Sink or Swim: IPOs and the Saudi Aramco float

It’s not every day that the world’s most profitable company has announced that they are going to issue an IPO…

That’s right, Saudi Aramco are going public!

The Basics:

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An IPO is one of the biggest changes a company can go through and a significant milestone in fundraising and the direction of the company. It is a mechanism for raising finance through the sale of shares (equity) as opposed to debt. IPOs grant a company immediate capital, a broad investment base, and legally no obligation to pay out an ongoing dividend (though practically, one will almost always be issued). Shareholders become entitled to part of the company, taking on a role in some decision-making functions and as unsecured creditors, entitled to capital upon the winding up of a business, if there’s anything left for them. 

As you may have noticed, there is a bit of contradiction here. An IPO is the process of a company ‘going public’, yet Saudi Aramco is already a public company in the sense that it is nationalised. So, how does this work?

The fact that Saudi Aramco is owned by the Saudi Arabian kingdom in essence makes very little difference to the fact that they are looking to float. It’s not incredibly rare that states will hold shares in nationalised companies which are then floated/parts of which are then floated. For example, both Royal Mail float and British Rail (more historically) are nationalised companies which have been floated!

What is the effect of an IPO?

An IPO is an extremely expensive, time-consuming and risky process. Nevertheless, an IPO can be incredibly rewarding. Here are the main pros and cons of an IPO:

All image rights belong to According To A Law Student.

Let’s expand on a few of these points.

Pros:

Other than to make the company seem more trustworthy, does translucence have any other influence in the IPO process? Yes, it does! The more transparent a company is, the easier it is to obtain a higher IPO valuation. The valuation of Saudi Aramco’s IPO has been a hot topic recently and we will touch on this later.

Cons:

Why do disclosure obligations become more stringent? When a company launches an IPO, the shareholder base often broadens from a smaller selection of individuals heavily involved with the company (for example directors), to ordinary people who can buy and trade shares online. These people naturally have far less knowledge of the goings on of the company and the law seeks to protect them by ensuring the company discloses financial, managerial and administrative information equally among shareholders, allowing these shareholders to make reasonable decisions in their investment strategy.

What other costs are associated with an IPO? Other costs include appointing the relevant parties to:

  • Ensuring the right documentation is available
  • Assessing the market appetite (this is often done by investment banks such as JP Morgan, Goldman Sachs and Morgan Stanley)
  • Ensuring that the company gains high-standard legal advice (White & Case are currently advising Saudi Aramco on their IPO)

Is the financial risk of an IPO worth taking? This depends largely on the company. Usually, most companies that issue IPOs are already:

  • Successful and well-established;
  • Highly leveraged (have taken on much debt compared to equity – e.g; in the form of share issuances); or
  • At a stage in their development whereby they are looking to grow more substantially and benefit from the status of being a public company.

However, just because a company may tick these boxes does not guarantee that their IPO will be successful. Share prices are always changing and often the success of public companies will be subject to the mercy of the stock market.

Why do companies choose to go public?

  1. Floating is the only way to sell shares to the public and so raise capital on a large scale.
  2. Going public allows shares to be increasingly liquid and tradeable, making them more attractive to investors. The general rule is that the more liquidity there is in the market, the more valuable the shares are.
  3. An IPO is a great exit strategy for investors and co-founders.

Taking a closer look…

Now that we have established a general knowledge of IPOs, the next step is to apply this to the current state of Saudi Aramco’s IPO.

Saudi Aramco have decided to issue an IPO for a number of ‘internal’ reasons:

The Vision 2030 Program: the global shift towards more eco-friendly alternatives to fossil fuels has posed a great risk to the future of oil companies. Oil companies are non-sustainable and it is crucial for them to make changes to remain profitable in the long run. In large, the Vision 2030 Program has been a key player in rebranding the kingdom. The program has made a number of promises from less reliance on oil to increasing women’s rights.

Current state of the Saudi economy: the economy has been struggling for a number of reasons. Here are a few:

  • We have already touched upon this previously, but the global move towards a greener economy has caused a threat to the future of the world’s dependance on oil.
  • The September drone attacks – this temporarily disabled 1/2 of Saudi Aramco’s oil production!
  • 2014 oil price crash.

The Battle of the Stock Markets:

According to an article on the FT, Saudi Aramco will begin to trade on Saudi’s domestic stock exchange, Tadawul.

However, it seems to be that Saudi Aramco’s decision to trade on Tadawul was an incredibly strategic move (we will see this later).

This decision, of course, has not come without its criticisms.

Both the LSE and NYSE have vied for the attentions of Saudi Aramco in recent years and so both will be bitterly disappointed with the result. The Financial Conduct Authority (FCA) has taken marked steps to tempt investment, developing a new category in the premium segment especially for sovereign-controlled companies. 

Saudi Aramco has also been heavily criticised by journalists. For more information, follow this link.

To any of those wondering, can a company issue an IPO in more than one stock exchange? The simple answer to this is yes! However, a company which floats on several stock exchanges will be subject to even more stringent compliance and ongoing obligations which may be challenging to follow and keep on top of. Nevertheless, floating on multiple stock exchanges does have some benefits; the main being that it allows a company to access different markets more easily. An example of a company that floats on more than one stock market it Alibaba (read this article for more information).

Expectations vs Reality:

Saudi Aramco have been extremely ambitious with their IPO – there’s no doubt about that! However, current circumstances are looking vastly different from what the oil company may have initially predicted…

Expectation 1: $2 trillion valuation:

REALITY: Unfortunately, this isn’t going to happen. The valuation of Saudi Aramco’s IPO has been a controversial topic lately. Tensions have run high between the oil company and a number of investment banks (namely Bank of America, Citigroup and Morgan Stanley) as they severely downscaled the company’s expected $2 trillion valuation. The Crown Prince Mohammed bin Salman was therefore given two options:

  1. Accept a $1.5 trillion deal with foreign investors; or
  2. Issue the IPO locally for $1.7 trillion.

As you can probably guess, the Crown Prince chose the latter option. While this has caused a great letdown for other stock markets, it is essentially a win-win situation for Saudi Aramco. Not only has the company secured a higher valuation, but they also have the advantage of keeping information about the company within the kingdom’s borders. Saudi Aramco’s unwillingness to expose information about their operations to foreign investors has been the subject of much criticism, and by floating in their own stock market they can partially avoid this bullet.

Expectation 2: selling 5% of shares

REALITY: The oil company is only going to sell 1.5% of its shares (around 3 billion shares) – a meagre and disappointing amount in comparison to their initial proposition. The shares will be priced from around 30 riyals ($8.00) to 32 riyals ($8.53). If this IPO is successful, it could be the biggest IPO in history and trump the current $25 billion record that was set by Alibaba in 2014!

Comparison with Unicorns:

What is a unicorn? Unicorn companies are the first fully-fledged generation of tech-based companies. Uber, Air BnB, Lyft and Pinterest are all examples who have launched IPOs.

The IPO comes at an interesting time after the flops of unicorns floating… and sinking so spectacularly earlier this year! Uber and Lyft have each experienced huge losses on their IPOs, with market excitement promptly snuffed out. Saudi Aramco represents a more traditional asset-backed business model and a less risky investment in many ways. As discussed above, the pricing was optimistic and market participants have been cautious to price the IPO lower than the Saudi Kingdom had hoped. Nevertheless, it remains to be seen how the shares will trade in the long-term and how whet the appetite for the shares are as investors decide whether to subscribe for the shares in coming weeks. 

This article was co-authored with Kim Rust, a future trainee at Linklaters. Kim also has her own legal blog, The Corporate Commute, which is definitely worth taking a look at!

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