Feb 12, 2020
“Curiosity is the lust of the mind”- Thomas Hobbes
In December 2019, Aramco IPO was announced the biggest ever with an Enterprise Value (EV) of $1.7 Trillion. The offering value of $25.6 Billion surpassed Alibaba's $25 Billion IPO subscribed in 2014. Some reports also mentioned Aramco’s intentions to finalize Saudi Arabia Basic Integrated Chemicals (SABIC) acquisition by Q1-2020. Reading all of this news raised curious questions: which of the financial evaluation scenarios prevailed? Did the base case scenario prove its viability? What were the financial model's main assumptions and variable inputs? How did they account for the qualitative risks using quantitative frameworks? Was SABIC cash flows incorporated in the projected outlook noting that Aramco is acquiring a 70% stake? Is it possible to conduct a dual listing in the future? Was there a sensitized or no-growth case scenario? The EV of $1.7 Trillion, is it considered a fair equilibrium value? If not, what is the possibility of an arbitrage?
Before answering these questions, we have to conduct some drilling in the IPO prospectus. The prospectus entailed useful information about the company’s industry outlook, future cost plan, waivers, and financial statements. During the offering period, the prospectus lacked information regarding the share price or equity stake offered. However, the prospectus included Aramco consolidated financials for FYE 2017, 2018, Q2 and Q3 of 2019. As mentioned in the waiver section, Aramco waived presenting FYE 2016 in its documentation. Nevertheless, FYE 2017 statements included FYE 2016 comparison figures. Hence, some reports speculated the offering share price to range between SAR 20 and SAR 50 / Share. The prospectus also included SABIC financials for the same period. The official announcement declared the final offering price to be SAR 32/ Share or $8.5/ Share if quoted at an exchange rate of $/SAR= 3.75. In addition, the offering represented a 1.5% stake of the 200 Billion outstanding common shares. Consequently, Aramco's total shares aggregated to a value of $1.7 Trillion.
In order to answer these questions, let’s first unleash our imagination. But first, we have to plug in the financial. By plugging in the data in Aramco financial statements, evaluation of exactly SAR 32/ Share and ultimately an EV of $1.7 Trillion is doable subject to hypothetical sensitized assumptions. Aramco is assumed to follow a no-growth scenario in its revenue for a projected outlook period from 2019-2024. Hence, the projected revenues are pegged to mimic FYE 2018 revenues and operating costs value. Consequently, the projected EBITDA will be more or less similar to FYE 2018 EBITDA mentioned in the prospectus Table (8). The slight EBITDA discrepancy could be attributed to the projected depreciation and amortization resulting from the declining assets and intangibles. So it is appropriate to assume that SABIC projected cash-flows were not accounted for. Subsequently, Aramco evaluation cash-flows will entail no terminal value and will be discounted only for the captioned period. Stipulating on same methodology, Aramco could be considered unlevered company where borrowings are neutralized by cash using the free cash flow to equity method especially that cash balances surpassed borrowings evidenced by historical performance. Hence, it will be appropriate to discount the projected excess cash and the EBITDA during the outlook period.
The ROE and WACC discounting parameters might clarify the offering price range between SAR 30-SAR 32/ Share. After being listed on the Saudi Stock Exchange (Tadawul), it is still early to quantify Aramco levered / unlevered beta. So energy exploration and refineries 1-year unlevered beta of 0.72 could be an alternative. This moves us to the Tadawul return pattern necessary to calculate the market risk premium. The interesting part is the volatility of the cumulative monthly return during 2019 and till the offering period from 17/11/2019 till 4/12/2019. During most of November 2019, the cumulative monthly return declined by a range of 7% to 9% where the latter prevailed during the last week of November and the early week of December. By plugging in this return range, it will produce a share price range of SAR 30-SAR 32/ Share. MSCI-Tadawul 30 is another index that supports the return hypothesis as it declined by almost 10.25% for the same period.
Finally, I don’t think the above mentioned hypothetical scenario is realistic. Stressing cash-flows to that extent may not reflect the stock equilibrium value and the firm’s true potential. But what if true, what pieces of the puzzle justify a share price of SAR 32. The general explanation could be conducting Aramco IPO on several phases and what we have witnessed was just the soft launch. Some might think the mega second phase will occur post officially finalizing SABIC acquisition. It might be the case and a piece of the puzzle if analyzed in accordance with the acquisition synergies mentioned in the prospectus. Starting from January 2020, Aramco will be eligible to claim a 20% taxes instead of 50% on its downstream portfolio including SABIC subject to applying certain consolidation conditions prior to 2024. Another piece might be preparing for a dual listing where full acquisition has to materialize prior to doing so. Bearing into mind, integrated oil and gas levered and unlevered beta (classified as Aramco industry) is not less than 1.3 and 1.1 respectively in some global stock markets. Consequently, this might increase the stock value to SAR 38 and SAR 43 respectively eliminating any discrepancy between the foreign and local share price. In addition, some global markets could not incorporate SABIC financials in its consolidated evaluation based only on share purchase agreement. Starting from January 2020, the concession royalty rate will be adjusted to record 15% instead of the current 20% for Brent prices below $ 70/barrel but increasing the rate for Brent thresholds above $70. Thus, it might be prudent to further monitor the Brent direction prior to launching another offering. I have some other curious questions about SABIC acquisition but this is another story.
This article was published in TalkMarkets on 3/2/2020
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