The Saudi Aramco IPO gets a Sad Trombone

By TradeSmith Research Team

Here is a pop quiz, or maybe a joke:

Q. When is it bitterly disappointing to have an initial public offering (IPO) worth $1.7 trillion?
A. When you were really hoping for $2 trillion, and you see it as a national embarrassment to have to take less, and your sense of money was already so distorted you paid $450 million for a possibly fake Da Vinci painting that lives on one of your yachts.

We speak of the initial public offering (IPO) for Saudi Aramco, the most profitable company on earth.

Crown Prince Mohammed bin Salman — the de facto head of the Saudi government, and the brash 34-year-old with the Da Vinci and the yacht — wanted the IPO to proceed at a valuation of $2 trillion.

But the investment banks working on the IPO couldn’t drum up sufficient investor interest at the $2 trillion level no matter how hard they tried, much to the annoyance of the crown prince.

To save face, the Saudis scaled back the ambition and locale of the offering — switching from a splashy global IPO to a subdued local one — and proceeded to arm-twist local Saudi investors (over whom the government has considerable influence) to support a smaller capital raise at a $1.7 trillion valuation.

The whole thing was meant to be a public relations splash for Saudi Arabia. That is why the $2 trillion valuation was so important; it was all about optics.

The fact that the Saudis couldn’t get $2 trillion, however, and in fact had to cancel the global IPO and swap it for a strong-armed local one, has become something of a public black eye. By overshooting in their ambitions, the crown prince and the Saudi government managed to snatch defeat from the jaws of victory. As a double insult, they didn’t need the money in the first place.

Saudi Aramco, the crown jewel of Saudi oil production, has a fascinating pedigree. It is one of the most secretive companies of all time — certainly the most secretive to ever go public — and arguably the single most profitable company in the history of the world.

Saudi Aramco traces its roots to John D. Rockefeller, arguably the richest man in history with adjustments for inflation. (Rockefeller became the world’s first billionaire — in literal terms, not inflation-adjusted — in 1916. Let that sink in for a minute: 1916! J.P. Morgan was dirt poor by comparison.)

In 1938, an offshoot of the Rockefeller family’s Standard Oil Co. struck oil in Saudi Arabia. They partnered with the locals to create the Arabia America Oil Co. and proceeded to make a killing over the next few decades.

By 1980, the Saudi government had taken full control, buying out the original shareholders to claim 100% ownership. Eight years later, in 1988, the Saudi Arabian Oil Co., commonly known today as Saudi Aramco, was formed.

Saudi Aramco “gushes profits” in the literal sense of the phrase. Their reported net profit for 2018 — not revenue or gross profit, but net after expenses — was $111 billion, a profit haul that dwarfs even Apple.

How do they do it? It helps to be sitting on an ocean of oil so easy to extract you can just about stick a straw in the ground.

Saudi Aramco’s cost of crude oil production in 2018, with an average output 10.3 million barrels per day, was estimated at $2.80 per barrel. If you are familiar with oil economics in the normal world — that is to say, outside of Saudi Arabia — a cost of production that low is mind-blowing.

And with an estimated 260 billion barrels in reserve — if you believe the company’s reports, which some do not — Saudi Aramco has more reserves than the top five oil majors combined, and more than 50 years of output at the current rate of flow.

Saudi Aramco also does a huge volume of business in natural gas and natural gas liquids, and has aggressive expansion plans for its refineries and petrochemicals business. They are sensitive to the fact that crude oil is a volatile commodity, and the Saudi government wants to diversify its revenue streams.

In retrospect, one of the strangest things about the Saudi Aramco IPO saga, which dragged out for quite a while as they fought and scraped to get that $2 trillion vanity valuation, is the fact that they didn’t need the money.

It’s odd, because going public is a costly and painful process as a rule. You have to jump through a lot of hoops, and pay a lot of money to investment bankers, and fill out a lot of paperwork. And then, once public, you are subjected to quarterly reporting and all kinds of stringent rules that a private organization can more or less ignore.

The normal reason to go through all that, and hold an IPO in the first place, is to raise fresh capital. Companies generally go public because they need the money to expand.

When a company opens itself up to public inspection and public shareholder ownership — and make no mistake, an initial public offering is a complex and revealing process — it usually does so in order to acquire funds.

The funds acquired in the IPO are then used to grow the business, or otherwise improve the profits of the business, and the potential to create new value with new funds is what attracts investors in the first place.

But none of this really applies to Saudi Aramco. They already had $111 billion in annual net profits!

Which raises the question: If you have a business that is minting more than $9 billion a month in net profit on average, why would you try to raise money by going public? Why wouldn’t you just wait three months or so, and have another $27 billion to play with?

This circles back to the public relations aspect of the Saudi Aramco IPO.

It seems the crown prince was more interested in drawing attention (that $2 trillion valuation again) and raising his country’s glamour profile than executing a rational business strategy.

The vanity logic of the crown prince doesn’t bode well for the other problems Saudi Arabia is facing. Depending on who is elected president in 2020, the United States may break off friendly relations with Saudi Arabia or even declare it a pariah state (the Jamal Khashoggi matter remains unburied).

At the same time, Iran — Saudi Arabia’s mortal enemy — is on a path to nuclear enrichment and renewing its grand ambitions for dominating the Middle East, and the oil-powered fossil fuel industry in general is under siege from clean energy alternatives.

That $1.7 trillion valuation, if they push it through, could be a high-water mark. Saudi Aramco, the crown prince, and the country of Saudi Arabia itself, have a bumpy road ahead.

TradeSmith Research Team