(Bloomberg Opinion) -- The initial sales pitch for Saudi Aramco, the world’s largest initial public offering, was pretty clear when it was launched on Sunday: This company can pay chunkier dividends for longer, and more reliably, than any other big oil company. The hope is clearly that investors will therefore pay a premium for the shares that carry those dividend promises. Whether they do should depend on their attitude to Aramco’s singular strategic profile and emerging-market risks.
Saudi Arabia has finally kicked off the long-anticipated share sale, reportedly having accepted that the market may not ascribe the $2 trillion valuation Crown Prince Mohammed bin Salman had sought for the kingdom’s state-owned oil company. While there’s no price range just yet, bankers may target a $1.6 trillion to $1.8 trillion valuation, according to Bloomberg News. Factor in the standard 10% to 15% discount on IPOs, and that is where you would pitch a $2 trillion valuation anyway.
From a high level, this isn’t an immediately enticing IPO, regardless of price. Investors generally aren’t looking to add more oil shares to their portfolios. That’s mainly an environmental issue, but it’s also a reflection of concerns about the longer-term outlook for oil demand as consumers seek lower-carbon alternatives.
From a narrowly financial perspective, though, the attractions are plain. Demand for oil isn’t ending any time soon, the offering lands with no gearing – net debt to total capital — and Aramco’s cash generation is, and will be, prodigious. The oil giant generated $59 billion of free cash flow in the last nine months and plans to pay $75 billion in annual dividends from 2020 to 2024. If dividends are less, outside investors get their pro-rata share of $75 billion, funded by the kingdom taking less. Tweaks to tax and royalty arrangements also look friendly to outside investors.
Aramco has more flexibility than peers to keep the payouts going amid swings in the oil price. It could let net borrowings rise, with a self-imposed gearing ceiling of 15%. It also appears to have more flexibility to turn off capital expenditures without harming its long-term investment case. By contrast, the Western oil majors seem trapped in a tricky balancing act, maintaining dividends and capex even within gearing targets roughly twice as high.
In isolation, these dynamics would support the dividend strongly and would justify buying the shares at a premium. At a $1.6 trillion valuation, the yield would be 4.7%, against 4% for Chevron Corp., 5% for Exxon Mobil Corp. and 6% each for Royal Dutch Shell Plc and BP Plc. (Note that Chevron’s yield, adjusted for buybacks, is closer to 6%.)
But strategically, there is nothing in Saudi Aramco’s listing materials so far that speaks directly to the anti-fossil fuel movement. At least Royal Dutch Shell Plc aspires to “thrive in the energy transition.” Aramco’s nod to environmental concerns is that its activities in extracting oil are less carbon-intensive than peers.
There are other concerns. Drone attacks on Aramco facilities in September were a reminder that Aramco resides in a volatile region. Government control brings the risk of decisions being made in the interest of Saudi Arabia, not minorities – for example, if Aramco engages in M&A with other entities controlled by the kingdom. And however much they wish to separate the company from its lead shareholder in their minds, international investors may be wary of co-investing with an repressive regime even if they are told the IPO is part of a reform drive.
Local demand, the prospect of a quick dividend after the listing, plus bonus shares for retail investors who keep their stock may provide some support for the offering and the share price right after listing. Selling 3% of the company would imply an issue of around $50 billion of stock; the world’s top five oil companies are collectively worth $1 trillion. There are investors for Aramco.
A “compromise” on valuation and the many inducements here will certainly help. But the shares will succumb to market forces in the end, which will decide whether Aramco’s relative financial strength counts for more than its very different strategic, governance and geopolitical profile compared to the existing listed oil majors.
--With assistance from Liam Denning.
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Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.
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