Saudi Aramco in discussion with banks as it considers pre-IPO debut Eurobond or sukuk

05 December,2017 - 04:00 pm UTC

Author(s): by Dan Alderson and Laura Gardner Cuesta and Hassan Jivraj
As Saudi Arabian Oil Company (Aramco) prepares for an expected initial public offering (IPO) in the coming year, discussions are underway with banks about the merits of issuing a pre-IPO debut international bond or sukuk, according to four sellside sources familiar with the situation.
 
With negotiations concerning the IPO heating up, focus has increasingly turned to the different strategies that Aramco could pursue in order to boost its valuation prospects and take steps towards the level of disclosure needed for a public share listing, said the sources familiar, as well as three GCC buysiders looking at the name.
 
“They’re talking to banks about doing a Eurobond,” said one sellside source. “Nothing has been decided yet, but they’d want to do it before the IPO. It would help them achieve their desired valuation and it would be a step towards opening up their accounts gradually. I think they could get up to USD 50bn in orders.”
 
A second sellside source said that Aramco has started discussions with banks for a USD-denominated debt capital markets transaction. The second source suggested that a deal could even come as early as 1Q18 and that it was more likely to be in the form of a sukuk than a conventional bond.
 
Two buysiders agreed that a debut international issue would make sense for Aramco.
 
“Right now, the whole focus for Aramco is around the IPO next year and whether it can achieve the valuation it is looking for,” said the first of the buyside sources. “That has been in question and goes a long way towards explaining Saudi’s backing for oil production cuts, which I predict will continue until the IPO is completed. What would also really help the valuation is improving the return on equity (ROE) for investors. Issuing debt adds leverage and so gives you this.”
 
The second buysider, however, offered an alternative rationale, arguing that Aramco has a range of strategies it could explore to improve the valuation that would be more straightforward than issuing public debt. But he agreed that an international debt issue made sense, as Aramco has high capital expenditure requirements (estimated by the company at more than USD 300bn over the coming decade).
 
“There is definitely scope for them to achieve a USD 50bn order book,” said the second buysider. “This could really help them from a capex point of view. But they would have to be cautious about crowding out the sovereign, especially if they were looking to come in the first half of the year.”
 
In April, the Government of Saudi Arabia printed a USD 4.5bn five-year debut sukuk with a 2.894% profit rate, along with USD 4.5bn of 10-year Islamic notes with a 3.628% profit rate. Books for the 144A/RegS senior unsecured offerings reached USD 33bn, as reported.
 
The kingdom will consider bringing a second sovereign USD sukuk in 1Q18 and issued its second Eurobond – a USD 12.5bn triple trancher – in September.
 
Before the sovereign’s USD 17.5bn debut Eurobond in October 2016, bond investors looking to access Saudi government risk had to rely on Saudi Electricity Company (SEC) issues – typically in the first half of each year – as the closest proxy for the sovereign. This year, SEC eschewed the bond market to close a five-year USD 1.75bn loan with banks in November.
 
While Aramco has yet to access international bond markets, the company printed a SAR 11.25bn (USD 3bn) sukuk in April, as reported by Debtwire. The seven-year Shariah-compliant notes, which followed a hybrid structure of floating mudaraba and murabaha, paid 25bps over the six-month Saudi Interbank Offered Rate (SAIBOR).
 
Riyad Capital, HSBC Saudi Arabia, Alinma Investment, NCB Capital, Saudi Banque Fransi, Gulf International Bank and Samba arranged the deal.
 
That debut Islamic debt issuance was part of a wider USD 10bn programme of bonds and sukuk, with Saudi Aramco planning to issue in both local currency and US dollars over the next three years, as reported.
 
But the second sellside source familiar with the Eurobond discussions noted that the existing sukuk programme only allows for Saudi riyal-denominated deals. As such, Aramco would need to establish a separate programme for an international sukuk.
 
The first buysider also noted the limitations of the domestic programme, saying that international funds would be unable to invest in local currency bonds or sukuk unless they opened an account with a local Saudi financial institution.
 
A third sellside source familiar agreed that the discussions underway go beyond the scope of the already established SAR bond programme. But for this reason, a 1Q18 issue would be surprising, the source added.
 
“They’ve been considering a Eurobond for a while,” said the third sellside source. “I don’t think they are near it though. There are other things they can do to boost their ROE, they don’t have to go down the Eurobond route. But yes, the debut domestic sukuk issue in April [this year] could be seen as a preparatory step for a Eurobond, but bear in mind that was privately placed.”
 
A third buysider suggested that that the requirements of an international bond issue could prove too exacting on Aramco for it to see this as a viable plan in advance of the IPO.
 
“That would surprise me because the biggest restriction right now to do the Eurobond would be having the financials ready,” said the third buysider. “I would imagine that must be where most of the work is right now, to get ready for the IPO, so I would find it surprising if they had enough time to do a bond before they are ready for the IPO itself.”
 
The fourth sellside source familiar agreed about the challenges that a Eurobond would present, but also allowed that Aramco has long considered the possibility.
 
“The Eurobond theme for them has been going on for years, even before the IPO was announced,” said the fourth sellside source. “What's keeping them is the disclosure requirements, even if they are less stringent for a Eurobond than for an IPO. You still need to list your most recent financials, and that's the big issue for them.”
 
The source added that Aramco would definitely need to establish a new programme, since the one they issued their local sukuk from in April only covers local markets. As such it presented less disclosure requirements.
 
“What's obvious is that they definitely need to increase their ROE via debt before any equity transaction,” said the fourth source, “but so far they and other Saudi corporates have chosen the local markets, because they can get away with less disclosure. Theoretically, the London Stock Exchange (LSE) could relax its disclosure requirements for both Eurobonds and IPOs, but it's very politically sensitive and they don't really want to be seen to be lowering their standards, despite the business it may bring.”
 
The location of the prospective IPO listing is a hot battle ground, with US President Donald Trump having waded into the tug-of-war between London and New York via Twitter last month. And today it was reported that The City of London would send a delegation to Saudi Arabia in an intensified effort to attract Aramco’s IPO to the LSE.
 
“They could also try listing on Singapore, which is less prescriptive than European exchanges,” said the fourth sellside source, “but it would defeat the point of them portraying themselves as ready to go out to the world, and banks would have to get comfortable with this.”
 
 
Saudi Aramco did not respond to a request for comment by time of press.