TheChek News Flow

Valuation and foreign investor demand will be a big test for Riyadh

For nearly four years Saudi Arabia has been dangling the promise of offering investors a chance to buy into the world’s most profitable company. On Sunday, it made a significant step towards delivering as officials sought to put aside questions over Saudi Aramco’s valuation to formally announce the kingdom’s intention to list the state oil giant.

The launch of the initial public offering process for Saudi Aramco in Dhahran was marked by a hard sell to Saudis who might be keen to have a slice of a national champion as well as foreign investors who are more sceptical about how Riyadh values the state energy company.

Amin Nasser, Saudi Aramco’s chief executive, told reporters, that an investment in the company was a unique opportunity. He emphasised the company’s access to some of the world’s most prolific oil reserves, low-cost barrels, as well as Saudi Aramco’s expansion plans into gas and chemicals. The company also lauded its low debt levels.

“It’s a historical moment,” he said. “Our mission is to provide our shareholders with long-term value creation through crude oil price cycles by maintaining our pre-eminence in oil and gas production.”

Although Saudi Aramco did not disclose how much of the company would be sold or how much money the kingdom planned to raise, people familiar with the IPO process have said Saudi Arabia could offer up to 3 per cent on the domestic Tadawul exchange and could raise as much as $60bn.

If all goes to plan, the prospectus will be released on November 9 with the listing in December.

Yet questions continue to hang over the company’s valuation and people briefed on the process say the kingdom could still halt listing plans at a later stage.

Crown Prince Mohammed bin Salman, for whom the IPO encapsulates plans to overhaul the country’s economy, has long advocated Saudi Aramco’s worth of at least $2tn. The proceeds are to be ploughed into the Public Investment Fund — the sovereign wealth fund spearheading his economic diversification plans.

“I believe it will be $2tn, above $2tn . . . it will be huge,” he told Bloomberg a year ago.

While some bankers and analysts have said $1.2tn-$1.5tn might be more realistic, others who secured work on the IPO have higher estimates. But people close to the IPO process have pushed to moderate the young prince’s valuation ambitions closer to $1.75tn in recent days, three people briefed on the matter have said.

Another person said Prince Mohammed has come to terms with the fact the market will determine the valuation and the success of his wider economic reforms are more important than securing a set target.

The valuation conundrum has been the core reason why the IPO, originally planned for 2018 has been repeatedly delayed, and why initial ambitions for a mega-listing at home and abroad have been scaled down to a domestic flotation for now.

A big test for the Riyadh listing, will be the level of foreign investor demand for the company that pumps one in eight barrels in the world but will expose them to the political risk of investing in Saudi Arabia.

“I’m confident there will be ample local retail participation because it’s the crown jewel and there’s a sense of national pride in Saudi Aramco,” said a senior banker. But, the banker added, “it’s important to have global demand for the IPO.”

Foreign institutions have raised concerns about state interference, governance and geopolitical risks that were underlined after drone and missile attacks on Saudi Aramco in September temporarily knocking out half the kingdom’s production.

Last year Saudi agents murdered journalist Jamal Khashoggi, triggering the kingdom’s biggest diplomatic crisis in years. A year earlier Prince Mohammed launched a crackdown on corruption that led to some 300 business tycoons and princes detained.

In a document outlining Saudi Aramco’s formal intention to float, the company showcased its earnings potential. After reporting net income of $111bn in 2018, latest figures showed Saudi Aramco earned $68bn in the first nine months of this year.

The kingdom has changed royalty rates, in an attempt to bolster Saudi Aramco’s valuation. Then on Sunday the oil company disclosed it would only pay a 20 per cent tax rate on its refining and chemicals business next year, down from a 50-80 per cent range.

Dividends too were in focus. After disclosing plans in September to pay at least $75bn annually, in an effort to woo investors, Saudi Aramco said on Sunday this could be even higher once you factor in any special payouts. The company has also said it would prioritise non-government shareholders in an unprecedented move.

An offer to boost the $75bn annual dividend to $80bn would, at an $1.8tn valuation, lift the expected yield for investors up to 4.4 per cent, roughly on par with the global average of listed oil firms’ yields, according to Tarek Fadlallah, regional chief executive of Nomura Asset Management.

“That might be enough to get it over the line,” he said.

Saudi Aramco confirmed plans to cut long-term capital expenditure, first reported by the Financial Times. Saudi Aramco expects to spend $35bn-$40bn in 2020 and up to $45bn the year after. Had Saudi Aramco continued with its prior ambitions, spending would have hit at least $55bn-$60bn, two people said.

The company also revealed the terms of its acquisition of petrochemicals giant Sabic, with 36 per cent of the $69bn consideration to be paid in cash on completion next year and the balance to be paid in promissory notes over six years.

It has sweetened the deal for investors at home as well. Retail investors in the kingdom will be permitted to receive one bonus share for every 10 if they hold the shares continuously for 180 days after the first day of trading.

“We want to share the Saudi Aramco shares with the citizens of Saudi Arabia,” said Yasir al-Rumayyan, chairman of Saudi Aramco. He added: “We want to get financial investors from all over the world.”

When asked about the timing of the IPO and what has prompted the urgency for a listing this year, Mr Rumayyan said: “The question could be: Why not now? . . . This is the right time for us.”

To bring a successful criminal case, investigators must prove Boeing repeatedly concealed or ignored engineering problems

Federal prosecutors would face a daunting challenge in mounting a criminal case against Boeing Co. BA 1.55% or its employees, legal experts said, even with evidence showing workers sounded alarms about the 737 MAX’s safety and a company pilot’s chat messages suggesting he misled regulators.

The Justice Department launched a criminal probe after Lion Air Flight 610 crashed in Indonesia in late 2018, killing 189 people, and continued after Ethiopian Airlines Flight 302 went down in Ethiopia, killing 157 people in March. It has focused on whether Boeing cut corners at the expense of safety in developing the 737 MAX and whether the plane maker provided misleading or incomplete information to airlines or regulators, said people familiar with the matter.

To bring a successful criminal case against Boeing itself, prosecutors would have to show that executives repeatedly concealed or ignored the 737 MAX’s engineering problems, experts said. And there is a larger economic and political component: A corporate indictment and potentially huge sanctions must be balanced against the economic and national-security risks of incapacitating the country’s second-biggest defense contractor behind Lockheed Martin Corp.

Boeing’s defense division backlog stood at $62 billion as of Sept. 30, much of that reflecting U.S. orders.

“The government can’t lose a company like Boeing as a defense contractor,” said Brandon Garrett, a Duke University law professor.

A Justice Department spokesman declined to comment for this article.

Lawmakers have added to Boeing’s pressure. On Wednesday, a House panel revealed internal Boeing documents suggesting engineers had weighed whether a 737 MAX flight-control system needed an additional safeguard and didn’t adhere to the company’s own standards in designing the feature. They also unveiled a senior plant manager’s email warning of safety risks related to ramping up production of the best-selling jet.

Boeing executives told lawmakers they addressed employees’ concerns, arguing the company’s culture supports discussion of safety matters. House investigators are waiting to talk with Boeing employees until after they are interviewed by prosecutors, congressional officials said.

A Boeing spokesman declined to comment about the Justice Department’s criminal probe, and the company has said it is cooperating with all government inquiries. Boeing, which hasn’t been accused of any wrongdoing, has said its highest priorities are safety, quality and integrity.

Unlike some countries in Europe and Asia where extensive criminal probes often follow major airliner crashes, the Justice Department has seldom ever prosecuted an aviation company following an airline accident, much less secured a conviction. Most corporate defendants are small privately held businesses with fewer than 50 employees, said William Laufer, a University of Pennsylvania professor of legal studies and business ethics.

In 2017, Japanese automotive supplier Takata Corp. admitted to providing misleading testing reports to auto makers on rupture-prone air bags, actions the company’s financial chief acknowledged were “deeply inappropriate.” Takata paid $1 billion in penalties. That same year, Volkswagen AG pleaded guilty to criminal charges for cheating on government emissions tests.

The 2002 Enron-related conviction of accounting firm Arthur Andersen led to its collapse, but most large companies prosecuted are able to survive and eventually rebound. Arthur Andersen’s conviction was overturned by the Supreme Court three years later.

In 2014, Toyota Motor Corp. faced claims of misleading consumers about safety problems, and JPMorgan Chase Bank faced allegations that it failed to alert authorities about Bernard Madoff’s massive Ponzi scheme. Those cases ended with deferred prosecution agreements.

Federal prosecutors can bring charges, secure a plea or negotiate sanctions in lieu of an indictment.

“What investigators scrutinize is the conduct, its duration, possible motives, roles and knowledge of the actors, and evidence of concealment to determine whether the conduct is an aberration or systemic,” said Jacob Frenkel, a white-collar defense lawyer in Washington, D.C.

Boeing has been the target of major federal criminal probes in the past, which will factor into the Justice Department’s decision-making, according to federal guidelines.

In May 2006, Boeing agreed to pay more than $600 million to end a three-year Justice Department investigation into alleged contracting and ethical lapses. At the time, prosecutors called it the largest financial penalty imposed on a U.S. military supplier for weapons-program improprieties.

The government agreed to forego criminal charges against the company or its officials, thus shielding Boeing from a suspension or cutoff of Pentagon or other government contracts. The company agreed to stepped-up federal monitoring of its contracting activities.

Authorities can also waive exclusions and suspensions or lift a contracting ban entirely, as in the case with Siemens AG . In 2008, the German engineering company settled charges it engaged in massive foreign bribery and paid an $800 million in criminal penalties.

The lead agency for U.S. federal government contracts issued a formal determination that Siemens remained a “responsible contractor” for U.S. government business.

In the Boeing probe, federal investigators for months have been interviewing former Boeing employees, gathering information from the manufacturer and airlines, and querying officials at unions representing the carriers’ pilots, the people familiar with the matter said.

At least some of the questioning has included Brian Kidd, a prosecutor who supervises the market integrity and major frauds unit in the Justice Department’s criminal division, some of these people said. Mr. Kidd was one of the lead prosecutors in the Takata case.

Barron’s Weekend Summary: Cover story says China’s domestic market is enormous and growing rapidly, fueling demand in a range of sectors; positive features on FCAU/PGA merger; cautious on PCG

(Saturday): Democratic presidential contender Elizabeth Warren unveiled a plan to pay for an expansive transformation of the nation’s health care system, proposing huge tax increases on businesses and wealthy Americans to help cover $20.5T in new federal spending; A New York Times/Siena College poll of likely found that Elizabeth Warren has the lead in the 2020 Iowa caucus, followed by Bernie Sanders, Pete Buttigieg, and Joe Biden, who has lost ground though he still leads in most national polls; Barney’s, the iconic New York department store, will be sold for parts—Authentic Brands Group will take control of the name and license it, while the five stores and two Warehouse locations will hold private sales before liquidating; Tens of thousands of Iraqis, with support from Shiite religious authorities and the country’s president, gathered in the center of the capital on Friday in the largest of a month’s worth of antigovernment protests; A Russian official said there would not be enough time to replace the New Start treaty—the last and most important nuclear arms-limitation treaty with the U.S.—before it expires early in 2021, leaving Washington and Moscow free to expand their arsenals without limits; A toxic, throat-burning cloud has settled over New Delhi, India’s capital, sending people to emergency rooms and prompting officials on Friday to declare a public health emergency and close schools; Trump will name Chad Wolf to be the next acting secretary of the Department of Homeland Security, the fifth person in the administration to lead the agency, and plans to nominate Dr. Stephen Hahn of the University of Texas to be the next FDA commissioner; The Committee on Foreign Investment in the United States opened a national security review of Chinese company ByteDance’s acquisition of the American company that became TikTok, the hugely popular short-form video app;

(Sunday): Every year, the 28-country European Union pays out $65B in subsidies to support farmers and keep rural communities alive, but across Hungary and much of Central and Eastern Europe, the bulk goes to a connected and powerful few, enriching politicians and emboldening strongmen and their corruption; Nearly two decades after 9/11, polls show that a majority of veterans are disenchanted with the continuing wars even as the national security elite continues to wage them, and are increasingly supporting Trump because of his campaign pledge to end ongoing conflicts; British prime minister Boris Johnson, once a supporter of fracking, will now order a halt to it after government energy authorities couldn’t rule out the possibility of consequences such as pollution risks and earthquakes; Gary Jones, the president of the United Automobile Workers union, which is under investigation over allegations of financial wrongdoing, is taking a leave of absence; Sunday Business: Story reports on the negotiations between NFLX and major theater chains over the release of Martin Scorsese’s new film, “The Irishman,” noting the streaming giant refused to allow theaters more than 45 days of exclusivity, as opposed to the 72 days they usually require.

WSJ (Weekend):

Front page story reports that while XOM, Royal Dutch Shell, and BP have long used hefty and reliable dividends to keep investors on board in a sector with volatile profits, the payouts are starting to strain their balance sheets; In the U.S., job growth remains strong in areas of the economy such as healthcare and hospitality that serve U.S. consumers and are generally shielded from global trends and trade disputes; The Department of Health and Human Services will no longer require organizations that get billions of dollars in federal grants to comply with rules that ban discrimination on the basis of sexual orientation; House lawmakers have called departing energy secretary Rick Perry to testify in the impeachment investigation, adding another key player in the Trump administration’s interactions with Ukraine to the witness roster; Former representative Beto O’Rourke announced he will drop out of the Democratic presidential race after failing to catch fire with voters in a crowded field; Syrian President Bashar al-Assad regained control over much of his country with the help of Russia and Iran, and is now set to take back much of the rest, in large part because of Donald Trump’s decision to withdraw troops; China will increase efforts to integrate Hong Kong with the mainland by strengthening patriotic education and retooling the city’s political and economic system, amid continuing protests against Beijing’s growing influence; Story profiles Jim Simons, a pioneer in the use of quantitative analysis who has outperformed the biggest names in the investment world over the past three decades—even after deducting investor fees that are much higher than those of rivals; The Trump administration is expected to announce next week that it will order the removal from the market all e-cigarettes except those that taste like tobacco and menthol; +/- PCG: California governor Gavin Newsom is threatening a state takeover of the troubled utility unless it exits bankruptcy and dramatically improves the safety of its electric grid before the next wildfire season; related story says insurers are likely to remain cautious about covering California homes and businesses in wildfire-prone areas, and more homeowners are likely to receive nonrenewal notices in the months ahead; H.O.T.S.: China is less corrupt than it once was, but it is also growing slower, which may not be a coincidence; Google’s acquisition of FIT could be risky given how big tech companies are under intense government scrutiny for their scale and influence; U.S. corporations may be hiring, but they are offsetting that by reining in costs on other fronts.

FT (Weekend):

Malaysia rejected an offer from GS of less than $2B as compensation for the 1MDB scandal, with prime minister Mahathir Mohamad holding firm in his demand for $7.5B; Japan is warning about the growing strength of China, and is seeking to maintain its security against China’s military might while avoiding becoming a proxy for a U.S. confrontation with Beijing; Big Read piece says UK prime minister Boris Johnson’s election strategy requires Conservatives to pick up Labour seats in depressed working class areas of the West Midlands and the North, but voter volatility is higher than it has been in decades; Lex Column: In the UK, Labour leader Jeremy Corbyn is unlikely to win power, and even if he does, he would struggle to reshape business as widely as promised; PINS, like other U.S. peers that have pioneered in China, wants to turn to e-commerce and other features to boost revenue; Nintendo investors’ hopes that moving into China will offset the company’s structural problems are overdone; Comment: The impeachment of Donald Trump “will probably electrify an electorate that is already on edge and leave it feeling even more divided,” says Lloyd Green, who says the move will be “a repeat of Brett Kavanaugh’s confirmation hearings on steroids.”

NY POST

(Saturday): +/- NKE: A debate has emerged about whether the company’s new high-tech Vaporfly shoes gave runners in the Vienna and Chicago marathons an unfair advantage; Hedge fund mogul Ken Fisher is launching an advertising campaign that showcases female employees to clear up his firm’s image after a scandal about lewd remarks he made about women he made at a conference;

(Sunday): The record debt U.S. consumers are ratcheting up—the current level is more than $14T—is propelling a rise in mental illness and widespread emotional distress, according to experts; Increasing numbers of American workers expect to be career freelancers, driven by a strong economy, low unemployment rates and the younger generation’s embrace of technology. - Source TradeTheNews.com

Hungarian central bank governor calls for an exit mechanism

The time has come to seek a way out of the euro trap. There is a harmful dogma that the euro was the “normal” next step towards unifying western Europe. But the common European currency was not normal at all, because almost none of the preconditions were met.

Two decades after the euro’s launch, most of the necessary pillars of a successful global currency — a common state, a budget covering at least 15-20 per cent of the eurozone’s total gross domestic product, a eurozone finance minister and a ministry to go with the post — are still missing.

We rarely admit the real roots of the ill-advised decision to create the common currency: it was a French snare. As Germany unified, François Mitterrand, then French president, feared growing German power and believed convincing the country to give up its Deutschemark would be enough to avoid a German Europe. The chancellor of the time, Helmut Kohl, gave in and considered the euro the ultimate price for a unified Germany.

They were both wrong. We now have a European Germany, not a German Europe, and the euro was un­able to prevent the emergence of another strong German power.

But the Germans also fell into the trap of the “too good to be true” euro. The inclusion of southern European economies in the eurozone led to an exchange rate that was weak enough to allow the Germans to become the strongest global export machine in the EU. This windfall opportunity made them complacent. They neglected to upgrade their infrastructure or to invest enough in future industries. They missed the digital revolution, miscalculated the emergence of China and failed to build pan-European global companies. At the same time, companies like Allianz, Deutsche Bank and Bayer launched fruitless efforts to conquer Wall Street and the US.

Most eurozone countries fared better before the euro than they did with it. According to analysis by the Centre for European Policy, there have been few winners and many losers in the first two decades of the euro.

The common currency was not needed for European success stories before 1999 and the majority of eurozone member states did not benefit from it later. During the 2008 financial crisis and the 2011-12 eurozone economic crisis, most members were badly hit, having piled up huge government debts. There is no free lunch and cheap loans often cost a lot later.

Alexandre Lamfalussy, the Hungarian-born economist, was right to tell us that a common currency was needed to strengthen the bond between European powers and defend the EU against the Soviets. There is only one snag: the final decision to create the euro was made in Maastricht in 1992, as the Soviet Union collapsed. The raison d’être of the currency ended precisely as it was being born.

The time has come to wake up from this harmful and fruitless dream. A good starting point would be to recognise that the single currency is a trap for practically all its members — for different reasons — not a gold mine. EU states, both in and outside the eurozone, should admit that the euro has been a strategic error. The aim of building a global western currency that vies with the dollar was a challenge to the US. The European vision of a United States of Europe has resulted in both open and hidden US warfare against the EU and the eurozone in the past two decades.

We need to work out how to free ourselves from this trap. Europeans must give up their risky fantasies of creating a power that rivals the US. Members of the eurozone should be allowed to leave the currency zone in the coming decades, and those remaining should build a more sustainable global currency. Let’s celebrate the 30th anniversary in 2022 of the Maastricht treaty that spawned the euro by rewriting the pact.

The writer is governor of the Hungarian National Bank

Decision by Apollo, Blackstone and others to switch from partnership to corporation status pays off

The shares of America’s biggest private equity firms have soared, swelling the fortunes of moguls such as Leon Black and providing them with firepower for deals after their decision to pay tens of millions of dollars a year in extra taxes by switching from partnership to corporation status.

Mr Black’s Apollo Global Management has notched up gains of more than 25 per cent since May, when it joined rivals Blackstone, KKR and Ares in renouncing a tax-advantaged partnership structure that made it difficult for mutual funds and index trackers to own the firms’ shares.

Vanguard, one of the world’s biggest mutual fund managers, now ranks among the biggest shareholders of all four firms, which are trading near record highs.

The higher share price could open the door to more deals in which private equity firms use their own equity as currency for acquiring strategic assets. Just last week Apollo paid $1.6bn, mostly in its own shares, to nearly double its stake in its affiliated life insurance company, Athene Holding.

“We think we’re only in the middle innings in terms of realising the benefits of our . . . conversion,” Joshua Harris, Apollo’s co-founder, said last week. He added that the firm’s inclusion in the so-called CRSP indices had prompted Vanguard to buy nearly 13m shares.

Rising valuations have also delivered a windfall to an ageing generation of financial tycoons who pioneered the alternative investment industry in the 1980s and 1990s. Most retain large stakes in the firms they founded, even in what some industry insiders speculate may be the final years of their careers. 

Stephen Schwarzman, Blackstone’s founder, last year negotiated a suite of unusual retirement benefits, including the right to keep his office in the firm’s midtown headquarters and lifetime access to a car and driver — although the 72-year-old tycoon “has absolutely no intention of retiring”, the firm said at the time. 

Mr Schwarzman’s Blackstone shares are today worth about $12.5bn, having risen by roughly $3.5bn since the firm announced in April that it was abandoning its partnership status.

The dramatic share price appreciation vindicates what looked like a risky gamble as recently as last February, when Ares became the first listed private equity firm to announce plans to become a corporation. 

As partnerships, the firms were allowed to bypass corporate taxes on some of their earnings, instead passing the money directly to investors. But the tax-advantaged status came with heavy bureaucracy, forcing holders to file complex tax returns in multiple US states if they owned even a single share. 

After Congress approved tax cuts that slashed the levy on corporate earnings, executives concluded the tax relief was worth less than the share price appreciation they could expect if mutual funds began buying the stock.

The firms have been rewarded with “meaningful shifts in their shareholder bases,” said Devin Ryan, an analyst at JMP Securities. “And it’s still early days. Long-only and passive ownership is up significantly, they are being added to indices, with more to come, and investor interest more broadly is up.”

David Rubenstein’s Carlyle Group will become the last major listed private equity group to make the switch when it drops its partnership status in January. The firm’s shares have climbed by nearly one-fifth since it announced the move in July.

Commerce secretary says sticking points in first phase of negotiations could be resolved soon

Wilbur Ross, the US commerce secretary, said on Sunday that he was “quite optimistic” that remaining sticking points in the first phase of American trade talks with China could be resolved soon, adding that the countries’ leaders still planned to meet later this month. 

US president Donald Trump and Chinese leader Xi Jinping were on track to meet in November, Mr Ross said, although the venue was a “work in progress”, following last week’s scrapping of the planned Apec summit in Santiago during Chile’s recent unrest. 

“You won’t have a deal on anything until you have a deal on everything,” Mr Ross told the Financial Times in Bangkok, where he is part of a large delegation of US officials attending a summit of Asean, the regional grouping, and associated meetings with Asian and Pacific leaders. “But we are quite optimistic that the remaining issues for the phase one can be closed out.” 

Mr Ross said that Alaska and Iowa — the latter mentioned by Mr Trump on Friday in a tweet — were potential alternative venues for the talks, and that “some [countries] in Asia as well” might host them. 

For Asian countries, the focus is on progress over the Regional Comprehensive Economic Partnership, a proposed mega-trading bloc comprising the 10 Asean nations that would also include China, India, Japan, South Korea, Australia and New Zealand that has been under negotiation since 2012. 

Hopes that a final deal on RCEP would be reached at the Asean summit receded at the weekend as leaders of the 16 nations argued over last-minute details of the proposed agreement. India, which is wary of the repercussions of opening its market to Chinese goods, is among the countries pushing for concessions. 

Mr Ross said that the US, which has voiced scepticism about RCEP, thought there were “quite enough regional associations”. 

However, he denied Washington would reward countries that refrained from joining, or punish members of the new grouping. “We treat countries favourably even if they have trade pacts with other nations,” he said. 

On Monday the Americans will host an “Indo-Pacific Business Forum” in Bangkok, in which Washington will seek to present itself as an alternative business partner for countries living in China’s shadow that have questioned the financial, environmental and other costs of Beijing-backed projects. The US commerce secretary will travel to Indonesia and Vietnam later in the week. 

Mr Ross, along with Robert O’Brien, the national security adviser, are leading the US delegation to the Asean summit, which officials previously had said Mr Trump or Mike Pence, vice-president, might join. 

“This is a major effort on the part of the US government,” he said, rejecting some regional analysts’ view that American economic power is being eclipsed by China’s, and adding that 24 senior government officials were in Bangkok, including 15 US ambassadors and chiefs of mission.