The much-speculated IPO of Saudi Arabia's national oil company Aramco is not happening for now, or ever, depending on whom you ask.
The IPO prompted a lot of discussion since it was announced in January 2016.
The main topic of conversation was the valuation, initially valued at $2 trillion by the Saudis. But there was plenty else to talk about, including minority rights for the 5% of Aramco that would be offered to which stock exchange(s) Aramco would be listed on.
It is now clear that in any scenario IPO will be delayed. To understand the delay in the IPO you need to understand first why it was planned, the three main challenges it faced, and the solution that is being deployed.
Aramco's planned IPO had both a short-term goal and a long-term goal. The short-term goal was to raise funds for Saudi's sovereign wealth fund PIF, famous for its $45 billion commitment to Softbank's Vision Fund as well as multi-billion-dollar investments in Uber and more recently in Tesla.
With a proposed valuation of $2 trillion for Aramco the 5% sale would raise $100 billion for Public Investment Fund of Saudi Arabi (PIF). This number is important as I will return to it later. The longer-term goal for Aramco's IPO was to diversify away from oil. The 5% sale at the IPO would be the first step as Saudi would continue to sell shares in Aramco and invest globally into a diversified portfolio.
Whether the short-term goal makes sense depends on how PIF planned to use the funds. The long-term goal is clearly in the best interest of Saudi and its economy.
Now that the goals are clear, I'll outline the three challenges it faced from the onset. The first of these challenges quite simply is that whoever controls Aramco today has great influence over the economy of Saudi Arabia.
The Kingdom is the world's largest exporter of oil, and petroleum sector represents about 42% of GDP, which is around $680 billion. When investors talk about minority rights of the 5% of Aramco that was for sale, they are not only asking for influence over Aramco, but for influence over the economy. Squaring that circle is a big challenge.
The second challenge was convincing global stock markets and investors that the Saudi government was a good equity partner, and that the minority rights and certain corporate governance principles could be waived. The challenge here is that there is no historical public example of having the Saudi government as a majority shareholder for global investors to evaluate having them as a partner. This made waiving rights and corporate governance principles untenable and triggered a severe investor backlash against stock markets
The third and final challenge was not broadcast internationally and had to do with domestic population. For decades the staple of the Saudi economy has been oil and oil-related industries. It is scary for many to make such a big change, not least because change is in itself something that people resist.
But there are two added factors. The first factor I discussed above and that is the introduction of foreign investors as influencers in the economy. The second is the trust in PIF to be able to deploy these funds productively.
Oil is a commodity, and it has intrinsic value. Uber and Tesla Inc (TSLA) have no intrinsic value, they are simply bets on companies with massive negative cashflows. Sure, they might, by some miracle, become cash flow positive, but would you be willing to be your economy on that?
Softbank's Vision Fund is a businessman backed by an investment banking team all trying to be private equity fund managers, for the first time. Again, are you willing to bet the economy on that?
So we come back to the original question, why was the Aramco IPO postponed?
Not simply because there were challenges, the decision makers in Saudi don't give up. They came up with an elegant solution.
Aramco would borrow $70 billion from the markets for the first time, and use it to buy the shares held by PIF of Sabic, a Saudi global diversified chemicals company. This ticks several boxes. The first is that PIF gets its funding. Not the whole $100 billion, but $70 billion ain't bad. The second benefit is that by issuing bonds Aramco takes some initial steps towards an IPO by providing transparency, allowing investors to get to know how the Saudis manage Aramco while at the same time giving the investors the protection they need: a bond is senior to equity and has a fixed life. The final benefit is to allow the Saudi's to build up a track record with their SWF that would ease the minds of both global investors and citizens alike.
Current stories denigrate Saudi for not achieving an ambitious goal. The primary goal was never to IPO Aramco. The primary goal was to fund PIF and the Saudis found a solution that works.