Last week Saudi Arabia announced that it is to launch its first
Euro-denominated bonds shortly, following the recent bond issue from Saudi
Aramco. At around the same time, the effective Saudi ruler, Crown Prince
Mohammed bin Salman (MbS), stated that the long-delayed initial public
offering (IPO) of 5% of Saudi Arabia’s oil and gas behemoth, Aramco, may
occur as early as next year. Given how relatively successful the Aramco bond
was and how perennially
unpopular the Aramco IPO idea has been, the natural question is why MbS
does not just authorise a bigger bond issue from Aramco rather than push
ahead with an IPO concept that has caused nothing but awkward questions since
it was originally mooted in 2016.
Certainly, on the face of it, the headline figures for the inaugural bond
issue from Saudi Aramco were impressive. Orders for the bond offering – over
five different maturities (2022, 2024, 2029, 2039, and 2049) – were slightly
over U$$100 billion, compared to the initial target level of US$10 billion.
This allowed Aramco to finally issue US$12 billion instead. Pricing at issue was
also tight, with the corporate’s benchmark 10-year (US$3 billion) tranche,
for example, priced to yield 105 basis points (bp) more than US Treasuries
(UST), 12.5 bp less than the similar-maturity sovereign bonds of Saudi
Arabia. A corporate pricing tighter than its sovereign is extremely rare.
As has perennially proven to be the case, though, with much to do with
Saudi Arabia, appearance is often very different from reality. “A lot of the
hundred billion would have come from bidders who, knowing that the bond
offering was likely to be heavily oversubscribed, increased the total size of
their bids in expectation that their final allocation would be cut down - the
scale of orders is not always a perfect metric,” Jeremy Stretch, senior
markets strategist for CIBC, in London, told OilPrice.com. In fact,
OilPrice.com understands from various investment bankers close to the
offering that the actual level of demand inflation in the book was around
35%. It also understands that a large proportion of the remaining genuine
bids were from entities closely associated with the banks that were
book-running the deal and with Saudi’s historical supporter institutions in
the Middle East, Asia, and the U.S. Related:
The Stock Market Bulls Still Have Room To Run
That there was nowhere near the real level of interest from independent
financial investors around the globe as would be inferred from this
well-publicised headline US$100 billion total book figure can be seen in the
later trading activity in the five tranches. Quite simply: if this degree of
genuine demand was there then the bonds would be expected to shoot up in
value the next day on frenzied bids from investors who did not manage to
obtain the allocations they wanted.
Not publicised at all, however, was the fact that some of the
shorter-dated tranches traded flat or lower in the secondary market than
their issue price. As an adjunct to his, the longer-dated Saudi sovereign
U.S. dollar bonds were also trading down the next day, by as much as a full
cent. “This would suggest that a number of investors saw the data relating to
Aramco, and to its relationship with Saudi, and vice-versa, and thought it
best to cut their risk exposure in both by trading out of the long end and
into the short end,” a senior oil trader in Singapore told OilPrice.com.
The actual marginal nature of the bond success leads into another reason
why the IPO mechanism is favoured over the bond route: the difference in fees
that MbS’s advisory banks will get from an IPO rather than another bond
offering. The lead book-runners on the Aramco bond issue was a veritable
‘Who’s Who’ of global powerhouse banks, including JPMorgan, Morgan Stanley,
HSBC, Citi, and Goldman Sachs, plus Saudi’s own National Commercial Bank. The
further 11 banks that worked as co-managers of the issue included the mighty
Bank of China, German titan Deutsche Bank, and Japanese majors, Mitsubishi
UFJ Financial Group, and Mizuho Financial Group.
“These banks were happy to be involved as this [bond issue] keeps them in
the frame for the big one [the IPO] from which they gain a lot more money and
kudos,” a senior London-based banker told OilPrice.com last week. “For the
bond it is likely that the basic fees per bank book-running would be around 1
basis point [0.01%],” he added. “This is a piddling amount compared to the
amounts that the lead advisory banks can take out of Saudi for an IPO, which
involves multiple fees for multiple stages of pre-deal advice and corollary
deals like syndicated loans and so on,” he underlined.
“The standard compensation pot for a usual developed market corporate IPO
varies between 0.5% and 1.0% of the total IPO value, and for an emerging
market corporate IPO between 2.0% and 2.5%,” he said. This would mean, a
total pot for the lead banks to split of between US$500 million and US$2.5
billion, working on the basis of a 5% float raising US$100 billion, as
envisaged by MbS. In context, the 35 banks that worked on Alibaba’s US$21.8
billion IPO split an estimated US$300 million between them, according to
industry figures. The team of banks that advised Saudi Arabia’s National
Commercial Bank IPO, the world’s second-largest after Alibaba at US$6 billion
in 2104, received US$4.8 million in total fees, or 0.08%.
In tandem with the fact that for their own legitimate business reasons
none of the advisory banks want to tell Salman that he is ignorant about how
the financial markets work and that doing a US$100 billion bond offer is a
much better idea than doing an IPO is the fact that Salman cannot afford to
lose face either by cancelling the IPO. He was a controversial appointment in
2017 as Crown Prince in the first place as it overturned years of tradition
in which the Saudi crown is passed sideways from brother-to-brother or
cousin-to-cousin. It had long been assumed that King Salman’s 58-year old nephew,
the then Crown Prince Mohammed bin Nayaf, would succeed him. Related:
The Mining Industry Is Staging A Comeback
This move was not supported by many of the senior Saudis whose negative
views of him were later compounded by being arrested and held until they
signed over in excess of US$100 billion to Salman’s appointees. In addition
to this unpopular move at home, Salman’s record abroad has been seen by
senior Saudis as damaging the country as well. In particular, the ongoing war
in Yemen, the crisis with neighbouring Qatar, the start of the dispute with
Lebanon, and the alleged murder of journalist Jamal Khashoggi, have been seen
as making Salman vulnerable amongst the leading Saudis.
Salman has also repeatedly made it clear that the 5% of Aramco to be
floated in the IPO should raise at least US$100 billion, which would imply a
valuation for the entire company of at least US$2 trillion. “It’s much more
than the money that’s involved, it’s the fact that Aramco is a representation
of MbS’s Saudi vision, so to cancel that IPO is like cancelling that very
vision and to see it go for less than the US$100 billion is a big setback to
that vision,” Stretch underlined. Bizarrely, according to various banking
sources spoken to by OilPrice.com since the Aramco bond issue, Salman
believes that the bond offering has actually increased the chances of an
Aramco IPO being successful. Aside from OilPrice’s own extensive analysis on
the shortcomings of Aramco and Saudi since the IPO was announced – including
questions over Saudi oil reserves levels, spare capacity capability,
ownerships of reserves, tax rates, and anti-trust issues to name but a few -
many of these worrying points were also evident in the Aramco bond prospectus
and have not been lost on international investors. “But bond investors are
not nearly as inquisitive about the issuing company as stock investors, which
again makes me wonder why they are doing an equity issue,” added Stretch.
“The purpose of the Aramco bond issues was to facilitate the extraction of
cash from the company and into MbS’s pet projects, allowing for the
monetisation of the asset without making any changes to governance, as an
equity sale would have demanded,” Marcus Chevenix, MENA analyst for
consultancy TS Lombard, in London, told OilPrice.com. “The bond prospectus
reveals a fascinatingly dysfunctional relationship between Aramco and the
Saudi government, in which the oil producer is expected both to compensate
the traditional centres of power for the money they are losing to MbS’s
projects and to provide extra financing for the PIF [Saudi Arabia’s Public
Investment Fund] itself,” he said.
Despite this negative backdrop, the outlook for the Aramco IPO is full of
other risks. “One specific potential risk worth bearing in mind is Aramco’s
present dependency on the China as its main off-taker,” Chevenix underlined.
“Although still for now at an early stage, the trend of denominating these
contracts in Chinese renminbi seems likely to intensify,” he concluded. This
FX risk factor could well prove a real-time valuation driver not just for
these bonds but also for the IPO if and when it happens, and for one of the
cornerstones of Saudi Arabia’s economy – the Saudi riyal’s longstanding peg
to the US dollar.
By Simon Watkins for Oilprice.com
