On the Eve of the Saudi Aramco IPO, Talk of a $2 Trillion Valuation Gains Momentum. Skeptics Aren’t Buying It

December 10, 2019, 2:34 PM UTC

Saudi Energy Minister Prince Abdulaziz bin Salman is confident that Saudi Aramco will achieve its longheld goal of scoring a $2 trillion valuation. It might not be tomorrow, when shares are scheduled to begin trading on Saudi Arabia’s Tadawul stock exchange. But give it a few months, he says, and Aramco will hit that high (and highly symbolic) level.

Zachary Cefaratti, chief executive of Dubai-based Dalma Capital, is even more bullish. Three of the funds they manage bought shares in the Aramco IPO. He says Aramco is likely to be bid up to $2 trillion or more in the first days of trading. That’s no small feat—it would require an 18% surge in the share price.

There’s always some swagger by the bulls ahead of a high profile listing, but this one feels different if only because there are so many skeptics who question whether the world’s biggest oil producer is worth anything near that.

One thing is for sure—with millions of Saudi citizens having invested in the IPO (some even taking out bank loans to participate), the Saudi government will be rooting extra hard that the share price stays in positive territory.

Bigger than Apple, Alibaba

Saudi Aramco, which will dethrone Apple as the world’s most valuable listed company, will have a market cap more than three times higher than the rest of the stocks on the Riyadh exchange put together.

Investors, mainly from Saudi Arabia and the Gulf, bid for 4.65 times the number of shares offered in the IPO, ensuring that the privatization of a 1.5% stake in the state-run oil giant will raise at least $25.6 billion, exceeding the previous world record IPO set by Alibaba in 2014.

That values the entire company at $1.7 trillion, some $300 billion below the $2 trillion valuation initially hoped for by the Saudi government. But it could have been worse. International asset managers gave Aramco an average valuation of no more than $1.26 trillion, according to a survey published by brokerage Bernstein last week.

The lukewarm reception for the IPO from many Western investors, put off by the high valuation, pushed an offended Saudi government to limit marketing of the IPO to Saudi Arabia and the Gulf, abandoning plans for presentations to investors in the United States, Europe and Asia.

The Saudi government has shelved—at least temporarily—plans to list shares in the world’s biggest oil producer in New York or London. It also scaled back the size of the offering, dealing a blow to its plans to raise up to $100 billion to help diversify the Saudi economy away from oil.

“Battered by the media”

Prince Abdulaziz’s comments on the IPO at an OPEC press conference in Vienna last Friday revealed the extent to which the Saudi government has staked national pride on achieving a premium price for its crown jewel. It also exposed some raw feelings.

“We’ve been battered by the media … In a few months from now, I’ll remind … I wouldn’t call them by names, but I think they would probably like not to have written those pieces that they have written. We will get Aramco and it will be higher than the two trillion and I can bet that this will happen,” said the energy minister, who is a half-brother of Crown Prince Mohammed, the kingdom’s de facto ruler.

Hailing the closing of the IPO book last week as a “proud day,” Prince Abdulaziz said 5.1 million individual investors had applied for Aramco shares; foreign investors were among the institutions that bid.

In a separate interview with CNBC, the energy minister put a brave face on the decision to list Aramco shares locally, saying it was the brightest day of his life when the Saudis decided to make the offer more of a “family and friends” affair.

Appointed energy minister in September, Prince Abdulaziz said many pension funds, banks, sovereign wealth funds and endowments had subscribed. “Surely one would simply deduce from that that they are there for the long term,” he said.

Cefaratti, the Dalma Capital CEO, said many institutional investors would find that they were significantly under their target weight of Aramco shares in their portfolios, and would need to buy shares in the first days of trading. Retail investors have an incentive to hold on to their shares for 180 days to qualify for a one-for-10 bonus share offer, he noted.

He believed it was highly likely that underwriters would exercise the “greenshoe” option available in the case of strong demand. That allows them to sell 15% more Aramco shares, raising the offering to $29.4 billion.

Even then, Cefaratti believes, the extra shares will not be enough to meet demand.

He expected Aramco to be included in the MSCI, FTSE and S&P emerging market indices within two weeks of the listing, leading to incremental buying of $3.4 billion as investment funds model their portfolios on the indices.

“In light of these dynamics we believe that it is likely that we will see Aramco bid up to $2 trillion or higher in the first days of trading, and potentially to trade-limit up on the first day,” he said in a note shared with Fortune.

Trading in Aramco shares, which will have the stock symbol 2222, will be halted if they rise or fall by 10% in any session.

“Missed an opportunity”

Many Western investment funds have steered clear of the IPO, seeing Aramco shares as over-priced. Bernstein said last week that Saudi Aramco had “missed an opportunity by not pricing the IPO at a level which would be attractive to institutional investors.”

Ellen Wald, an expert on Saudi Aramco, said she expected to see a fairly low volume of trading in Aramco shares this week because “everyone who is interested in buying, particularly among retail investors, has bought in at the IPO, and the government is doing a lot to make sure there are a lot of incentives for people not to sell shares within the first six months of the listing.”

She thought it highly unlikely at this point that the Saudis would follow the domestic listing with an international IPO.

“Any other stock market that they list on, they will have to give up some measure of control. They will be opening themselves up to potential lawsuits from shareholders, and that is not something that the Saudi government can really handle,” said Wald, president of Transversal Consulting and author of Saudi, Inc, a book about Saudi Arabia and Aramco.

“As it stands now, if the Saudi government decides to do things with Aramco that hurt the public shareholders, there is no legal recourse for these people, because they are subject to the rules and laws of Saudi Arabia. And that doesn’t really provide for legal recourse against the king,” she told Fortune.

She expected the IPO to increase transparency at Aramco, but also to lead to more Saudi government interference in the way the company is run.

The Saudi government has taken various steps in recent months to make Saudi Aramco more attractive to investors, including reducing corporate taxation and changing the royalty structure. Saudi Aramco says these measures, which mostly take effect from next year, would have increased its cash flow by $4.5 billion if they had been in place in the first half of 2019.

Saudi Aramco, which pumped 10.3 million barrels of crude oil a day in 2018 and made a net profit of $111 billion, has pledged to pay a dividend of at least $75 billion a year for the next five years, but its 4.4% yield is lower than that of Exxon Mobil, BP or Royal Dutch Shell.

A key factor influencing Aramco’s share price will be oil prices, which have been subdued since slumping in the second half of 2014.

The final pricing of the Aramco IPO last week coincided with a decision by Saudi Arabia, other OPEC countries and their allies, meeting in Vienna, to make deeper cuts to their oil output to prop up oil prices.

Some analysts have suggested that part of Saudi Arabia’s motivation for supporting the output cut was to make the Aramco IPO a success, although the Saudi energy minister denied any link between the two events.

Wald has a different take. She argues that future Saudi oil policy may be influenced by a desire to raise Saudi Aramco’s revenues and share price by increasing oil production.

In the past, the Saudi government saw increasing oil prices as a way to make more money, but that dynamic could change once Aramco becomes a public company.

“When public oil companies need to increase their share price, they need to show revenue growth. The best way to show revenue growth is to produce more oil and sell more oil. Saudi Aramco has a unique ability to be able to increase its oil production … Even if that pushed oil prices down, it would show a big revenue growth because it only costs Aramco $2.80 to pump a barrel of oil,” she said.

If the Saudis wanted to sell more Aramco shares in future, “the fastest way to increase the share price and to show revenue growth is to pump more oil, not less,” she said. “So that may become a big influencer in Saudi oil policy.”

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