Saudi Aramco’s Acquisition of SABIC
By: Daniel Chen, Mia Johnson-Wright, Jakub Berkowski
Overview of the deal
On the 27th of March, Saudi Aramco announced that it would acquire 70% of SABIC’s shares from the Public Investment Fund of Saudi Arabia, who were advised by Bank of America, Goldman Sachs and Michael Klein. The transaction was valued at $69.1 billion and represented a further step in Aramco’s strategy to become an IOC, as well as prepare for a low-carbon future by reducing reliance on revenue from crude production. Aramco was initially supposed to pay 50% of the transaction outright in cash and the rest in two instalments. After several changes to the deal’s financing terms, it was finally agreed that PIF would provide a seller’s loan, to be paid over an extended period until 2028. However, the value of the transaction did not change from the initial agreement.
Company Details: Saudi Aramco
Saudi Aramco is the largest integrated oil and gas company in the world, leveraging KSA’s extensive base of almost 300 billion barrels of proven oil reserves. It specialises in the extraction and production of crude oil, as well as in refining and chemicals. Although it has been incorporated as recently as 1988, its origins date back to 1933, when the Saudi government has signed an oil concession with Standard Oil Company of California. As of Q3 2020, Aramco’s daily production was 12.3 million barrels of oil equivalent, making it the largest producer in the world. In December 2019, shares making up 1.5% of Aramco’s value started floating on TADAWUL, raising $25.6 billion in what became the world’s biggest IPO.
Headquarters: Dhahran, Saudi Arabia
CEO: Amin H. Nasser (since 2015)
Number of employees: 79,800
LTM Revenue: $222.0bn
LTM EBITDA: $132.0bn
LTM EV/Revenue: 9.0
LTM EV/EBITDA: 15.2
Advisors: J.P. Morgan, Morgan Stanley
Company Details: SABIC
SABIC is a multinational chemical manufacturing company, operating within four main areas: petrochemicals, agri-nutrients, metals, and speciality chemicals. It was founded by a royal decree in 1976 to enhance the value of crude production by utilising natural gas released during the process. Since then, it has become the world’s 4th largest chemical company by sales and 2nd largest publicly traded company in the middle east, with 30% of its shares floating on Riyadh-based TADAWUL.
Headquarters: Riyadh, Saudi Arabia
CEO: Yousef bin Abdullah Al-Benyan (since 2015)
Number of employees: 33,000+
LTM Revenue: $37.3bn
LTM EBITDA: $5.5bn
LTM EV/Revenue: 2.16
LTM EV/EBITDA: 14.6
This transaction presents itself as a follow-up to Saudi Aramco’s IPO, which plays into the diversification strategy pursued in Mohammed bin Salman’s Vision 2030 in an attempt to reduce Saudi Arabia’s economic dependence on oil. The acquisition of SABIC becomes especially pivotal during the COVID-19 pandemic, where declining global demand and price volatility of oil can be observed. The development of Saudi Aramco’s downstream operations not only enables downside protection from the current market environment but also provides access to SABIC’s strategic position in the petrochemicals industry.
Global oil demand has fallen by around 10% relative to last year, and Brent crude prices dropped from an average $64 a barrel in 2019 to only $42 this year. Since upstream’s share in Saudi Aramco’s revenue consistently amounted to approx. 65% in recent years, the low price environment poses a significant threat to the company’s profitability. On the other hand, petrochemical companies benefit from slumps in crude prices, since they are synonymous with lower feedstock costs and thus higher margins. It is important to mention that SABIC has already sourced its feed from Aramco prior to the deal, therefore no cost synergies will be realised. Additionally, petrochemicals are predicted to record the fastest growth in oil demand. As organic development of a presence in that lucrative market would take years and require extensive expertise, the acquisition of SABIC will accelerate Aramco’s downstream expansion and provide a source of resilient cash flows.
As the acquisition was financed through a seller’s loan - where PIF was the lender - Saudi Aramco has taken on an extensive debt burden. This was reflected in its gearing ratio, which surged from -4.9% to 20.1%, well above its target range of 5-15%. On the other hand, it has pledged a $75b dividend for 2020 to lure investors into its IPO. It seems like this decision has backfired, as the cash flow generated in H1 2020 was insufficient to cover the initial payout of $37.5b. The factors mentioned above strongly suggest that Aramco may not be too enthusiastic about splashing billions on new growth projects. We might be seeing some early indicators of that, as the long-announced $20 billion oil-to-chemicals complex, which was to be developed as a collaborative effort with SABIC, is now being reassessed and potentially downscaled.
Despite the recent technological progress in renewables and electric vehicles, not all sectors can become fully independent from crude. According to Amin Nasser, Saudi Aramco’s CEO, these constitute 80% of the demand for oil and gas. Therefore, it is only logical for the world’s largest crude producer to increase exposure to them. Acquisition of SABIC opens up an opportunity to secure a stable demand for crude to produce petrochemicals. Aramco plans to divert as much as 30% of its upstream production for this purpose, creating a cushion for reduced demand from industries embracing environmentally friendly alternatives to crude.
Although Aramco does demonstrate strength in research and development, it is limited to the upstream segment. Its 70% stake in SABIC yields massive technological gains considering SABIC’s impressive growth in research capability after its $11.6bn purchase of General Electric’s plastics business in 2007. This acquisition opened doors to plants in 35 countries and advanced research, giving rise to the 12,291 patents issued by SABIC as of today. Ultimately, this is yet another step in Aramco’s pursuit to compete with the world’s largest modern IOCs, following in the steps of key players such as BP, Total and Shell in their focus on natural gas and related products.
This acquisition also enables Aramco to capitalise on SABIC’s extensive experience in the technical sale of advanced chemicals. Considering the time requirements and financial implications of establishing a similar marketing organisation, access to SABIC’s intimate understanding of their clients’ technical needs could be seen as a significant cost synergy.
However, a more explicit example of cost savings can be realized with the rationalisation of production facilities and personnel. SABIC’s position in the manufacturing of industrial polymers such as HDPE, LDPE and LLDPE puts the necessity of some of Aramco’s affiliates into question. As a result, Aramco’s acquisition of SABIC is likely to cause the consolidation of the facilities and personnel of major joint ventures such as Sadara Chemical Company and Petro Rabigh, and cost synergies may be achieved through this. However, it directly conflicts with the economic objectives presented in the MBS Vision 2030.
The consequences of this deal span outside the companies’ business endeavours, as they both play a significant role in the economy of Saudi Arabia. SABIC has been initially acquired by the Public Investment Fund to reduce the kingdom's dependence on crude production. However, the Crown Prince’s Vision 2030 framework puts an even higher emphasis on diversification, as KSA still relies on crude for about 64% of its revenue. In light of that, the COVID-19 shock has been catastrophic to the Kingdom’s budget balance. Apart from an additional borrowing of $20b, public expenditure and investment were slashed, while value-added tax tripled. Faced with a fiscal strain on one side, and over $1.15 trillion of future projects in the pipeline on the other, the sale of SABIC will free up capital much needed to accelerate KSA’s transition from oil.
Risks and uncertainties
With the collapse of oil prices during the COVID-19 pandemic and amid geo-political tensions, Saudi Aramco saw a 25% decrease in first-quarter earnings, as demand for the commodity fell. Despite this considerable drop, we have seen Aramco remain committed to dividend payments, shelling out $18.8bn to shareholders in May after only earning $15bn in the first quarter of 2020, meaning that the company likely had to borrow in order to cover it. Following a seller loan provided by Saudi Arabia’s Public Investment Fund (PIF), Aramco has committed to making payments to cover the transaction, which will be fully paid off by 2028. Despite the continued commitment to dividend payments, clear attempts to conserve cash have been made, with Aramco announcing that they would be reducing capital spending by as much as $8bn from 2019’s $33bn expenses, to just $25bn. In conjunction with the massive decrease in income, this has a huge knock-on effect on Saudi Arabia’s oil-dependent economy. The initial deal, intended to inject cash into Saudi Arabia’s oil-dependent economy and create high-paying jobs for the Saudi people, this has meant that the country has been hard hit by the pandemic, triggering one of the biggest economic crises in Saudi Arabia and seeing the introduction of austerity measures in the country.
Another major concern for investors is Aramco’s strong relationship with the Saudi government, who remain as the majority shareholders within the company. The Saudi Arabian government's difficult foreign relations has proved to be particularly damaging, with Aramco facilities being targeted in terror attacks. This was seen on September 14th 2019, when Iranian attacks cut Aramco’s production capacities for a number of days, having a knock-on effect and diminishing Aramco’s IPO fundraising efforts, which saw only 1.5% of the company being floated on Saudi Arabia’s stock exchange, the Tadawul. This record-breaking IPO raised $25.6bn for the company, valuing Aramco at $1.7tn, despite the initial 2016 IPO announcement hoping to raise $100bn by floating 5% of the company on the Tadawul, thus valuing the company at $2tn. More recent attacks such as the Yemen Houthi rebel missile attacks in November 2020, which caused a fire in a fuel tank, remains an ongoing concern to investors, despite, in this instance, no cessation to oil production occurring.