Why Is Saudi Aramco IPO overvalued

Saudi Aramco IPO overview

The Saudi Aramco IPO may become the world’s biggest, surpassing Ali Baba’s in 2014 if the valuation reaches the upper end. Saudi Aramco, a Saudi Arabian national petroleum and natural gas company located in Dhahran, is targeting a valuation between $1.6 trillion and $1.7 trillion for its initial public offering and a price of $8-8.50 per share. The natural gas company is offering its IPO exclusively to investors from the Middle East, India, Russia, and China. The company is contemplating to sell only 1.5% of its shares on the local stock exchange, which would enable Riyadh to raise $25.5 billion for the country’s Public Investment Fund. Aramco continues to be the world’s most valuable company by net income, and the current valuation would provide the stock a yield of between 4.4% and 5%, which is slightly lesser than the average return of Western international oil companies, at 5.7%. 

Saudi Aramco IPO overvalued

Saudi Aramco is unhappy with the level of foreign interest for the company and hence abandoned its earlier plans for a significant global offering. The oil giant will now sell stakes mainly to Saudi Arabians using capital loaned to them by Saudi Arabian banks. This method is similar to borrowing money to fill 401k with employer’s stock.
The company has committed to giving an annual dividend of at least $75 billion for the next five years. Besides, the firm also grants bonus shares on offer for loyal investors. The mooted price range indicates a dividend yield of about 4.4% to 4.7% higher than the sub 4% yield of bonds issued by the company and the state. The prospective return signifies nearly flat oil prices, roughly $60 Brent crude oil. This flat oil price set in the valuation range is reassuring because if oil price plummets for some reason, then that, coupled with the floor provided by the dividend guarantee, could stoke gains. On the flip side, the lower the discount rate on the cash flows, the lower the oil price needed for a given valuation. This method is the advantage to Aramco’s current state shareholder of having the IPO mostly at home, where the risk profile and scope of investment options seem very different compared to the view in places like New York, London, and Tokyo.
Aramco’s stock is expected to price the day of the next Organization of the Petroleum Exporting Countries (OPEC) conference; with speculation prevailing, the group may even declare even lower cuts to balance an anticipated surge in non-OPEC supply. If we assume 11 million barrels a day of crude oil production and $65 oil rate, this implies price to earnings (P/E) ratio of 15-16 times as per the Aramco’s valuation range. This ratio puts the company toward the top end of its peer group and well above other emerging market national oil companies. When we decrease the production to 9.5 million barrels a day and $60 oil price, the P/E multiple rises to 19-20 times.In evading a global IPO, Saudi Aramco realized the advantage of a higher headline price. At the same time, its voters are not getting Aramco at a lower price, particularly if they are borrowing for the right.