Investors Want Saudi Aramco to Untangle Itself from Saudi Arabia -- It Won't Be Easy
DOW JONES & COMPANY, INC. 11:22 AM ET 5/25/2017
By Justin Scheck, Bradley Hope and Summer Said
RUMAH, Saudi Arabia -- To understand the deep bonds between Saudi Arabian Oil Co. and the country's royal family, consider a $55-plus million project the state oil giant recently completed on an empty expanse of desert north of Riyadh.
It includes a mosque, a children's camp and a museum. Broad boulevards with solar-powered streetlamps lead to gleaming white grandstands at the complex's centerpiece -- a stage for Saudi Arabia's most prestigious camel beauty contest.
In a country with limited industrial capability, Saudi Aramco, as the oil company is known, was one of the few firms that could build the project in time for the springtime pageant, an event cherished by King Salman bin Abdulaziz Al Saud. "Within 50 days, they made this city," said Badah Alsubaie, a camel-complex official.
The kingdom wants to list a minority of Aramco's shares in what could be the world's largest-ever initial public offering, planned for the second half of 2018. First, however, the company needs to be separated from the kingdom.
The kingdom's oil company and its gargantuan cash flow drove the development of modern Saudi Arabia. In addition to being the engine of the national economy, Aramco is a core part of the government apparatus, so much so that some Aramco employees call their employer the "Ministry of Aramco."
Yet many potential investors say that, to be valued on a footing with publicly traded peers such as Exxon Mobil Corp. and Royal Dutch Shell PLC, Aramco will need to present financial statements showing the company is independent, and that its profits aren't subsidizing pavilions for camel beauty pageants or other Saudi budget items.
"I'd much rather have a simple, straightforward company that specializes in that area of the market than one that might go off in other directions," says Paul Mumford, a fund manager who invests in energy stocks for Cavendish Asset Management.
The company and the kingdom are so deeply enmeshed that, a year into IPO preparations, company and government officials are still wrestling with how to untangle them, according to interviews with more than two dozen current and former Aramco executives, government officials and outside advisers, as well as corporate and government documents reviewed by The Wall Street Journal.
The IPO is crucial to the ambitions of Deputy Crown Prince Mohammed bin Salman, who wants to invest the proceeds in other industries to make Saudi Arabia's economy less reliant on oil.
Saudi Aramco said in a statement it has "initiated a multi-phased program to define our relationship with our stakeholders for the future." The company said it couldn't answer certain specific questions about IPO preparation due to concerns about complying with stock-exchange regulations ahead of the offering.
Saudi Aramco's chairman, Saudi Energy Minister Khalid al-Falih, said in a March interview that Aramco is "ring- fenced financially" from the state, with governance comparable to multinationals.
Yet people familiar with the behemoth's finances say that it is often unclear even to some officials high up in the company whether Aramco has been reimbursed in full for projects, and how the reimbursement process works.
Discussing the desert construction complex, a Saudi Aramco spokesman said in an emailed statement the company "was fully reimbursed for its costs relating to this event."
Aramco, which contributes over 70% of government revenues, has a range of roles beyond infrastructure building, including economic planning. It also provides heavily discounted fuel to support companies and consumers with inexpensive power.
Half of Saudi Arabia's 10 largest nonbank companies by market capitalization rely heavily on business with Aramco, including receiving products at below-market-rate prices, according to an analysis of Saudi corporate disclosures.
A spokesman for Aramco said that "its sales within the Kingdom are regulated by the government."
Saudi Electricity Company, the third-largest nonfinancial company in the kingdom, said in 2015 it owed some 73.7 billion riyals ($19.7 billion) to the government and Aramco for fuel it received from Aramco since 2000. Aramco owns 6.9% of the company. That fuel allows Saudi citizens and businesses to buy electricity at a discount.
Two people with knowledge of Aramco's finances say Saudi Electricity still hasn't paid Aramco for the fuel.
Saudi Arabian Mining Company, the sixth-largest nonfinancial company, disclosed in 2016 that one of its biggest competitive advantages was access to "quality phosphate rock and molten sulphur from Saudi Aramco." An Aramco spokesman said the sulphur "is a byproduct of operations and is sold on a commercial basis."
The company that became Aramco started in 1933 as a joint venture between the Saudi government and Standard Oil Company of California, and for years was largely U.S.-run. Control shifted to Saudis through the 1960s and '70s; in 1980, the government became Aramco's outright owner through a deal it struck with its U.S. partner.
As the world's thirst for oil grew, Aramco kept pace, and has accounted for more than 10% of global oil production in recent years. The company broadened its expertise from tapping and managing the world's biggest oil reservoirs to shipping and processing crude into more-valuable products. Aramco now has joint ventures with multinationals including Exxon Mobil and Dow Chemical Co.
Its profits built the modern Saudi state almost from scratch.
In 1968, Saudi Arabia's gross domestic product was less than $4.2 billion, according to World Bank data, and a Saudi born that year could expect to live less than 51 years. In 2015, Saudi GDP was $646 billion, and life expectancy reached nearly 75 years.
Aramco took on infrastructure projects including roads, hospitals and schools, and provided a host of social and economic programs: interest-free housing loans, funding for U.S.-bound students and malaria eradication.
The company said its construction projects are part of a "program of corporate citizenship" that has included " national capacity building, training, schools and education." In addition, the company said it has "also undertaken infrastructure projects at the request of the Government of the Kingdom of Saudi Arabia" for which it said it received " due compensation."
Other people with direct knowledge of Aramco's finances dispute that, saying the company hasn't been reimbursed for some projects built at the government's request.
Untangling the paybacks is difficult, says a person involved in the process, because the government and Aramco sometimes deal with compensation as part of the negotiation of Aramco's annual payments to the government.
In 2006, then-King Abdullah ordered up Saudi Arabia's first coed university for an estimated $2 billion to $3 billion. An Aramco spokesman says "the government bore the substantial majority of the costs" for the project, and that the government reimbursed Aramco for building a $1 billion "sports city" encompassing a soccer stadium and at least five mosques.
On other specific projects, such as a years-long stormwater-drainage project in Jeddah, the company declined to comment. Another project, a futuristic museum and cultural center rising from Saudi Arabia's eastern desert, cost Aramco more than $800 million, people familiar with the project said. The company still owns and runs the King Abdulaziz Center for World Culture, which is slated to open next year.
Aramco was also involved in building the counter-terrorism center in Riyadh where President Donald Trump and King Salman were photographed earlier this week touching a glowing orb, says a person familiar with the matter.
In 2014, some Aramco officials began confronting Saudi Arabia's brewing economic problems. In their unofficial role as the country's economic steward, they prepared a private report warning the government of a looming demographic explosion, where the country would need to create some 300,000 to 350,000 jobs annually to keep unemployment below 20%. The government didn't initially act.
Then oil prices crashed. Abdullah died in 2015; instead of asking for stadiums, his successor King Salman asked his son, Prince Mohammed, to break the kingdom's oil dependence, and empowered the prince to oversee a sweeping economic overhaul.
On Jan. 7, 2016, Aramco employees learned about their future from The Economist magazine: Prince Mohammed told an interviewer the company would go public.
"There was a shudder of silence in the room when it was announced," said one employee. "We were the ones pushing the research saying the economy needed to be diversified, but we never considered an IPO as the way to do that."
Public-relations staff rushed to issue a statement that made the news look like the result of a long-running study, say people familiar with the event.
The announcement set off a race to figure out how to list a company so big and so intertwined with the government that taking it public, some bankers have said, would be equivalent to "floating a country."
Former British Prime Minister Tony Blair sat with Prince Mohammed in a desert camp; Larry Summers, a veteran of Clinton and Obama White Houses, met Saudi leaders, as did former Republican House Majority Leader Eric Cantor, say people familiar with the meetings.
The former politicians, experts in politics and economics, are also affiliated with banks vying for Aramco IPO business. Mr. Blair is the chairman of J.P. Morgan Chase & Co.'s international council, which advises the bank (Aramco's chairman, Mr. Falih, was also on that council). Messrs. Summers and Cantor are affiliated with boutique firms advising Aramco.
In his meetings with Prince Mohammed, Mr. Blair discussed "general Middle East politics," but nothing to do with " business" or his role at J.P. Morgan, according to a person close to Mr. Blair.
As a first step, Mr. Falih and Aramco Chief Executive Amin Nasser appointed Motassim al-Maashouq to lead a group that would figure out how to untangle the oil, fuels and chemicals businesses from Aramco's government obligations.
In a speech to the corporate-planning department, Mr. Maashouq, the goateed and gregarious onetime head of an Aramco division that builds non-oil projects, told employees the IPO would be "a landmark" for Aramco and that " transparency and efficiency will make things better," one attendee recalls.
Mr. Maashouq enlisted more than 20 Aramco employees. They were assigned to teams called "Project X," "Project Y" and "Project Z," say people familiar with the matter, and began meeting in offices with combination locks on the doors. Project X worked up a plan to take the entire company public; Projects Y and Z examined more modest offerings of Aramco's processing businesses, say people familiar with the matter.
Executives decided to move ahead with Project X, they say, and put together another team, "Project R," to focus on getting the company ready to go public.
The teams, along with outside advisers, developed plans to move subsidies off Aramco's books and put non-energy functions -- such as building stadiums and camel complexes -- under government ministries.
The very process of realizing the prince's economic overhaul only served to highlight the blurred lines around Aramco's role.
The government began asking Aramco's oil-price-forecasting group for about 10 reports a week on countries and companies the prince viewed as alternative investment opportunities. Those included Russia, Japan's SoftBank, the Comoros Islands and an amusement-park company.
"We're going, 'What's Six Flags got to do with the price oil?' " says a person involved in the assignment.
The internal team preparing the company's IPO began to realize they might not meet the lofty price publicly predicted by Prince Mohammed of $2 trillion.
According to internal documents, the team reached a valuation of less than $1.5 trillion under current tax rates and royalty rates.
Within Aramco, worries about potential disruption caused by the IPO effort have led some employees to work on what one calls a "constructive sabotage" effort -- an attempt to persuade superiors Aramco should remain an arm of government.
Their quiet rebellion seems unlikely to succeed. Prince Mohammed is committed to the IPO, according to people in his circle. An Aramco spokesman declined to comment on the potential valuation or on the prince's plans.
Saudi business leaders also were becoming unsettled by aspects of the economic overhaul plan. Already hit by reduced government support, companies were facing new taxes and other measures aimed at weaning the country off oil revenue. To some, it felt like the government was focused on one thing: maximizing an Aramco IPO. On March 4, several Saudi business leaders sat with Prince Mohammed to air their grievances, according to minutes of the meeting reviewed by The Journal.
Changes the prince planned to introduce as part of Vision 2030 -- the name of the government's economic transformation plan -- would add to their costs, they complained, including by hampering their ability to bring in foreign workers.
The only sector exempted, they pointed out, was oil, according to the meeting minutes. The prince offered little comfort.
The take-away for one executive whose company was represented: "What 2030 stands for is we take 30 and give you 20."
While the meeting was being held, Aramco was close to finishing the camel stage.
On a recent afternoon, hundreds of camels chewed their cuds in dusty paddocks. One white female -- made particularly desirable by the downturned snout towering two feet over her caregiver's head -- was the subject of a $10 million auction bid. Her owner turned it down.
Aramco engineers were on site through the contest, said Mr. Alsubaie, the camel-complex official.
Saudi officials frame Aramco's involvement as a marriage of Bedouin tradition and modern wealth that epitomizes today's Saudi Arabia. The government called the contest, which gave out some $30 million in prizes, "part of the transformation of the country's oil-dependent economy." Top prizes went to two Saudi princes.
In the weeks since the camel facility was finished, government thinking on untangling Aramco has shifted, say people familiar with the matter. For months, company officials and their bankers signaled they would break Aramco's non- oil functions from the company ahead of the IPO.
On the eve of the camel pageant finale in April, senior officials said they now intend to keep the construction function in the company, hoping it can make a profit. The work is so good, say officials involved in the process, investors will want a piece.
Write to Justin Scheck at justin.scheck@wsj.com, Bradley Hope at bradley.hope@wsj.com and Summer Said at summer.said@wsj.com
(END) Dow Jones Newswires
05-25-171122ET
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