Why Saudi Aramco's Early Gains Won't Last for Long
The Saudi crown prince's pointless and silly dream goes live... Why he's so desperate to declare victory... Hitting the magical $2 trillion mark... So what?... Why Saudi Aramco's early gains won't last for long... Saudi Arabia will do what it takes to support the stock... The 'bigger picture' concern for investors...
The Saudi crown prince's pointless and silly dream took its latest turn this week...
Saudi Aramco – the biggest initial public offering ("IPO") in world history – went live on Wednesday on Saudi Arabia's stock exchange, the Tadawul. And then... the stock's share price spiked 10% higher.
But Crown Prince Mohammed bin Salman, Saudi Arabia's de facto leader, wasn't happy.
Aramco, the government-controlled oil company, raised $25.6 billion in its IPO by selling a 1.5% stake in the world's biggest, and most profitable, company. At a price of 32 riyals a share (about $8.30 in U.S. dollars), the implied valuation of the company was an extraordinary $1.7 trillion... roughly 42% bigger than the previous No. 1, U.S. consumer-electronics giant Apple (AAPL).
But bin Salman pined for years for Aramco to boast a $2 trillion valuation...
You can understand why Bin Salman is so desperate to declare victory with the IPO.
Saudi Arabia is synonymous with "oil wealth." Its petroleum reserves are the envy of the world. That has helped make Aramco the most profitable company on the planet... With $111 billion in annual profits, the company's net income doubles Apple's. And it's five times higher than American oil giant ExxonMobil (XOM).
Bin Salman took four years crafting his plan to wring billions out of a public offering. It's a key component of his "Vision 2030" plan for modernizing Saudi Arabia's economy and reducing the kingdom's reliance on oil.
Bin Salman was so determined to get the $2 trillion valuation that when foreign investors balked at it, he decided to focus on local retail investors.
In the end, around 15% of the total population bought into the deal. He strong-armed local funds and families to buy into the IPO. He also got neighboring Persian Gulf states to pony up... in the name of "regional solidarity." (And when a notoriously violent dictator like bin Salman demands a favor, these folks know better than to refuse.)
And so, the deal was done... but at $1.7 trillion. At that valuation, it generated only a quarter of the $100 billion that bin Salman was aiming for.
But bin Salman still wanted to hit his magical mark – $2 trillion.
Earlier this week, the Financial Times reported that after the IPO, the Saudis made a "last-ditch effort" to talk institutions and wealthy families into buying shares in the market...
As part of a plan to drive up the Saudi oil company's stock price, state investment funds are being encouraged to buy Saudi Aramco shares following the start of trading in Riyadh, two people briefed on the matter said.
"All the focus now is how to reach $2 [trillion]," one of the people said. "They've been told to keep some powder dry for buying in the secondary market," said another.
And sure enough, the shares of Aramco hit 38.7 riyals (about $10.30) on Thursday, reaching the $2 trillion market cap threshold, Reuters reported. The stock closed at 36.8 riyals, a $1.96 trillion market cap.
But the bigger question remains – so what?
A $2 trillion market cap is a completely arbitrary target. It's meaningless to everyone but bin Salman, it seems.
The point of an IPO is to raise capital... That's what Aramco did to the tune of $25.6 billion. Any company new to public markets likes to see its share price rise in the secondary market. It's good news for investors in the IPO, who can immediately see a paper gain (or sell and book the gain).
But it doesn't help the issuer much... since it already sold shares. A particularly strong first-day move in the share price actually suggests the company left money on the table... that it could have taken the company public at a higher price.
Telling investors to save "dry powder" for the secondary market is silly. The artificial buying will subside soon enough, and those investors who were "encouraged" to buy in the secondary market will want their "powder" back.
Saudi Arabia will do whatever it can to support the oil price – and Aramco's share price...
But now that Aramco is a public company, delivering value to shareholders is a marathon... not a sprint, like bin Salman seems to think. And the temporary gains in the Aramco share price won't hold for long. As I said in the November 27 Digest, during the lead-up to the IPO...
IPOs tend to substantially underperform the market as a whole – and any sustained effort by the Saudi government to support Aramco shares could wind up being very expensive.
But it's probably a matter of time before bin Salman tries again to entice international investors to buy Aramco... maybe through a secondary offering in New York or London. The Saudi government's thirst for capital is enormous... and it will want to try to repair its wounded pride.
For now, most individual U.S. investors have limited exposure to Aramco.
Global index provider MSCI told financial-news website MarketWatch that Aramco did qualify for inclusion in its Saudi Arabia index, the MSCI Saudi Arabia IMI 25/50 Index, starting next week. So anyone holding tracking funds – like the iShares MSCI Saudi Arabia Fund (KSA) – should be aware that they may soon have some exposure to the company.
But as I said last month... the "bigger picture" concern is what this means for oil. No one is more of an insider in the oil world than the Saudi leadership. The kingdom is the world's No. 2 oil producer... and it dominates the OPEC oil cartel.
If the Saudis are selling even a small share of their oil company, it could be that they see a long-term top in oil. At the very least, it means they have better things in mind for their capital. And as I said before, if you're an investor in oil, that's a big cause for pause.
Again, be warned.
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In today's mailbag, one subscriber parses words... What do you think? As always, e-mail us at feedback@stansberryresearch.com.
"Be careful about using the phrase 'infinite money.' Infinite money doesn't exist. It can't. If you were to amass all of the money in the world, it still wouldn't be 'infinite.' 'It would be 'finite.' If you could somehow double that amount, it still wouldn't be 'infinite.'
"Similarly, it isn't possible to get an 'infinite return' on an investment." – Paid-up subscriber Kurt S.
Corey McLaughlin comment: Point taken, but central banks sure seem to think there's infinite money, no?
In any case, in yesterday's Digest, Retirement Trader analyst Jeff Havenstein was only citing someone else's use of the phrase.
More important, Jeff wrote the essay in hopes of helping as many folks as possible learn about Dr. David "Doc" Eifrig's powerful options strategy. And one of the keys to Doc's strategy is that it uses options to reduce your risk, not to speculate recklessly.
If you haven't yet checked out Doc's latest lesson, we encourage you to click here.
Regards,
Kim Iskyan
Singapore
December 13, 2019