US over the past
decade, according to the US Energy Information Administration. In public, OPEC
has clung to the view that shale-gas production has peaked, and that OPEC is
well positioned to reassert its dominance. Yet shale-gas production has been
increasing each year, and is not expected to peak until 2040.
The
second megatrend is that public sentiment in the Western world toward fossil
fuels has turned sharply negative. Storms, floods, fires, and droughts are now
more incessant and harsher, and there is widespread acknowledgement that these
phenomena are linked to fossil-fuel use. Changing weather patterns and global
activism have put pressure on politicians in Western democracies to develop
policies to address climate change.
For
most of the 20th century, the primary fear was that the world would run out of
oil sometime in the second half of this 21st century. Today, some experts
expect the demand for oil to taper off before oil runs out. And though there is
a wide variation in opinion on when oil demand will begin to decline, there is
a consensus that the substitution away from oil will happen within the next
four decades.
Apart from the two megatrends, investors should
take into accounts the risks and rewards of investing in Aramco as well. On the
positive side, Aramco has advantages in extracting oil at world’s lowest
average cost of $2.8 per barrel in 2018. Its EBITDA margin of 63 percent is
twice as big as its largest rival, Russia’s Gazprom, and its proven oil
reserves of 260 billion barrels of oil are more than three times greater than
the reserves of the next five largest oil companies combined.
To boost demand, Aramco has “promised”
investors an annual $75 billion dividend for the next five years. At the
valuation of $1.7 trillion, the yield will equal just 4.4%. In current zero
interest rates world, this could be attractive. But it’s less than holders of
the company’s 30-year bond are getting. Also, Exxon’s dividend yield is about
5% today. For Aramco to match Exxon yield, its market value would have to be
closer to $1.5 trillion (Bloomberg, 2019).
Aswath Damodaran, a New
York University professor, viewed Aramco’s valuation of $1.7 trillion as a pretty good investment for Saudi nationals, with dividends representing the primary return but limited
room for any price appreciation. Global demand, climate change, and
geopolitical risks are factors that could make the company difficult to grow in
the long term.
Reference:
1. Saudi Aramco raises $25.6bn in
world's biggest share sale, 6 Dec 2019, BBC News
2. Ram Shivakumar, The big risks for
investors in the Aramco IPO https://review.chicagobooth.edu
3. Aramco’s Giant IPO Is Finally Set, 14
Oct 2019, Bloomberg
4. Aswath Damodaran, A coming out party
for the world's most valuable company: Aramco's long awaited IPO! http://aswathdamodaran.blogspot.com
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