– December 6, 2019
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Imagine for a moment, the following: In an industry with global demand there is one organization that has the following advantages. It has the lowest cost of production for its product, exported and used by every country on the planet, and is part of a publicly recognized and accepted price fixing cartel that can counteract swings in supply and price. 

In 2018 this organization generated profits of over $111 billion on revenues of almost $356 billion, outstripping profits of market titans such as Apple and Walmart. Best of all, and for the first time in decades, the management of this organization is looking to participate in an IPO and allow new investors to participate in this profit bonanza. 

Sound too good to be true? The answer is both yes and no. The organization described in the above paragraph is real; the Saudi Arabian Oil Company, commonly referred to as Saudi Aramco. Controlled by Saudi Arabia, leading member of the OPEC cartel which still does exercise influence over global oil supply and prices despite increased non-OPEC production, Aramco holds a unique position in the petrochemical industry. Record profits, the support of a nation-state, and a product that every country in the world consumers – what could possibly go wrong? 

Unfortunately, the story is not all bumper profits and limitless returns for investors as the proposed IPO (initially announced in 2016) is just now reaching fruition. Under the scrutiny that inevitably accompanies an IPO process the valuation of Aramco has dropped from $2 trillion to a range between $1.3 and $1.7 trillion, the amount of company stock to be issued to the public has dropped from an initial estimate from 5% to just 1.5%, and the scope of the IPO has been scaled back. Initial plans of issuances in the US, London, and Hong Kong have been cancelled and replaced with an exclusive listing in Riyadh. 

With this local-only issuance of shares the tactic being employed involves strongly encouraging Saudi residents, including the very same wealthy individuals held captive at the Ritz Carlton last year, to invest in the share issuance. In other words, the very same wealthy citizens that were, in essence, shaken down for billions of dollars prior to being released are once again being strong-armed to help prop up a lackluster IPO. 

Not quite the grand reorientation of the Saudi economy that was initially promised, dubbed Saudi Vision 2030.

What Happened? 

During the last several years as the IPO process has slogged forward there has been much speculation about just what exactly went wrong. Recently it has become fashionable to blame 1) a downturn in oil prices, and 2) the attack on major Aramco facilities in September that led to over 50% of total production being offline, albeit only for a short time. Taking a closer look, however, reveals several factors that contradict the facade put forward by the management of Aramco seeking to raise capital. There are three reasons why this otherwise promising IPO has stalled, shrinking both in scope and market impact.

First and foremost it is important to note, and despite the fact that many extremely competent professionals work for Aramco, the only management decision makers that really matter are the royal family. Not a board of directors elected by shareholders, not globally recognized experts in the petro-chemical markets, and not shareholders. These positions may very well exist, but the true influence lies elsewhere. In fact, Aramco operates under a lease concession model that results in profits and dividends being allocated directly to state coffers to be spent on whatever project currently has the attention of the family. This arrangement follows the seizure of assets previously operated by international oil players during the 1970s.

This closely held and unusual ownership structure also resulted in an opaque and mysterious operating structure and a lack of verifiable financial information for market participants to assess. Prior to the release of partial financial information as part of the lead up to the proposed IPO, hard numbers had been difficult to come by. Even with these releases, however, much remains uncertain as to just how Aramco operates from a financial and operational perspective. Accounting reports and disclosures required by markets such as the U.S. would have dramatically increased the scrutiny the organization would have operated under. 

Last but not least, the key management decision maker in Aramco is the Saudi royal family, led by a man who has been accused by many as playing a key role in organizing the murder and dismemberment of a journalist and other human rights violations. There are also mounting suspicions, attended by facts, that the government of Saudi Arabia had a role in the September 11th attacks in New York and Washington D.C. 

Taking into account that only 1.5% of the company is set to be issued, and that the lease concession operating structure does not seem set to substantially change this means that any global investor would be getting into a partnership with a direct extension of the government. No government or individual is perfect, but the laundry list of human rights abuses may have given some institutional investors cold feet given the contentious global political landscape.

So What’s Next 

It seems like the Aramco IPO will go forward, in no small part because the Saudi government needs to salvage something from this saga as well as raise some much needed capital, currently estimated to be approximately $25 billion. This would rank the IPO as one of, if not the largest, IPOs of all time.  

The Aramco story may have unfolded in Saudi Arabia, but it should serve as a dire warning for pundits across the globe. Even an organization with every possible advantage in its favor is unable to overcome a government seen as overly involved in operations of the organization, and operating as the only management voice that matters. Aramco may seem like an extreme example, but the truth is that this story has been repeated innumerable times with innumerable governments.

A successful business is a like a good recipe: too much of any single ingredient can ruin the whole batch. That includes too much governmental meddling. 

Sean Stein Smith

Sean Stein Smith is a Visiting Research Fellow at the American Institute for Economic Research, focusing on blockchain, cryptoassets, and the economic impact of these technologies. He is an Assistant Professor at the City University of New York (Lehman College), serves on the Advisory Board of Wall Street Blockchain Alliance, where he also chairs the Accounting Working Group, and chairs the Emerging Technology Interest Group of the New Jersey Society of CPAs.  His research has been quoted in dozens of scholarly and practitioner publications, and he is a regular speaker at accounting and technology conferences. Follow him on Twitter.
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