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The Saudi Aramco IPO idea that was a winner: But what next?

By Matein Khalid
I had recommended buying the Tadawul ETF iShares MSCI Saudi Arabia (symbol KSA on NYSE) on November 30 to benefit from the post-IPO surge in the price of the Saudi Aramco IPO shares on the Tadawul. This tactical trade was a beauty even before Saudi Aramco shares soared 20% on its Thursday December 12 to peak at 38.7 Saudi riyals (SAR). As I expected, the shares closed limit up twice on their debut in Riyadh, thanks to the sheer size of the oversubscription bid, goosed by government sanctioned leverage to 5 million Saudi retail investors and corporate/family offices.

While Saudi Aramco has beaten China’s Alibaba as the largest listing in history, I would not chase the IPO at a valuation of almost $1.96 trillion as I write. Speculative manias goosed by millions of capital markets illiterate retail investors, flush with high octane bank leverage (2 for 1 for state owned oil company trading at 24 times earnings? Please) rarely end well. I remember the mass hysteria/frenzy that greeted Dana Gas, Salama Insurance, Tamweel, Amlak and so many other UAE IPO’s in the 2004 – 2006 bubble era – none of them ended well for buy and hold investors. In fact, in the past decade, every IPO deal in the UAE I know is down 50 – 90% from its offer price. The point of maximum euphoria for leverage punters is also the point of maximum danger for investors. Get real, book profits – while you can.

I acknowledge the Saudi Aramco IPO is unlike all the Mickey Mouse deals that have gutted investors wealth all over the Gulf (what happened to the retail blind pool that acquired the Cheeky Monkey food chain in Dubai?) but I cannot abandon my philosophy on risk management. Why?

One, as Godzilla insisted, size matters. Saudi Aramco reflects history’s biggest geological windfall, The Prize, that generated $111 billion in net profits for the kingdom in 2018 alone.

Two, the success of the Saudi Aramco IPO is inextricably intertwined with the Saudi Crown Prince’s Vision 2030 program for the social/economic transformation of the kingdom. So it is certain that the kingdom’s Public Investment Fund (PIF) will buy shares on any major selloff, as PIF did after every economic/political shock to hit the Tadawul exchange since 2017. It is no coincidence that Yasir Al-Rumayyan, chairman of Saudi Aramco, is also the chief executive officer of the PIF and a direct report to the Crown Prince of Saudi Arabia.

Three, bankers estimate that 75% of the free float (a mere 1.5% of Saudi Aramco’s 200 billion share count) are held by Saudi retail/corporate investors, who will not sell for obvious reasons. The participation of global energy specialist fund managers in Wall Street and the City of London I respect, who are the most fastidious about valuation and governance, is almost non-existent in this deal. Non Saudi investors tend to be the sovereign wealth funds of Abu Dhabi, Kuwait, China and Russia, who will not risk their diplomatic relations with the kingdom by flipping their shares.

Four, even though the market capitalization of Saudi Aramco is $1.96 trillion on Tadawul, these domestic leverage/international political complexities and the miniscule free float tells me that this is not a natural or sustainable valuation or market price.

Five, does Saudi Aramco deserve this stratospheric valuation premium in the stock market? It is now worth more than double all the fabled Seven Sisters oil and gas supermajors combined! Unquestionably, no. True, its cost of oil and gas drilling/production is the lowest in the world and below anything Exxon, Chevron, Total, BP and Shell can boast. Yet 24 times earnings and a dividend yield of 3.6% is a nosebleed valuation premium when BP trades at 10 times earnings and a dividend yield of 6.9% at a time of asset sales, restructuring and new project growth.

There are several reasons why the world’s most powerful investment banks were unable to generate interest in Saudi Aramco at the $2 trillion valuation sought by the Royal Court in Riyadh. One, after the disasters in the Petrobras and Chinese state energy IPO’s a decade ago, global fund managers avoid state owned oil and gas companies like the plague. These deals are unquantifiable, unknowable, geopolitical risk puppies.

Saudi Aramco, the House of Saud and the Saudi government are all impossible to risk assess, let alone risk manage even for insiders. Governance is yet another dimension in which GCC companies simply do not meet basic international norms, as investors and bankers in the Gulf have learnt the hard way for decades during my adult life in the Middle East capital markets. I wonder how many billion dollars in market value and bank loans will have to be written off now that the promoters of Drake and Skull (one public deal only) looted from their contracting empire.

Has the Dubai regulator given a credible explanation to the financial world how Abraaj Capital, a bastion of crime, theft, embezzlement and self-dealing, could simply vaporize after trying to steal from global investors like the Bill and Melinda Gates Foundation and the IFC/World Bank? I am a professional investor in the Gulf since the mid-1990’s and I cannot fathom the governance norms or corporate/bank balance sheets or risk management protocols in this region. This is sad but true.

John Maynard Keynes’s argument that markets can stay irrational a lot longer than investors can stay solvent holds true for the Saudi Aramco IPO in the short run. Yet a valuation of $1.96 trillion for a state oil and gas colossus that has to fork out up to 85% of its revenues in royalties to the Saudi government if Brent rises to $100 a barrel is simply absurd to me.

As an investor in BP, I would stand to benefit from the full rise in the price of Brent as the company is owned by its shareholders, not the British (or any other) government, though it owns a strategic stake in Russia’s Rosneft, resurrected by the Kremlin from the dismembered carcass of Mikhail’s Yukos oil. BP shares (and revenues) would soar if Brent rose to $100 a barrel. That is not the case with Saudi Aramco as the revenue windfall would be taken by the Saudi state, not trickled down to shareholders.

The 98.5% Saudi state ownership and escalating royalties/tax regime makes Saudi Aramco uninvestible for me and most institutional investors I know. So it is important to let some other genius have the last 10% pop in a leveraged deal which go up like escalators but come down like demented elevators due to the existential logic of a tsunami of margin calls. So book profits on the IPO when you can, not sell when the margin clerks force you to.

There are other reasons to avoid the oil and gas sector, the worst performing sector on the S&P 500 index in 2019 and the entire decade. Energy is now a mere 4.25% weight on the S&P 500 index, less than the index weight of, say, Microsoft, let alone Apple. One of the world’s top energy economists told me at a Dubai lunch briefing that US shale oil and gas output could well rise to 18 million barrels a day from the current 12.9 MBD by 2024. Electric cars will gut the demand for fossil fuels. There is a structural supply glut in the global oil and gas market that not even Saudi Arabia or Russia can combat with OPEC plus output cuts ad infinitum.

On Wall Street, Big Oil is a target for climate change/environmental activists, as anathema a sector as Big Tobacco/Big Cancer. Can I envisage a world where Brent trades at $20 and oil/gas empires trade at valuation multiples of 5 or 6 times earnings? Absolutely, yes I can . After all, cable TV channels and auto legends like Daimler and Ford trade at joke, even single digit valuation multiples now. Can global oil majors lose 50% of their value on Wall Street if the grim supply/demand equations in the world crude oil markets play out to their logical conclusion in 2020? Yes – unquestionably. Can the same fate happen to Saudi Aramco or any listed, state owned oil and gas colossus in the world? Absolutely, yes.

Geopolitical risk to Aramco’s oil processing facilities in the Eastern Province, attacked by Houthi/Iran drone and missiles, remain elevated, even if they are glossed over by retail investors. State owned oil companies in high risk emerging markets trade at steep valuation discounts – Malaysia’s Petronas and China’s Petro-China trade below 10 times earnings.

The valuation discount of emerging market oil and gas companies is at a 30 – 40% discount to, say, the Seven Sisters while Saudi Aramco trades at a 50% premium! If Saudi long life reserves (controversial data), output curbs (OPEC mandated cuts for the swing producer?), governance and operating metrics are evaluated, I concluded Aramco was worth 1.1 trillion or a 7.4% forward dividend yield at $65 Brent. So, in my valuation paradigm, Saudi Aramco is overvalued by $800 billion on Tadawul now. So I book profits on the KSA exchange traded fund (ETF) and move into cash. The Tadawul is 2.6% of the Morgan Stanley MSCI Emerging Market Index, more than the weight of Mexico, Malaysia, Poland the Philippines but only mere 0.15% weight for active EM fund managers. So I conclude that the Tadawul is boosted by the mother of all leveraged bubbles and remember the nightmare of 2005/06 when the Saudi stock index plunged from 21,000 to 5,000. This is the endgame of all speculative manias goosed by state sanctioned bank leverage. Time, as usual will heal all wounds and gut all financial bubbles. That much, at least, is certain.

Triumph, tragedy and trauma in the Arab capital markets!
Published on December 16, 2019
It was the best of times, it was the worst of times. Charles Dickens’s chronicle about Paris and London at the time of the French Revolution in the 1790’s captures my feelings about the Arab capital markets in 2019. The best of times? Saudi Arabia issued $12 billion in Aramco Eurobonds that were oversubscribed ten times in the global capital markets.

Saudi Aramco’s blowout success with the Saudi Aramco IPO on the Tadawul, up 20% in its first two days as a public company, was history’s largest listing (state sanctioned leveraged IPO), stunned the Middle East and a sceptical Western world. Yet the euphoria in the Tadawul contrasted in real time with a banking, currency and sovereign debt meltdown in Lebanon. Bloody civil wars in Syria, Libya, Yemen and Iraq take their toll in human slaughter as I write.

Dubai home prices fell 10% in the fifth year of a property bear market and property developers profits fell 85 – 90% from their peak, as did their share prices. Algeria and Sudan were paralyzed by anti-regime street protest and palace coups within the ruling Praetorian elite. Geopolitical tensions with Iran escalated after Ayatullah Khamenei’s Revolutionary Guards mined, sabotaged and seized foreign flag oil tankers in a bid to disrupt the maritime chokepoints of the Straits of Hormuz and Gulf of Oman after the Trump White House’s “maximum pressure” sanctions strangled Iran’s crude oil exports. The Qatar embargo continued. Turkish combat troops invaded the Kurdish enclave in northeast Syria. The Kremlin invited the leaders of Turkey and Iran to ink a new Sykes-Picot blueprint for the Arab Levant. Israel continued to enforce its mass prison in Gaza and the US moved its embassy from Tel Aviv to Jerusalem in yet another nail in the coffin for a two state solution in Palestine.

The Arab world’s capital markets endured the best of times and the worst of times in 2019. There were seminal milestones in the evolution of the capital markets. J.P. Morgan included five GCC countries in its bellwether EMBI emerging market bond index – and amplified a blowout performance for the Bloomberg Barclays GCC bond and sukuk index, already sizzling after three successive FOMC rate cuts by the Powell Fed. Saudi Arabia’s Tadawul was added to the MSCI EM equities index and is now the ninth largest index constituent with a 2.64% weight, more than Mexico, Philippines and Malaysia.

Egypt continued to make progress in its $12 billion IMF bailout mandated austerity program and inflation’s dramatic fall enabled 500 basis points in central bank policy rates cuts and an almost 20% rise in the Egyptian pound, as the highest interest rates in MENA attracted a tsunami of offshore and diaspora Misri capital. The Nile water dispute between Egypt and Ethiopia on the Great Renaissance Dam threatened to escalate into war even as Ethiopia Prime Minister Abiy Ahmed won the Nobel Peace Prize, once proudly won by Menachem Begin, wanted Irgun terrorist in 1948 and the later the butcher of West Beirut in 1982.

International institutional investors have put more than $23 billion in Saudi Arabian large cap shares before and after the MSCI EM upgrade. Saudi Arabia’s outperformance in the GCC since early 2018 ended with a 15% correction in the Tadawul after May 2019, a recurrent theme in post MSCI EM inclusion countries in the emerging markets.

Then the Saudi Aramco IPO in December once again galvanized the Tadawul with almost $110 billion in bids for the $25.6 billion new issue, bigger than the Alibaba and Nippon Telecom jumbo IPO’s. While Brent crude is $20 below the kingdom’s budget break even oil price and the 2019 State Budget is the most expansionary since King Khalid’s reign in the late 1970’s, Saudi Arabia’s economy has returned to consumption growth, with the Aramco IPO a spectacular win for the Crown Prince’s Vision 2030 reform agenda.

Saudi Arabia will be the most exciting economic diversification, corporate earnings growth, Makkah religious tourism and privatization IPO listing story in the Arab world in 2020 – 21. The Saudi Aramco IPO’s $2 trillion valuation is unsustainable given that peers like Shell and BP offer almost 7% cash on cash dividend yields and a much lower valuation multiple without steeply progressive royalty payouts. A secondary international listing of Saudi Aramco in London or New York will be another vindication of the Vision 2030 blueprint and its quest for the kingdom’s socio-economic transformation.

I expect Kuwait will be the next MSCI EM upgrade candidate, given the scale of its fiscal/capital markets reform and industrial diversification. Kuwait was the pioneer in the Gulf’s sovereign wealth constellation, with the establishment of the Kuwait Investment Authority in the 1950’s. I fondly remember my visits to the Kuwait Investment Office in London in the 1990’s where even young princes of the ruling Al Sabah dynasty were proud to work as equity portfolio managers and analysts. A generation after the $90 billion Souk-al-Manak speculative bubble and Saddam Hussein’s brutal invasion of the emirate in August 1990, Kuwait remains one of the most attractive petrocurrency economies in the emerging markets, with an estimated $500 billion in foreign reserves, low public debt/GDP ratios and a stable, well capitalized banking system that has survived wars, invasion, foreign military occupation, recurrent property busts and regional turmoil. Oil economists estimate Kuwait’s budget breakeven Brent price is only $49 a barrel, a tribute to the fiscal prudence of HH The Amir Sheikh Sabah Al Ahmed Al Sabah.

I have been uber-bullish on Egypt’s stock market since early 2017 due to President Sisi’s structural reforms and removal of fuel/electricity subsidies, something not even Nasser, Sadat and Mubarak achieved. Egypt has made substantial progress in its IMF structural adjustment program, benefited from the draconian Bretton Woods twin mandated November 2016 devaluation and accumulated $45 billion in hard currency and gold reserves.

When I first invested in Egypt in the late 1990’s, in the era of Youssef Boutros Ghali’s privatization mantra and Naguib Sawiris’s Mobinil IPO, Egypt was known as the “Arab tiger on the Nile”. Of course, Herodotus, my boyhood hero, called it “the gift of the Nile” 2500 years ago. There are fabulous money making opportunities in Egypt. My close friend and Asas Capital prop book colleague Ehab Hassan made five times his allocated capital in Egyptian energy stocks after the November 2016 devaluation, a testament to human brilliance and real time market intelligence in the Arab world’s most populous economy, yet where one third of its 100 million people live on $2 a day. Ehab and his generation of millennial financiers will hopefully help change Egypt’s economic destiny, as Alaa (Alan) and Gamal (Jimmy) Mubarak’s charmed Sharm Al Shaikh falool set I knew could not.

Finance Minister Tarek Amer is one of the finest economic technocrats in the Arab world since my old Wharton prof. Dr. Farouk El Okdah, as the dramatic fall in Egyptian inflation and interest rates attests. Egypt is on the path to macroeconomic stability and so I evoke the ghost of the great French-Misri chanteuse Dalida – helwa ya baladi!

I had desperately hoped that Iraq would be the next frontier market fairytale after Baghdad’s rapprochement with Saudi Arabia, UAE and Kuwait but I was proven horribly wrong. An estimated 450 young people have been killed by snipers or masked assassins with butcher’s knives in Baghdad’s Tahrir Square. Who is responsible for this monstrous crime against humanity, against young people who just dared to revolt against a corrupt political class? Iran’s Pasdaran spies and their murderous Hashd Al Shaabi militias, four of whose commanders have been rightly sanctioned by the US Treasury this week.

There can be no investment fairytale in Iraq until the US and its Arab allies finally convince Tehran to respect the sovereignty of an ancient land that has known only horror and tragedy since the murder of its last Hashemite king, the young, doomed Faisal II in July 1958. King Faisal’s last state visit was to Pakistan where my maternal grandfather met him and his entourage in Karachi, our then capital. When Faisal died, the civilized DNA of Iraqi politics died with him and the torture chambers of the Baathist nightmare emerged on Euphrates and Tigris. Turkey, Iran, Pakistan and Iraq were united in the Bagdad Pact in 1958, run by civilized men sworn to defend their societies against the barbarians. Sadly, it is 2019 now and the barbarians won in all five signatories of the Baghdad Pact.

I cannot be objective about the UAE, my second home since 1976, crucible of my boyhood fascination with the Arab world’s ancient culture, society, politics, language, literature, music, food – and, yes, stock markets! 2019 was not bullish for the Dubai Financial Market, Abu Dhabi Securities Market or home prices in the seven emirates (and the eight emirate London, LOL).

Despite the current malaise in the property, construction, banking and retail markets, the UAE remains the most cosmopolitan, most globalized economy in the Arab world, the Singapore and Miami of the Middle East. The Dubai Internet City is the Arab world Silicon Valley (with Amman’s software hubs) and the DIFC is the Arab world’s Wall Street, City and Bahnhofstrasse. The UAE is the Arab world’s ultimate futuristic hub for people, ideas, money, a potential successor to the wonder that was Andalusian Cordoba or the (early) Abbasid Baghdad, the catalyst for a new Arab Enlightenment. That much, at least, is certain.