On Dec. 11, the Saudi Arabian Oil Co., generally known as Aramco, officially became a public company. After many months of negotiations and planning, the Saudi state-run oil empire made its debut with a market capitalization of $1.2 trillion, which was below the $2 trillion it had hoped for.
Shares surged 10% during the first day of trading, officially making Aramco the most valuable public company in the world. The next day, the stock shot up again, delivering the desired $2 trillion valuation in the process.
At first glance, it would seem that Aramco has proven the investment bankers wrong. However, there is more to the stock surge than meets the eye.
Keeping a lid on supply
Saudi Arabia is familiar with the power of limiting the supply of certain assets. As a leading voice of the Organization of Petroleum Exporting Countries (OPEC), the world’s most powerful oil cartel, Saudi Arabia has worked for decades to keep oil production constrained in order to reap elevated profits through higher prices. Hence it should be a surprise to no one that Aramco has only permitted 1.5% of its total share count to trade publicly.
On the day of the initial public offering, the New York Times reported on how this artificial shortage of shares may result in upward pressure on Aramco’s stock for some time:
“Analysts say that in the short term, investors with buy orders for Aramco shares may find few sellers. Saudi small investors will be rewarded for holding the shares for six months, earning a bonus share for each 10 that they buy, up to a ceiling of 100 bonus shares, so they are unlikely to bail out soon. “It is not obvious who is going to be selling,” said Zachary Cefaratti, chief executive of Dalma Capital, a Dubai-based financial firm with three funds focused on Saudi Arabia. At the same time, Mr. Cefaratti said, fund managers who follow certain stock indexes would be under pressure to buy Aramco shares. MSCI, an index provider, for instance, plans to include Aramco in several stock indexes beginning Tuesday. An adviser on the I.P.O. estimated that such pressures could create $3 billion to $5 billion of new demand for the shares.”
A radically constrained float can have odd effects even on a company with a notional valuation as massive as Aramco’s. Indeed, as Javier Blas, Bloomberg’s chief energy correspondent, observed on Dec. 11, it does not take much to move this name:
“How much [does] it cost to move Aramco share price? No much. According to @TheTerminal data, Aramco saw a volume of ~31.6 million shares. Multiply by 35.20 riyals per share, and you get ~$297 million. So, $300 *million* caused a valuation upside of $188 *billion* as Aramco rallied 10%. Compared to other mega-cap companies, like Apple or Amazon, Saudi Aramco has a tiny free-float of just 1.5%, meaning that relatively small purchases can have an outsize effect on the valuation.”
Virtually every mega-cap stock has a far bigger float. This is even the case for companies still tightly controlled by their founders, such as Amazon.com Inc. (AMZN, Financial). Aramco is a true oddity, but that may end up working in its favor.
Harness the power of FOMO
Constrained supply may support Aramco’s stock for a while, but how far can it actually run? According to Bloomberg’s Matt Levine, that may depend on how susceptible international investors are to peer pressure:
“Maybe peer pressure and fear of missing out on a hot stock will work in Aramco’s favor, the way peer pressure and fear of catching a falling knife seem to have worked against Aramco in this round. If nobody’s paying more than $1.2 trillion for Aramco, it’s easy to refuse to pay more than $1.2 trillion for Aramco. Once it’s trading at $2 trillion—even debatably, even artificially—then it’s easier to say yes.”
The fear of missing out (or FOMO, as it is often abbreviated these days) can be a powerful psychological force. Sitting on the sidelines as the stock continues to climb may simply be too much for some fund managers and investors to bear.
Unproven IPO
Conceptually speaking, a publicly traded company’s valuation is determined by the market day to day. In other words, a company is worth whatever people are willing to pay for it. Matt Levine has applied this reasoning to Aramco with humorous effect:
“If Aramco goes public and trades at a $2 trillion valuation, then that’s a pretty good argument that it deserves a $2 trillion valuation. It’s not an airtight argument, and all of the objections that investors had to this IPO—the relatively low dividend yield compared to peers, the lack of transparency, the geopolitical risk, the fact that ‘nobody at Aramco could convincingly explain why Aramco deserved its $2 trillion valuation’— will still apply even if Aramco trades up to $2 trillion on a tiny float in a friendly local market.”
The valuation may end up justifying itself, at least for a while. Having gotten to the promised land of a $2 trillion valuation, we will likely see an expansion of the share float. This will gradually reduce the pricing pressure from constrained supply, but it may not matter once a higher valuation is set and accepted by the wider market.
Verdict
Constrained supply and rising FOMO present a powerful force to drive Aramco’s share price higher. Indeed, it is not difficult to envision that Aramco’s discounted initial public offering may actually end up being considered a roaring success.
Disclosure: No positions.
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