Aramco IPO: stay away or rush in?

Aramco’s valuation up in the air

Anyone looking at putting money into Aramco shares when they list will want to know how much the firm is worth. Unfortunately, at present the estimated valuation produced by investment banks ranges from $1 trillion to $2 trillion.

Even if it is only worth around $1.5 trillion, this would still make it the largest company in the world, according to PWC. This would make it bigger than the entire stock markets of some countries. Investors will only have a small slice of this giant pie, but even 5% of a $1 trillion company is still $50 billion. Aramco plans to pay out $75 billion in dividends, five times the size of Apple’s dividend, which is the biggest payout in the S&P 500.

As the Wall Street Journal’s James Mackintosh notes, valuing Aramco on similar metrics to US oil giants Exxon and Chevron would make it worth around $1.5 trillion, using earnings, or $1.25 trillion using cash flow. For a dividend comparison, he notes, it would need to have a yield of 3.8% to be worth $2 trillion, which would mean its yield is below that of Exxon and Chevron, companies that do not have the same political issues as Aramco.

Will Aramco’s valuation have a ‘margin of safety’?

Oil demand has been weak of late, while supply has been plentiful thanks to US shale. If demand does pick up, then we can expect Aramco’s cash flow to increase, potentially boosting its dividend too. But for any valuation, there must be a ‘margin of safety’, as value investors like Ben Graham and Warren Buffett would argue. This means that the valuation needs to account for potential difficulties in the future, and for Saudi Arabia that could be anything from war and revolution to just political disturbances and regular crackdowns on dissidents.

As a result, investors may well balk at a valuation that is too high. It would appear to promise too much in terms of oil prices, and also not leave sufficient room for any political or geopolitical disturbances. For example, a conflict in the Middle East could see Aramco’s facilities targeted, while disturbances in Saudi Arabia might see the government look to take more cash from Aramco to help placate the populace.

Such events will depress the stock price, and hit the valuation as well. If the worst happened, the company might disappear entirely, leaving investors with nothing. Some might point to the parallels with Imperial Russia – investors in Russian infrastructure prior to the First World War lost practically everything when the Tsarist regime collapsed. This is an unlikely prospect for Saudi Arabia, but investors must always be aware of the potential pitfalls.

Aramco might be a wonderful investment, with the initial public offering (IPO) a savvy move by a forward-looking Saudi government. But it could also be a major headache. Only time will tell.