The Saudi Aramco IPO Price Might Not Be as High as You Think

Investors eager to participate in the world's largest public offering are waiting to find out the Saudi Aramco IPO price. But the final IPO price might be much different than expected...

Saudi Aramco IPO priceSaudi Aramco is the world's largest oil company, and the Saudi government is planning to sell it in a public offering soon. There's no firm Saudi Aramco IPO date yet, but 2018 and 2019 are both possibilities.

Even without a set date, the IPO is catching investors' attention. The company is valued at a whopping $2 trillion. Just a 5% offering at that valuation would make it the biggest IPO ever, with a market cap of $100 billion.

But the massive Aramco valuation might not actually be that high, and an underwhelming market cap could lower the Saudi Aramco IPO price...

The Saudi Aramco IPO Price Is Still Up in the Air

It's easy to think that the $2 trillion valuation will translate into an expensive IPO price, but that's not necessarily how it will work.

The share price of Aramco stock will mostly be determined by the number of shares Aramco issues. More shares issued will lead to a lower IPO price, while fewer shares will make them more expensive.

But demand for the company's shares will also determine its selling price, and that's also up in the air...

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The Aramco IPO price will be set by the company's underwriters, led by JPMorgan Chase & Co. (NYSE: JPM) and Morgan Stanley (NYSE: MS). The underwriting banks assess what the market will pay for shares of Aramco, then they set an IPO price to shop to hedge funds and other insiders. The catch is, if there's not enough demand for shares of Aramco stock at the IPO price, the underwriters are obligated to buy it up.

The underwriters have an incentive to make sure the IPO price will match demand for the stock as closely as possible. And that means the perception of the company by potential investors will play an important role in pricing Aramco stock.

And there are two problems hurting Aramco's perception with investors. The first is its valuation may not be quite as high as advertised...

The Aramco Valuation Is in Doubt

Saudi Crown Prince Mohammed bin Salman announced Aramco was worth a total valuation of $2 trillion back in 2016, but outside analysts are starting to doubt the estimate.

That $2 trillion valuation initially turned heads.

A $2 trillion valuation makes the company worth more than Chevron Corp. (NYSE: CVX), BP Plc. (NYSE ADR: BP), Exxon Mobil Corp. (NYSE: XOM), and Royal Dutch Shell Plc. (NYSE: RDS.A) - combined.

That made sense too, because Aramco has unfettered access to 90% of Saudi Arabia's oil reserves. Companies like Chevron have to compete for oil resources in countries like the United States and Canada, which means they have to spend more money and have less oil under their control.

But doubts are growing about Aramco's valuation...

This April, according to The Wall Street Journal, Aramco officials were quoted as saying the $2 trillion valuation was "unrealistic and mind-blowing." They estimated the real valuation was at least 25% less than that.

Part of the lower valuation is because the price of oil has dropped over the last three years. In 2014, Brent crude traded over $115 per barrel. But now, Brent trades at just $56.84 a barrel, less than half of its 2014 high.

Indeed, the falling price of oil may have pushed the valuation down to $1 trillion, according to Bloomberg. And energy consultants at Rystad Energy place Saudi Aramco's valuation at $1.4 trillion, assuming Brent crude reaches a $75-per-barrel oil price.

A lower valuation might mean investors won't be as excited about owning Aramco stock, and that could mean the underwriters will be forced to reduce the Aramco IPO price.

But there's an even bigger obstacle standing in the way of the IPO, one that will directly affect the Aramco share price...

This Is the Biggest Obstacle for the Aramco IPO Price

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The next biggest obstacle ahead of the Aramco IPO is the disclosure rules for western stock exchanges. That's not only slowing down the IPO process, but it could make investors less interested in buying the stock...

"There has been an ongoing disagreement within both the government and the leadership at Aramco over where the IPO should be issued," said Money Morning Global Energy Strategist Dr. Kent Moors.

One reason for the debate is the Saudi government's reluctance to agree to the transparency rules required to list on the London Stock Exchange (LSE) or New York Stock Exchange (NYSE).

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 the official number of its oil wells and size of its oil reserves secret for strategic reasons.

If Aramco lists on the NYSE, that could become public information due to U.S. securities law.

The entanglement between the Saudi government and Aramco goes even deeper, too.

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%.

But the LSE has offered Aramco a way out of its problematic connections to the Saudi government. The LSE may create a new listing structure that would allow Aramco to sell shares on the London exchange but wouldn't force it to adhere to transparency laws.

This potential solution has attracted some parts of the Saudi royal family, according to WSJ, even as the LSE is taking criticism for giving Aramco special treatment. Moors agrees.

"Of course, more than a few Saudi officials (at Aramco and elsewhere) have used both the United Kingdom and the LSE as conduits for their own financial dealings," said Moors.

And if Aramco receives special treatment, investors might not feel as comfortable buying shares of the stock. That's especially true if Aramco doesn't have to divulge the audited financial information every other company is obligated to.

Again, we won't know the IPO price until it's set by the underwriters, and the number of shares Aramco issues will be a major factor. But the doubts over the valuation and where shares will be listed could be weakening demand.

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