This IPO Will Change the Future of America

Matthew Carr By Matthew Carr, Emerging Trends Strategist, The Oxford Club

Oil & Gas

Last week, I wrote about energy and resource initial public offerings.

I told you how the number of energy and resource IPOs is expected to triple by year’s end.

But one of the biggest IPOs in history – not just in energy, but in the entire market – is scheduled to take place next year… Saudi Aramco.

And the implications are staggering.

In fact, one of the reasons OPEC agreed to production cuts was to aid in boosting Aramco’s IPO valuation. And it’s a central piece of Saudi Arabia’s government.

As the world’s largest oil company, Saudi Aramco pumps more oil per day than the entire U.S. oil industry combined.

And it’s sitting on the second-largest oil reserves in the world…

Saudi Arabia wants the company to go public with a $2 trillion valuation.

That means selling the proposed 5% stake would need to raise $100 billion… which is more than four times the largest IPO to date, Alibaba (NYSE: BABA) in 2014.

And that’s not so far-fetched.

Already, Saudi Arabia can produce oil at an enviably low level – less than $10 per barrel. And it has 261 billion barrels in reserves. That would give Saudi Aramco a valuation of $2.6 trillion.

But, again, the Aramco IPO has much larger implications.

International crude is trading around $50 per barrel. So you’d think the Saudis would be making money, since it costs them just $10 to produce it… But they aren’t.

The biggest problem with the OPEC countries and their economies is they’re focused on pretty much just one thing – oil or natural gas.

Nothing else contributes to their growth… or is taxed for revenue.

So Saudi Arabia – even though it produces oil at less than $10 per barrel – needs to sell it for $86 per barrel. And that’s just to keep the kingdom’s budget balanced.

In 2015, Saudi Arabia ran a deficit of $98 billion – all because it’s completely dependent on the price of oil…

Now, you might think the U.S. government is a large, nebulous and inefficient employer… especially the U.S. Postal Service.

But 70% of Saudi nationals are employed by the kingdom’s government.

On top of that, government workers earn 1.7 times their counterparts in the private sector… And the private sector is dominated by foreign workers.

The citizens rely on the government.

And Saudi Aramco is the largest source of government revenue.

So its IPO will determine the trajectory of Saudi Arabia’s future.

That’s why Saudi Arabia and OPEC (outside of Iran) will do everything they can to make sure it succeeds.

If the IPO does well, Deputy Crown Prince Mohammed bin Salman’s political capital increases. And Saudi Arabia can focus on quickly diversifying its economy, which is the main piece of the kingdom’s Vision 2030 program.

The Saudi economy has grown at an annual rate of 4% for the past 25 years. It’s now one of the 20 largest economies in the world. But it wants to be in the top 15 by 2030. To grow further, it’s privatizing state-owned assets and looking beyond the oil patch for growth.

The Saudi Aramco IPO is the first step in this process. And stakes are high.

The Most Secure Dividend in the World?

Saudi Arabia’s government is doing everything it can to ensure the Aramco IPO’s success.

This week, the kingdom slashed the oil giant’s income tax rate.

The tax rate on Saudi Aramco’s profits was a staggering 85%. Again, it’s the engine that runs the kingdom’s economy, so no big surprise there. But this rate was cut to a more manageable 50%.

This also brings Saudi Aramco’s tax rate more in line with international benchmarks.

More importantly, it means Saudi Aramco’s net income increases by 300%.

Plus, its per-barrel profits will then be comparable to those of other international oil majors like Exxon Mobil (NYSE: XOM).

The move also frees up cash flow.

This is a bigger deal than it might seem. It enables Saudi Aramco to offer a higher dividend. This is a central tenant to attracting investors and making sure that $2 trillion valuation is hit.

Now, here’s where things get interesting… Approximately 60% of Saudi government revenue comes from taxes on oil production. So slashing the tax rate of Saudi Aramco’s income creates a huge gap.

Saudi Aramco still pays a 20% royalty on revenue to the Saudi government, which won’t change.

But freeing up Saudi Aramco to pay a higher dividend is extremely important because the kingdom plans to replace the reduction in taxes with dividend payments.

Naturally, the Saudi citizens raised concerns when the Saudi government announced that it was dramatically reducing taxes on its primary source of income…

But the kingdom is assuring people that what it’s losing in taxes, it’s making up for in dividend payments.

Talk about dividend security!

But this move by Saudi Arabia will open its economy to international investors. And it will enable the kingdom to diversify away from crude and hydrocarbons.

One of the final moves left to prepare for the Saudi Aramco IPO is for the Saudi government to decide how investors will be taxed on shares. And then where to list… because all exchanges in the world are fighting for the opportunity.

Good investing,

Matthew