As Saudi Aramco listing gets closer, debate rises over its valuation and risks

The proposed sale of 5 percent of Saudi Aramco is not just likely to be the biggest initial public offering (IPO) of all time. "It's like Gibraltar selling the rock," as one expert on Saudi Arabia's oil policy puts it.

The world's biggest oil company keeps the House of Saud in power, bankrolled 60 percent of the national budget last year, and is a paragon of efficiency in an economy otherwise mired in bureaucracy.

The elevation last week of Mohammed bin Salman, the 31-year-old architect of the IPO, to crown prince is likely to add more momentum to a sale planned for the second half of 2018. The news will further sideline domestic critics of the IPO, some wondering whether it would be better to borrow the money than sell the family silver.

But the success of the IPO is not guaranteed. The tendency of MBS, as the prince is known, to micromanage the listing runs counter to the spirit of openness and liberalization that he says he wants for Saudi Arabia. That could backfire on the IPO itself. The more he interferes, the less keen investors will be to buy shares.

Aramco's role underpinning the Saudi economy is an even bigger challenge in valuing this IPO than the firm's immense size.

On the one hand, advisers say, its low costs and lean workforce make it comparable to such blue-chip oil supermajors as Exxon Mobil and Royal Dutch Shell. On the other, the risks of political interference mean that it is likely to suffer from the stigma associated with being a national oil company (NOC).

Many NOCs, such as PetroChina and Brazil's Petrobras, have come to market amid the sort of fanfare that Aramco is generating. In a decade, they have destroyed more than $500 billion-worth of value compared with their private peers.

By the time it lists, its advisers hope it will have a board structure similar to that of the supermajors, and will be comparable on a number of parameters, including dividend projections, that will enable investors to value it accordingly. "The day this company goes public, it will look like one of the top blue-chip oil companies," one said.

The trouble is, MBS has already stated what he thinks the valuation should be — and at $2 trillion — it is punchy enough to make even a Silicon Valley boss look bashful. To achieve it, a 5 percent sliver would be worth $100 billion — four times the biggest IPO to date, that of China's Alibaba, an e-commerce firm, in 2014.

According to an analysis by Sanford C. Bernstein, a research firm, at $2 trillion its value per barrel of oil equivalent coming out of the ground would be about 60 percent higher than that of its blue-chip peers. A valuation at or below $1.5 trillion would be closer to the mark, but that risks disappointing the new crown prince.

"He may have to make a choice between selling cheap and pulling the plug on the process. Either case would be a loss of face," says Steffen Hertog of the London School of Economics, a writer on the state and oil in Saudi Arabia.

To get closer to his target, the kingdom recently slashed tax rates on Aramco, from 85 percent to 50 percent. That brings them nearer to international norms for oil firms and will appeal to investors: lower taxes mean the company can pay out higher dividends.

But investors would be wise not to view issues like taxes and subsidies in isolation. Some analysts express worry that dividends are unstable, and that the kingdom would have to unwind the tax cuts on Aramco if the state needed the money. The introduction of more realistic pricing could also have political and social ramifications, since Saudis are some of the world's biggest consumers of cheap energy.

Another worry for investors would be if MBS continues to use Aramco as a tool of global oil policy on behalf of OPEC, the producers' cartel. The kingdom may believe that OPEC serves as a stabilizing force in global oil markets, which benefits Aramco. But its latest attempts to play puppet-master with the oil market have been counterproductive.

On June 21, global oil prices fell to their lowest level since August, despite an agreement by OPEC and non-OPEC producers to cut output until next March. As a result, Aramco is not only losing income, it is losing market share to rivals not bound by the cuts.

Last, as his global stature grows, the prince may be tempted to mix up geopolitics and commerce. Anecdotal evidence of this emerged during President Donald Trump's visit to Riyadh in May. Even as Aramco was supposedly disentangling itself from the myriad noncore activities it carries out on behalf of the state, the firm was on extracurricular duty.

At breakneck pace, it built the Global Center for Combating Extremist Ideology in Riyadh, where Trump and MBS's 81-year-old father, King Salman bin Abdel Aziz Al Saud, performed a weird inauguration ceremony involving a glowing globe. The reason for Aramco's involvement: no other body in the kingdom could do it half as quickly.