The Real Aramco IPO Value Could Be Slashed in Half

The Aramco IPO value is reported to be over $2 trillion, but that eye-popping number might not be the most accurate valuation.

Aramco ipo valueThe Saudi Aramco IPO valuation of $2 trillion would make it the largest IPO in history, even if only 5% of the company was offered publicly, which is Saudi Arabia's plan. If the Saudi Aramco IPO is just 5% of that total, the IPO could be worth $100 billion, still making it the largest IPO in history. The largest IPO to date was the 2014 launch of Alibaba Group Holding Ltd. (NYSE: BABA) with a market cap of $25 billion.

But that historic valuation might not be completely accurate, and that means investors need to do some more research ahead of the Aramco IPO...

What Is the True Saudi Aramco IPO Value?

Saudi Aramco first announced it was going to explore IPO options back in January 2016. At that time, the value of Aramco was reported to be over $2 trillion. But that's probably no longer accurate.

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Saudi Aramco is so valuable because it controls all of Saudi Arabia's vast oil reserves. Saudi Arabia's reserves are 20% of the entire world's oil reserves, or 267 billion barrels of oil. Because Saudi Aramco is state-owned, it doesn't have to compete with any other companies for access to these oil deposits. Other oil giants, like ExxonMobil Corp. (NYSE: XOM), have to buy real estate or sign leases for the right to access oil in countries like the United States and Canada.

That's one of the reasons Aramco will be bigger than its global oil rivals. The combined market cap of ExxonMobil Corp., Royal Dutch Shell Plc. (NYSE: RDS.A), BP Plc. (NYSE ADR: BP), and Chevron Corp. (NYSE: CVX) is about $888 billion. That's less than half of the reported $2 trillion Aramco IPO valuation.

While unfettered access to Saudi Arabia's oil is one of the reasons for Aramco's high valuation and why investors are eager for the opportunity to profit from it, low oil prices might decrease its value.

The company first announced the Aramco IPO in January 2016. But that announcement came during a massive oil price crash. That meant the Saudi government wasn't getting nearly as much money on oil sales as it had in 2014 and earlier.

Brent crude oil prices hit their high of $114.81 in June 2014, but they dropped 70% by the time of the Aramco IPO announcement, hitting $33.55 on Jan. 8, 2016.

Despite Saudi Arabia's efforts to boost oil prices through the Organization of the Petroleum Exporting Countries' (OPEC) production cut, Brent crude still only trades at less than half its 2014 value at $48.15. That's given analysts pause about the whopping $2 trillion valuation. Even if Saudi Aramco controls Saudi Arabia's oil, that oil is now worth half the price it was just three years ago, and OPEC has struggled to get oil prices above even $50 a barrel.

That's why Bloomberg reported in March that the Aramco IPO valuation might be half of the reported $2 trillion valuation. Similarly, Rystad Energy now says it's updating its valuation of Aramco to $1.4 trillion on the assumption that oil will reach $75 a barrel. That would be a 56% jump from today's oil price.

But even if the true Aramco IPO value is less than $2 trillion, it's still going to be the biggest IPO ever. If the new value is $1.5 trillion, a 5% stake would equal $75 billion, three times the size of the record-breaking Alibaba IPO.

And that means even if flagging oil prices have cut into Aramco's valuation, everyone still wants a piece of the Saudi oil giant...

Where Will Saudi Aramco Be Listed?

The next big decision for the Saudi oil company will be where to list its shares.

But its first big decisions were deciding who would advise and who would underwrite the massive IPO.

In February 2017, the company chose Moelis & Co. (NYSE: MC) as the investment bank that would handle its IPO. In March, it selected the banks that would underwrite the IPO. These include JPMorgan Chase & Co. (NYSE: JPM), HSBC Holdings Plc. (NYSE ADR: HSBC), and Morgan Stanley (NYSE: MS).

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The Wall Street banks were eager to sign on to the Aramco IPO because of its potential valuation. Analysts are reporting these banks could get a slice of over $1 billion in fees, not to mention future work with the company.

And now that the company must decide which stock exchange to list on, exchanges are competing to attract their next biggest client.

Given this value, it's no wonder that the world's major exchanges like the New York Stock Exchange (NYSE) and the London Stock Exchange (LSE) are vying for a chance to list the company when it goes public. These stock exchanges have even sent executives to Saudi Arabia this year in an effort to woo the kingdom to choose their exchange for the IPO. The London chief accompanied UK Prime Minister Theresa May on her trip to Riyadh, and the NYSE head went with U.S. President Donald Trump when he visited the Saudi Kingdom.

While the choice in stock exchange affects the value of a stock, Saudi Aramco doesn't need to rush this important decision. The company was originally rumored to have a target IPO date of 2018, but that has now been pushed back to 2019.

But choosing where to list the IPO might be more difficult than you think, and that's not the only obstacle facing the Aramco IPO...

Two Major Obstacles Remain for the Saudi Aramco IPO

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The two obstacles ahead of the Aramco IPO are the disclosure rules for stock exchanges and convincing investors it's still worth owning as oil prices stay under $50 a barrel.

Money Morning Global Energy Strategist Dr. Kent Moors says because the company is now owned by the Saudi government, it's reluctant to agree to the transparency required to list on the LSE or NYSE.

That's because the public transparency and financial disclosures required by the world's leading stock exchanges mean Saudi state secrets could be exposed to the public. For example, Moors says the Saudi government keeps both the number of its oil wells and the size of its oil reserves secret for strategic reasons. But if Aramco lists on the NYSE, that could become public information.

But the entanglement between the Saudi government and Aramco goes even deeper. The Saudi government is used to collecting nearly all the revenue created by Aramco, but a tax rate above 90% is not attractive to investors. Saudi Arabia just slashed that tax rate to 50% last month, but that's still more than double what other countries tax corporations. The OECD average corporate tax rate is 24.1%.

Aramco's other hurdle is oil's price per barrel. As we mentioned, the IPO's valuation is affected by the price of oil, but with oil trading at $49.55 a barrel, the company will need higher oil prices to hit the $1.4 trillion valuation outlined by Rystad Energy.

To get higher oil prices, Saudi Arabia and other OPEC members have been cutting oil production to weaken oil supply. That sort of effort from OPEC could boost oil prices over the coming year, but it means Aramco will be producing less oil.

Saudi Arabia and Aramco might have to convince potential buyers that this won't limit the company in the future, and potential investors need to be aware of this dynamic with oil prices before jumping into the IPO, especially as the Saudi government is using it to diversify its economy away from oil.

But the desire to own a stake in Saudi Arabia's lucrative oil fields will keep investors on the edge of their seats.

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