Strategic Implications Of The Saudi Aramco IPO

Transparency, liquidity, psychology — the Saudi Aramco IPO is all about expanding options for the Kingdom.

The decision announced by the Saudi government to take its national oil company public has generated a lot of interest given the size of Aramco and the fact that it would become the largest publicly traded company on earth.

It has also become a contentious issue within Saudi Arabia, where skeptics and critics of the decision have been rather vocal. International observers have discussed the potential valuation and the merits of different listings (NYSE, London, and Asia) and the potential success or lack thereof. And while there has been skepticism regarding whether the government will really allow transparency into its crown jewel, Saudi commentators have generally taken what can best be called a 1960s’ nationalistic attitude toward the IPO, griping about selling the national patrimony to foreigners, an attitude I find as logical as the pro-Brexit arguments in Britain.

The Aramco IPO is certainly a very bold move for Saudi Arabia. Aramco, which has probably been one of the most successful FDI (foreign direct investment) experiments in modern history, was founded by US oil companies in the 1930s in Saudi Arabia and was managed wisely and harmoniously with the Saudi government until the early 1980s, when it was nationalized in a consensual arrangement, with the oil companies selling their shares to the government for full value. In this case, Saudi Arabia’s welcoming attitude toward foreign oil companies, which was diametrically opposed to the traditional third world acrimonious attitude toward most MNCs that had been operating in those respective countries (mostly ending up in hostile nationalizations), allowed the kingdom to capture the maximum value from its patrimony and, more importantly, have the time to train its people to take over management with the full support and cooperation of these US oil companies.

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It is no secret then why Aramco today is widely recognized as the best-run NOC (national oil company) in the world by far, with first-class staff, access to the latest knowledge, capital, and technology, and full integration as a player in the global oil industry and market. You only need to compare that to NOCs from Mexico to Venezuela to Iran to see the difference.

The logic behind taking Aramco public is a powerful one. The idea of having the government monetize a portion of its ownership in the company to help finance its budgetary requirements is one clear immediate benefit, but that is hardly the only benefit.To begin with, the Saudi economy is fundamentally driven by government spending, something that will continue for the foreseeable future. This means that the government’s “wealth,” that is, its capacity to continue to spend, is an important factor underlying economic growth. All the talk about Saudi Arabia burning through its foreign reserves at a fast clip that has dominated the commentary for the past two years has created the impression that the kingdom will run out of money in five years if it continues its deficit spending at the same rate.What that talk ignores is the actual total size of the wealth of the state, not just its liquid assets and liabilities. That total wealth includes maybe $3 trillion in assets that could be monetized over time, of which Aramco is the principal asset. So, by floating a tiny percentage of Aramco, a market price is allocated to this asset, which can then be added to the balance sheet of state wealth. This is critical, if only for its psychological impact. Public sentiment is crucial to any economy. If investors, both domestic and foreign, see the primary driver of economic growth—in this case, government spending—as diminishing rapidly, then not only will they avoid investing, but also those already in country may divest and start to liquidate and transfer wealth abroad.

The reclassification of Aramco from a hidden asset of unknown value and no liquidity to a publicly quoted potentially liquid asset with a clearly identifiable market value achieves the aim of inspiring such confidence. That added to government holdings in other companies, like the petrochemical giant SABIC (the state today owns more than 50 percent of all publicly quoted stocks on the Saudi stock market), and other assets that are in line to be privatized, gives a much more accurate picture of the government’s total realizable wealth.

The second benefit is transparency. Good governance, which people are gradually coming to realize is far more important than experimenting with democracy in developing countries ill-prepared for it, will increasingly depend on transparency. By pushing for transparency at the most important national company, the Saudi government is sending a critical message to other state entities that this trend will continue.

Some observers have minimized the transparency factor, commenting that “if the government wanted transparency, it could simply instruct Aramco to be more transparent.” Such superficial comments belie a lack of understanding of bureaucracy and the required checks and balances for transparency. Any transparent process needs the constant vigilance of the media and public shareholders that can question, sometimes even publicly embarrass, and castigate management when the company is being poorly or inefficiently run.

Saudi Arabia has practical experience with this process in SABIC, the world’s largest petrochemical company, which, while government controlled, has been publicly listed for decades. Well-run, it has been subjected to constant shareholder pressure in public forums over the years, and with a great deal of success. A simple government order to be transparent would never be able to achieve such an outcome, since bureaucracies can always over time develop strategies to deal with government rules absent public and/or independent pressure.

Here it is important to also comment on the discussions in global media that have swirled around the value of Aramco, with commentators wondering whether the anticipated value of $2 trillion is realistic, and whether government actions, such as Saudi oil policy, will be dictated by having to make the IPO a success.

What many people do not understand is that this is not an IPO of a tech start-up where the founding investors need to capture maximum value at IPO and hence where everything between now and the IPO date will have to be targeted toward maximizing the value of the listing price. In Aramco’s case, this is a very long-term strategic move by the state, and as such the state and Aramco retain a lot of flexibility in how they carry this out. For example, a public listing is not even necessarily the first step. An interim step may be to sell a small stake to strategic private equity investors who would introduce sophisticated third-party investors into the company prior to an IPO.

Another option would be to list a much smaller percentage, say 1%, on the Saudi stock exchange to start the process, and at a price that is concessionary and available initially only to Saudi citizens. This would get the whole process moving and give the state the option of listing a far larger chunk in the future when markets improve. It would also be a way to transfer some wealth to Saudi citizens.

My point here is that there is no immediate need for the liquidity generated by the IPO; hence, the state has several options that give it flexibility. With this in mind, the state’s actions in other areas, like oil pricing, do not have to be constrained by the upcoming IPO, as many think will be the case. The gradual privatization of Aramco will be a strategic step of long-term benefit to the economy, and the drivers of its success will be much more strategic in nature than simply maximizing the price of a tiny percentage of the company in the immediate future.