After Shelving Biggest-Ever IPO, Can Saudis Pull Off a Mega Bond?

(Bloomberg) -- Two months after Saudi Arabia pulled a share sale that could have raised $100 billion for its sovereign wealth fund, the kingdom faces a tough sell in convincing bond investors to pick up the tab.

Saudi financial engineers are cooking up a plan to raise as much as $70 billion for the Public Investment Fund by having state oil giant Aramco buy PIF’s entire stake in sister company Sabic. That could include a bond sale the likes of which the world has never seen.

After Shelving Biggest-Ever IPO, Can Saudis Pull Off a Mega Bond?

Problem is, this year’s selloff in emerging markets has sent borrowing costs surging and new debt issuance has dried up, with offerings down 14 percent from last year.

And yet Crown Prince Mohammed bin Salman needs to flood PIF with cash so it can accelerate a buying spree that’s seen it snap up stakes in Tesla Inc. and Uber Technologies Inc. since 2016. His vision is that by 2030, PIF will control $2 trillion in assets just as oil’s dominance worldwide starts waning.

Since shelving plans in July to sell 5 percent of oil giant Aramco to the public, the prince has shifted gears and now wants to keep ownership in the kingdom’s hands with the Sabic deal. As Aramco meets bankers in London this week to figure out how to pay for the acquisition, the question on everyone’s mind is: Can the Saudis pull it off?

After Shelving Biggest-Ever IPO, Can Saudis Pull Off a Mega Bond?

1) How much could Aramco feasibly raise in the bond market?

Aramco’s issuance could conceivably be the biggest corporate bond sale if it surpasses the $49 billion Verizon Communications Inc. raised in 2013 to buy a stake in Verizon Wireless Inc. Bond brokers are divided on how much appetite there will be. Some say Aramco won’t be able to raise more than $10 billion at the price it wants; others think it can pull off $50 billion or even $70 billion.

That may be ambitious. Once person with direct knowledge of the financing talks said Aramco is likely to arrange a short-term bridge loan with a group of banks of potentially $40 billion. Bankers would then aim to raise at least part of that amount in the bond market.

To be sure, Saudi Arabia isn’t afraid to go big. Since Prince Salman first unveiled a plan to transform the kingdom’s economy in 2016, the sovereign has raised upwards of $50 billion on international bond markets, including the biggest-ever EM sale of $17.5 billion that year.

2) Can the market absorb a mega Saudi bond?

Markets are in a different place now than they were in 2016. It’s not as compelling for investors hunting for yield to venture into emerging markets when U.S. interest rates are on the rise. Add to that concerns that major developing economies are either facing slowing growth of entering recessions, and the argument in favor of taking on EM risk has fallen apart.

"It’ll be a big stretch on the market, if they want to do more than $20 billion by year-end," said Pavel Mamai, the co-founder of hedge fund Promeritum Investment in London.

3) Who is likely to buy the Aramco bond?

Given that Saudi Arabia is an investment-grade issuer, some of the world’s biggest sovereign wealth funds are likely to back the Aramco offering nonetheless. This is especially true because the notes are likely to be eligible for inclusion in the JPMorgan Emerging Market Bond Index tracked by $360 billion of investors.

That said, since Aramco may be deemed a quasi-sovereign issuer, loading up on this much debt could prompt ratings companies to reconsider their grades. Since 2016, the three major ratings firms have knocked down Saudi Arabia’s ranking at least one notch.

After Shelving Biggest-Ever IPO, Can Saudis Pull Off a Mega Bond?

4) Why might traditional emerging-market investors hesitate?

Demand could be capped because investors have plenty of options in EM. The yield on Saudi Arabia’s $5.5 billion of 10-year debt sold in 2016 is now at 4.14 percent -- almost two percentage points less than the average for sovereign Eurobonds on the Bloomberg Barclays Emerging Markets Hard Currency Aggregate Index.

Buyers are better off in places like Argentina, Russia and Turkey -- where 10-year debt yields as high as 10 percent, according to Lutz Roehmeyer, chief investment officer at Capitulum Asset Management in Berlin. “So many bonds get completely destroyed in the recent selloff that you can pick up now so many cheap bonds that high grade issuer will face little crossover inflows."

5) But those issuers are junk-rated -- surely investors chasing high-grade debt will be keen on Aramco?

True, Saudi Arabia offers investors seeking stability a place to park their cash. The sovereign holds an A1 rating at Moody’s Investors Service, the fifth-highest investment grade. Oil prices are up 18 percent this year and the Saudi central bank has almost $500 billion in foreign assets.

Aramco isn’t rated though, and investors may not be keen to hold long-term debt in a pure oil play when oil demand is forecast to increasingly be replaced by renewable energy. There was also a broad selloff in investment-grade debt in the past year, with companies like Apple Inc. offering 3.57 percent yields on notes due in 2026.

Saudi Arabia will have to give a competitive first-issuer premium to woo this segment of buyers. Angad Rajpal, a senior fund manager at Emirates NBD Asset Management, said anywhere from 25 basis points to 40 basis points above equivalent-maturity Saudi sovereign debt would do the trick.

6) Where does this leave banks?

If Aramco can pull off a mega bond sale, it could mean a fee bonanza for bankers reeling from the cancellation of the IPO, according to Jeff Nassof, a director at Freeman & Co.  in New York. If it can raise $70 billion of bonds to fully fund the Sabic purchase at a fee rate of 0.1 percent, for instance, banks could get a $70 million windfall, the largest underwriting fee ever paid in the Middle East.

But that’s a big if. Whatever Aramco can’t raise in bonds it will presumably need to borrow in loans, which means more Saudi risk on bank balance sheets. Lenders have already extended tens of billions of dollars in loans to help the kingdom weather the downturn in oil since 2014.

©2018 Bloomberg L.P.