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.
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.
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.