Sunday Strategist: How Saudi Aramco Boosted Its IPO Price

(Bloomberg Businessweek) -- Saudi Aramco wanted to sell a lot of shares at a high price, but the smart money showed no interest. So the company’s bosses had a tough choice to make. They could cut the price, or they could reduce the size of the sale. They opted mostly for the latter.

Whether that was the right choice is an interesting question. We may not know the answer for weeks or even years. Ultimately it’s a question of high vs. low pricing strategy—a dilemma that’s familiar to lots of businesspeople, whether they’re selling haircuts or jet aircraft.

On or about Wednesday, Dec. 11, the shares will begin trading in Saudi Arabia, and Saudi Aramco will become, or at least be deemed, the world’s most valuable publicly traded company. 

Let’s dig into what that means. Mechanically, it's simple. The company has 200 billion shares. Multiplying that sum by the initial public offering price of $8.53 (32 Saudi riyals) gives a valuation for the shares of $1.7 trillion. Apple Inc. and Microsoft Corp. are worth around $1.2 trillion each.

In reality, it’s not so straightforward. As with haircuts and jet aircraft, scarcity matters. The Saudis managed to get an IPO price of $8.53 because they are selling only a 1.5% stake in the company. That raises just over $25 billion. Originally Crown Prince Mohammed bin Salman wanted to sell a 5% stake for $10 a share, raising $100 billion and valuing the company at $2 trillion. But a survey by Bernstein Research of 31 major global investors found that the average valuation they put on Saudi Aramco was just $1.26 trillion—which comes to around $6.30 a share.

Think of the downward-sloping demand curve from econ class. When the quantity sold is very small, over on the left side of the graph, the price can be very high, because there’s always one sucker who's willing to pay an exorbitant amount. As you move to the right—and sell more—you have to lower the price to capture people who are more price-sensitive. By keeping the volume small, Saudi Aramco is capturing just the people with the maximum willingness to pay.

Shrinking the offering may have allowed Saudi Aramco to get a higher price per share, but it comes with downsides. It raises less money. And rather than building a base of sophisticated international investors, the company is selling largely to citizens and institutions in Saudi Arabia and its neighbors, who may be overoptimistic about the company's prospects. 

Billboards for the IPO are all over Saudi Arabia, and Saudi banks are even advertising loans to help people buy shares. If the price falls, a lot of ordinary Saudis may feel they’ve been tricked by their own government. In reality, they’re the last people who should be buying shares. They already depend on Saudi Aramco for the taxes and royalties it pays. Now they’re going to depend on it for dividend income as well. That's the opposite of diversification.

The moment of truth may come when there’s a big drop in the oil price. Or it may come the next time Saudi Aramco needs to sell shares, and global investors continue to balk at paying the price the Saudis want. I recommend this story by my Bloomberg colleagues Alaa Shahine and Matthew Martin. “It’s difficult to see how this level of subscription can be repeated to raise the sort of revenue required by Vision 2030,” the kingdom’s economic plan, Bill Farren-Price, a consultant at RS Energy Group, told them. “And Saudi economic diversification will need a lot more of that.”

In the short term the Saudi strategy gave the oil giant an impressive-sounding valuation. In the long term it could very well backfire.

Businessweek and Beyond

• From finance to fashion and technology to trade, these are the people who defined 2019
• Cristina Fernández cements comeback in Argentina politics
• CEOs goose their pay with buybacks
• French strike aims to save an envied, but convoluted, approach to pensions
• How poverty ends the many paths to progress—and why they might not continue

To contact the editor responsible for this story: Silvia Killingsworth at skillingswo2@bloomberg.net

©2019 Bloomberg L.P.