Saudi Aramco IPO hangs on same old question: Is it worth $2 trillion?

The trouble with Saudi Aramco’s off-again, on-again initial public offering has always been the valuation. Ever since Crown Prince Mohammed bin Salman insisted the world’s largest oil producer was worth $2 trillion in 2016, he’s been determined to prove the skeptics wrong.

His optimism met the reality of the global capital markets on Thursday, when the latest plan to float the state-owned company was delayed by at least a few weeks.

At a meeting to give a green light for a deal, bankers made clear that international investors had little appetite to buy at a $2 trillion valuation, according to people familiar with the matter. To draw widespread interest Aramco’s value would need to be closer to $1.5 trillion, one of the people said, asking not to named discussing private conversations.

What happens now will depend on how keen the crown prince is to attract foreign money to the Aramco offering and whether he’s finally willing to compromise on the valuation to get it.

The outlook for what could be the largest IPO ever is likely to dominate the Future Investment Initiative at the end of the month, Saudi Arabia’s annual showcase for the crown prince’s economic agenda that’s been dubbed Davos in the Desert. Many of the Wall Street banks hired to work on the IPO will send senior executives to Riyadh, where they’ll rub shoulders with the crown prince and the rest of the Saudi leadership as well as some of the world’s largest investors.

Aramco said in a statement that the timing of the IPO will depend on market conditions and that it continues to engage with shareholders on activities related to the listing.

One leading international money manager, who recently met Aramco executives in Saudi Arabia to discuss the IPO, said the main problem is officials in Riyadh believe Aramco should trade at a premium to other international oil companies. Many investors disagree and argue the risks of investing in Saudi Arabia merit a discount — or at very best parity — to the likes of Exxon Mobil Corp. and Royal Dutch Shell Plc.

There’s little question Aramco merits a unique valuation. Drilling from some of the world’s largest fields under the barren Saudi desert, the company pumps more than twice the volume Exxon does and has some of the lowest production costs in the world.

But there are also concerns for potential Aramco investors that don’t apply to Exxon, Shell and their ilk. Last month’s attack on the company’s largest crude processing plant at Abqaiq showed the political risk associated with the kingdom. There are also governance issues: the IPO would offer only a sliver of Aramco’s equity, leaving strategy in the hands of the Saudi state. As OPEC’s most important member, Saudi oil production would remain a political decision.

One rough and ready way to value Aramco is to look at dividend yield. As part of the campaign to attract outside investors, Aramco pledged to soup up investor payments to $75bn next year. At $2 trillion that means a dividend yield of 3.75 per cent. That’s a lot less than the 5.1 per cent currently offered by Exxon and the 6.6 per cent Shell shareholders are getting.

Bringing the dividend into line with Exxon would mean a valuation that’s much closer to $1.5 trillion. If Saudi Arabia accepted that benchmark, it would still create the world’s most valuable company — outstripping both Apple Inc. and Microsoft Corp. — and a sale of 2 per cent of the equity would yield $30bn, more than the $25bn Chinese e-commerce giant Alibaba Group Holding Ltd. raised in its 2014 IPO.

If the crown prince doesn’t want to compromise on valuation, he has another option to get the deal done and raise money for the kingdom’s sovereign wealth fund. He can rely on Saudi money by securing big pledges from rich Saudi families — some of whom had members held in the Ritz-Carlton hotel during 2017’s corruption clampdown — pitching a retail offering to small investors and leaning on banks to lend to potential buyers.

Even though it ditched plans for an international listing in New York or London, the Saudi government is still keen to get some foreign institutions to invest, one person involved in the deal said.