IPO + Private Placement, or No?

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1 OCTOBER 27, 2017 Understanding the Saudi Aramco IPO IPO + Private Placement, or No? Earlier this week, I appeared on CNBC s Closing Bell to discuss some of the concerns surrounding the Saudi Aramco IPO. As usual for such gigs, there was no time to lay out the essentials, let alone delve into the details or outline the potential difficulties. Therefore, I will expand on all of it here. Despite being at least a year away from issue, the IPO will be one of the most hotly anticipated offerings in years. Five percent of the Saudi national oil company Aramco will be available. Despite some recent rumors about private placements, with the Chinese at the top of the list, my contacts in Riyadh confirm that the IPO will be floated on one or more stock exchanges. That public offering will be heavily oversubscribed regardless of the exchange(s) selected. There has already been considerable movement in preliminary anticipated moves among my contacts in the international finance community. The overwhelming assumption among these folks is that this is going to be primarily (or exclusively) a public IPO, thereby not including any significant portion of private placement. This public/private distinction has occasioned some disagreement within the government. A faction believes that both New York and London (the expected frontrunners) would require a level of transparency resisted in certain Saudi quarters while also introducing Western oversight. Still, from the standpoints of liquidity and generating the highest price, the NYSE and LSE remain the preferred options. Then there is the other stock market objective. There has been no secret that the IPO will also have some shares listed on the Riyadh Stock Exchange. The intent here is to increase the capitalization of the Saudi bourse. And that may prove more of a stimulus to the trade in shares obtained from the real objective of the IPO (more on that below). There is some indication that there may be additional supplementary floats considered after the first issuance. Several well placed Saudi investors have suggested another 5% may end up on offer with some of that ending up as private placement, although there has been no confirmation of that from any of my official sources.

2 UNDERSTANDING THE SAUDI ARAMCO IPO 2 Of course, additional availability would depend upon the success next year in the first placement. Regardless of the public offer/private placement structure of any later additions, the capitalization level is still fundamentally determined by the value of Aramco. That, in turn, depends upon the market price for oil. Saudis, therefore have a vested interest in keeping the oil price as high as possible. On Tuesday of this week, Crown Prince Mohammad bin Salman (MBS) opened the Future Investment Initiative in Riyadh. Representatives from about 60 countries attended. As I anticipated, there were no major announcement on the IPO other than confirmation that it will open as expected toward the end of MBS will use the Saudi Council of Economic and Development Affairs (CEDA) and the Public Investment Fund (PIF), both of which he controls, to apply IPO proceeds to diversification. There remains a difference of opinion in the Saudi government and among Aramco executives over a private stake in the IPO. It is here that the Chinese connection surfaces. All of my Saudi and regional connections, along with the European based bankers I advise, expect the bulk of the IPO to float on exchanges. A private portion would serve to undergird valuation, but would not facilitate the move (aside from perhaps playing a political card with major Western exchanges). Any additional secondary offerings beyond the initial 5% could be weighted more heavily to private placement, but only if the resulting initial valuation reaches the expected levels. Those funds, in turn, will be leveraged to expand significantly the actual clout of PIF. Valuation Prognostication The main problem in all of this involves valuation of the offer. For this, Aramco must provide the kind of reserve data that have refused to release since That is when Saudi Arabia took over Aramco from the coterie of American companies that had created it. The genuine state of Saudi oil reserves has been a topic of debate among outside analysts for decades. I had posited several years ago in an earlier series of TV appearances that aggressive extraction practices have compromised the geological reservoir integrity of the main Saudi drilling areas (including the massive Ghawar field). That has led to a decline in production, although offset by the subsequent bringing on line of satellite locations.

3 UNDERSTANDING THE SAUDI ARAMCO IPO 3 However, even in this case, the drilling program has occasioned debate. On my most recent trip to the kingdom, I was shown a new field that had just been opened. Upon closer examination, I realized that the absolute majority of well installations were injection not production. Secondary and enhanced recovery was being introduced with the very beginning of production. This serves to enhance initial lifting volume, but at the expense of the reservoir integrity. The Saudis, it seems, have their own version of creaming in operation. The Aramco shares emerging will operate in secondary trading the same way as any other oil company stock. That means two factors will determine the value: the impact of market pricing on drilling margins; and the amount of the company s booked reserves. The valuation of oil company shares is influenced more by the volume a company can bring up as market conditions warrant than it is by the oil sold. The overall condition of reserves, and more importantly the data made public to substantiate those reserves, will be decisive. Yet the prevailing opinion both in Riyadh and at Dhahran (the Aramco headquarters in the prolific Eastern Province) regards the reserve figures as matters of national security. That combined with concerns over the level of transparency required to list in New York or London remains a major hurdle resulting from internal politics. Where in the World is Saudi Aramco? MBS will diversify the Saudi economy from the outside in. This is by far the most important takeaway from the way this IPO s proceeds will be applied. PIF and CEDA strategy will emphasize diversification through acquiring positions in energy and non energy assets elsewhere in the world, rather than primarily expanding direct investment into the Saudi economy. This is the essential touchstone that is driving action among my international network, where scenarios are already underway to identify and acquire positions in the targets of the new Saudi investment. This Saudi move abroad will also be the main engine to increase global participation on the Riyadh Stock Exchange and accompanying improvements in rising liquidity and valuations. The intention here is to develop Riyadh into a regional competitor to the financial centers in Dubai and Doha. But it will also extend the secondary trading ripples from the massive Saudi investment fund

4 UNDERSTANDING THE SAUDI ARAMCO IPO 4 merging to other players and other locations globally. This IPO will change trading expectations in Europe, Asia, and North America more than any single event in my lifetime.

5 UNDERSTANDING THE SAUDI ARAMCO IPO 5 About the Author Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk management, emerging market economic development, and market risk assessment. He serves as an advisor to the highest levels of 27 countries, including the U.S., Russian, Kazakh, Chinese, Iraqi, and Kurdish governments, to the governors of several U.S. states, and to the premiers of two Canadian provinces. He s served as a consultant to private companies, financial institutions and law firms in 29 countries, and has appeared more than 2,300 times as a featured radio and television commentator. He appears regularly on ABC, BBC, Bloomberg TV, CBS, CNBC, CNN, NBC, Russian RTV, and the Fox Business Network. A prolific writer and lecturer, his six books, more than 2,700 professional and market publications, and over 650 private/public sector presentations and workshops have appeared in 47 countries.