Foreign funds balk at crown prince's Aramco IPO valuation

Saudi Arabia's Crown Prince Mohammed Bin Salman may have lowered his valuation target for Saudi Aramco as it prepares an initial public offering, but some of the world's biggest investors say he's not gone far enough.

Money managers including AllianceBernstein and Frankfurt-based Union Investment Privatfonds believe the energy giant is worth less than the approximately $1.7 trillion that the prince is now said to be willing to accept, down from $2 trillion initially.

They're concerned the Saudi government — which may sell only about 2% of Aramco — won't give enough say to minority shareholders. Regional geopolitical risks, which were underscored when the company's facilities were struck by missiles and drones in September, are also weighing on investors' calculations.

While the bulk of the money is expected to come from Saudi investors as well as China, a failure to attract foreign cash or a slump in Aramco's share price when it starts trading in Riyadh on Dec. 11 could backfire on the 34-year-old prince. The IPO is a key part of his grand vision to open up the kingdom's economy to foreign investment and reduce its reliance on oil.

"If Aramco decides to significantly lower its overambitious valuation expectations and float the company on investor-friendly terms, these will be considered a sign of strength and wisdom rather than weakness," said Slava Breusov, a New York-based senior analyst with the emerging and frontier equities team at AllianceBernstein, which manages almost $600 billion. "A successful IPO is one that makes money for investors, not the one that commands the highest valuation."

Aramco is worth "way below $1.5 trillion," according to Mr. Breusov, who said an analyst from one of the banks arranging the share sale failed to persuade him otherwise at a meeting Wednesday. "I don't think enough discount is assigned to any potential misalignment of interests between minorities and the state."

Oil accounted for more than 60% of the kingdom's fiscal revenue in 2017. Saudi Arabia is the most important member of the OPEC cartel with Aramco pumping about 10% of the world's crude. The IPO money will go to the Public Investment Fund — the sovereign wealth fund spearheading the prince's economic-diversification plans.

"In terms of scale and quality of Aramco's assets, they've got the world's best, bar none," said Dwight Anderson, the founder of hedge fund Ospraie Management. "But the decisions that they make are optimized to achieve the country's objectives, not yours as an individual shareholder."

Analyst estimates for the listing, which may be the largest ever, even at a lower valuation, span from $1.2 trillion to $2.3 trillion. Sanford C. Bernstein & Co., which isn't involved in the IPO, said a fair number is $1.2 trillion to $1.5 trillion, based on metrics such as dividends and earnings forecasts.

"If I had to buy such a mercurial asset, I would seek to buy at the low end: $1.2 trillion to $1.3 trillion," said Marcus Chenevix, an analyst at TS Lombard, a research firm in London. "The most concerning thing about the company is that its overriding priority is not to provide shareholder value or corporate stability, but to fund the Saudi state."

Aramco's appeal would lie in its ability to regularly pay dividends, said Colin Croft, a London-based portfolio manager at Jupiter Asset Management. Even so, it's worth closer to $1.2 trillion than $2.3 trillion, he said.

Ekaterina Iliouchenko, a money manager at Union Investment Privatfonds, said she'd want a dividend yield of about 6.5%. That would would mean a market capitalization of $1.2 trillion, based on Aramco's original promise for an annual payout of $75 billion, she said, adding that some Russian energy stocks have 9% yields.

As part of Prince Mohammed's concessions, he's now considering boosting next year's dividend to $80 billion, according to people briefed on the matter. But even that would not be enough to raise the valuation much beyond $1.2 trillion if investors insisted on a 6.5% dividend yield. The company's 2049 dollar bond was trading at a 4% yield on Friday, up eleven basis points in the week.

"I don't have any concerns at all about Aramco — I'm an emerging-market investor," said Ms. Iliouchenko, who oversees a fund covering Central Europe, the Middle East and Africa. "It's just the valuation."