(Bloomberg View) -- Aramco.
Exxon Mobil Corp. made $19.7 billion of net income in 2017 and its stock is worth about $330 billion, giving it a price-earnings ratio of about 16.6. Other big oil companies have different price-earnings ratios, depending on their growth prospects and business mixes and financial position and management skill and whatever else oil-company valuations depend on. But if you know how much money an oil company makes, you can generally get a decent sense of how much it is worth.
Saudi Aramco is a little different. It is not a public company, it doesn't have publicly traded stock with a market capitalization, and it doesn't release its net income, so you don't know how much money it makes, and you don't know how much it is worth.
Not only that, it's hard to even know what you would mean if you talked about Aramco's net income. The Kingdom of Saudi Arabia, now, is the residual claimant on Aramco's economic value. How it receives that claim doesn't matter much. It could be paid "taxes," or "dividends," or have "capital appreciation," or Aramco could just help out Saudi Arabia around the house. Aramco built a $55 million complex for a camel beauty pageant for the Saudi kingdom; it also does construction work and provides discounted fuel and electricity to Saudi companies and consumers. Does Saudi Arabia get those benefits as a shareholder (a dividend paid in buildings), or as a government (a tax paid in buildings), or as an arm's-length customer (paying market rate for the buildings), or something else? Who cares? With only one claimant, there's no real need to distinguish or track or, certainly, publicize which is which.
And so Saudi Aramco doesn't really get valued based on traditional financial metrics. It doesn't get valued at all, really. It is just sort of mythical, the world's largest and most profitable oil company, which "produces from some of the largest, lowest-cost fields in the world," and which haunts the dreams of investors and bankers who imagine the day when it might become a public company. And so when Saudi Arabia started talking about taking it public, it talked in mythic terms:
Saudi Crown Prince Mohammed bin Salman, who’s made the Aramco IPO a key part of his ambitions to ready the kingdom for the post-oil age, wants to raise a record $100 billion by selling a 5 percent stake. That would value the company at $2 trillion.
Why not? Those nice, round, gigantic numbers only add to the mythology. "Did you hear about the $2 trillion company," people whisper in awe. They dream of the largest initial public offering ever; they don't dive into the weeds of the financial statements.
Except eventually they do! If Aramco is actually going to sell shares to shareholders, then they will want to know how much of the value of Aramco goes to them (in dividends, or in reinvestment in the company that will grow its value over time), and how much of it goes to the government (in taxes, or in building stuff for the government rather than for shareholders). And they will want to know how much of the shareholdery stuff -- the net income -- there was last year, and how much there will be this year, and how much there would be at different oil prices. And they will want it in writing, in tables, audited by auditors, with multiple significant digits, with decimal points even. Even if those numbers are amazing, they will tarnish the myth a bit, because no myth can survive contact with decimal points.
Anyway Bloomberg News got its hands on some decimal points:
Now, a first glimpse of the state oil giant’s finances shows Aramco churned out $33.8 billion in net income the first six months of 2017, easily outstripping U.S. titans like Apple Inc., JPMorgan Chase & Co. and Exxon Mobil Corp. ...
The accounts, prepared to an IFRS standard, also show Aramco’s sensitivity to oil prices. In the first of half of 2016, when crude averaged $41, the company made $7.2 billion in net income. This year, profits are likely to be significantly higher than 2017 after the recent rally in oil to more than $70 a barrel.
A natural question to ask is whether that $2 trillion valuation is in line with other oil companies, given those earnings. I note that Exxon made about $7.4 billion in the first half of 2017, and about $19.7 billion for the full year; at the same ratio, Saudi Aramco's (extremely hypothetical and pro forma!) full-year income would have been about $90 billion, for a 22ish price-earnings ratio. Rich but not, you know, the stuff of legends.
There's a reason that billion-dollar private companies in Silicon Valley are called "unicorns" -- and that they seem to be in no hurry to go public. If you are a giant private company you can maintain some sense of mystery, of infinite possibility. Going public is unappealing not only because you have to hire more accountants and lawyers and fill out more forms and meet with more activist shareholders; it also destroys a bit of the magic.
Bank earnings.
The recent story of financial markets is that they were pretty boring for a pretty long time, and then in early February of this year they went a little nuts. It is not entirely obvious what caused this regime change -- the world was about as nuts before February as it has been since -- but it clearly happened. The CBOE Volatility Index, the VIX, which is the common measure of this sort of thing, averaged about 11.1 from the beginning of 2016 through Feb. 4, 2018, and never got above 17.3 in that period. It jumped to 37.3 on Feb. 5 and has averaged 20.9 since.
Counterintuitively, perhaps, a lot of people spent the last year worrying that low volatility meant complacency, and are loving the new regime. Banks, in particular, seem thrilled:
Citigroup Inc. is profiting from Donald Trump’s unpredictable presidency.
Wild stock markets through the end of March -- spurred by Trump’s tweets on global trade -- helped the firm’s equities business generate the most revenue since 2010, handily surpassing a $1 billion mark the bank said just weeks ago might be within reach. That made up for a surprise drop in fees from handling fixed-income products. A lower-than-forecast tax rate also left more profit for shareholders.
And:
For JPMorgan Chase & Co., last quarter’s volatility appears to have been just right.
Revenue and profit for the first three months of 2018 rose to all-time highs, the bank said Friday, spurred by record results from stock trading. ... Bankers who last year griped about the lack of volatility suddenly had the opposite complaint: Wild market swings were threatening to push wary investors to the sidelines. But all told, the first-quarter mix featured enough activity to boost revenue.
The phrase "Goldilocks volatility" is sometimes thrown around: Banks' trading desks don't do well in quiet markets when there's nothing to do, don't do well in very wild markets where it's easy to lose money, but do do well in medium markets where clients have reasons to trade and risk management is possible.
We talk sometimes around here about the broadly successful efforts over the last decade to make banking boring. The big banks are better capitalized, less trading-oriented, less risk-seeking, and generally less fun than they used to be. So it might be a bit surprising to find their fortunes still pinned to volatility, to find that the right amount of volatility for them is not "as little as possible" but "a nice healthy amount." And of course it is a reflection of the continuing importance of their trading businesses.
But perhaps it's not purely that. We also talk sometimes around here about the deep and discomfiting magic of the basic model of banking, which is that banks issue risk-free liabilities (deposits) in order to buy risky stuff (loans, etc.). If you just think about banks abstractly as engines for transforming risk-free savings into risky investments, then it makes sense that they like a certain amount of volatility. In a boring world, there is no need for that function: Anyone can invest in anything and it'll be safe enough, without a bank doing any magic to it. In an excessively volatile world, banks can't do that function: The risks are too big, and if they invest in risky things (even AAA-rated mortgage securities, sometimes), they'll lose their depositors' money. In a medium-volatility world, the banks' function of filtering volatility into palatable forms is both possible and valuable.
Anyway Wells Fargo & Co. also had a nice quarter. Here are JPMorgan's earnings release, presentation and supplement; Citi's release, presentation and supplement; and Wells Fargo's release and supplement.
Banking culture.
Moelis & Co. co-President Jeff Raich reminded top bankers in a meeting this week to treat young bankers well as the firm embarks on another hiring push, according to people familiar with the matter.
Raich, 51, addressed managing directors after industry forum Wall Street Oasis posted parts of an email that a “Moelis Staffer” sent to the firm’s analysts after discovering many of them weren’t in the office after midnight, according to a blog post on the website.
“Given that new staffings continue to flow in and you are all very near capacity, the only way I can think of to differentiate among you is to see who is in the office in the wee hours of the morning,” the Moelis manager, who wasn’t identified in the blog post, wrote in the email.
The thing is, if you read that post, it's pretty clear that the staffer was being nice. I mean, nice for an investment-banking staffer. The staffer is in charge of staffing, of assigning work to analysts; he or she wasn't touring the floor at 2 a.m. to be a jerk, but to find people to give work to. Or, more accurately, to find people not to give work to: If you were there at 2 a.m., the staffer took pity on you and did not give you any more work; if you were at home, then you arrived the next (um, same) morning to find more work. "This method isn't perfect," conceded the staffer, "and if you have any suggestions on how I can do this more accurately, I'm all ears."
There can be two big problems with how investment banks treat young bankers:
- They are mean to them, and
- They give them too much work.
If your bank is being mean to young bankers, just stop doing that. It is dumb. Yes whatever there are social-cohesion benefits to hazing or whatever, but come on, cut it out. But if your bank is giving young bankers too much work, that is not as simple to fix. Perhaps you are giving them dumb busywork -- definitely a possibility! -- in which case, you know, cut that out too. But perhaps you have a lot of clients and are doing a lot of work for them so you can make a lot of money. This one is harder to solve. You want the money. Your young analysts probably want the money too. You could hire a bunch more of them so they could all work less, but that might "dilute their experience" and would surely dilute their pay. "We are an entrepreneurial growth company, and all work incredibly hard to deliver the absolute best for our clients," said a Moelis spokeswoman. Your best bet, as a bank, might be to get the young analysts to believe that.
Elsewhere: "Wall Street Era of Deducting $65 Dry-Aged Steaks Could Be Over."
Is disclosure bad?
Justin Lahart notes that bad tax disclosure can be good for shareholders:
When investors want to dig into a company’s tax position, they know where to go: The tax footnote that appears in its annual report. But the Internal Revenue Service knows that is the place to go, too. That creates a dilemma for companies trying to avoid taxes. They can provide clarity to shareholders, and risk getting a call from the IRS. Or they can obfuscate, making things trickier for shareholders, but reducing the chances of an IRS inquiry.
For companies that engage heavily in tax-avoidance efforts, obfuscation is the way to go, according to a new paper from a group of accounting professors in the Journal of the American Taxation Association. The research finds that among these companies, the more opaque the tax footnote language, the higher their stock market valuation tends to be.
There is no obvious reason that this would be unique to taxes. Companies could describe their business strategy in great detail in their annual reports, and securities regulators encourage them to do so, and that discussion might be of intellectual and even practical interest to their shareholders. It might also be of interest to their competitors. The shareholders should want an equilibrium in which the disclosure is less useful than the competitors might want, even if it is also less useful than the shareholders might want. Or, alternatively, the shareholders should just want the companies to stay private.
Everything is securities fraud.
Sexual harassment is securities fraud, selling opioids is securities fraud, mispricing chickens is securities fraud, and sure, why not, mistreating orcas is securities fraud:
SeaWorld Entertainment Inc. will probably face civil charges that it violated securities laws several years ago, when the company was dealing with scrutiny over its treatment of captive killer whales.
The U.S. Securities and Exchange Commission sent a Wells notice to the Orlando, Florida-based theme-park operator on April 6 regarding “certain disclosures and public statements made by the company and certain individuals on or before August 2014,” according to a filing Thursday. The Justice Department is also investigating, SeaWorld said last June.
This is not a core case of "everything is securities fraud" in that SeaWorld is apparently under scrutiny for denying that a boycott campaign against it, and the orca-abuse documentary "Blackfish," were hurting attendance. It's not that they were allegedly abusing orcas and no one knew about it; it's that after people found out about their alleged treatment of orcas, they nonetheless denied that it was hurting business. But yes in any case the victims of SeaWorld's treatment of orcas were, of course, its shareholders.
Things happen.
Global Banks Face Chill of Russian Sanctions. Lackluster U.S. Bond Auctions Add to Worries of Foreign Pullback. "Silicon Valley, long the undisputed king of venture capital, is now sharing its throne with Asia." Tech IPO Market Shows Signs of Warming. "Only 14 U.S. debt funds were managed exclusively by women as of September 2017, compared with 47 in 2004," though the women have outperformed. Tesla May Be the Most Hated (and Loved) Stock in America. Tesla, Safety Agency Feud Over Fatal-Crash Probe. $658 Million Cryptocurrency Fraud Allegation Spurs Vietnam Probe. Privacy fatigue. Here's Steve Schwarzman's naming-rights agreement with his high school. Threatened: A Green-Haired Turtle That Can Breathe Through Its Genitals. Merger-agreement wedding invitations.
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Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
To contact the editor responsible for this story: James Greiff at jgreiff@bloomberg.net.
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