The biggest family-run IPO in history

black and white arial photo of Riyadh, Saudi Arabia

I just returned from a trip to Saudi Arabia to check on existing investments and to explore the ever-changing macro backdrop there. The bottom line: change in Saudi Arabia is symbolized by the potential public listing of Saudi Aramco, an event that is similar to the IPO of a family-run company, but on a monumental scale.

Saudi Arabia turned inward in the late 1970s, in part due to terrorist attacks on the holy cities of Mecca and Medina, as well as the Islamic Revolution in Iran. The country shut off cultural and financial interaction with the broader world, with the exception of its oil exports. These generated enough cash to fund the Saudi business model: government handouts, subsidies and expat workers.

 

A seaport off the coast of the Red Sea in Jeddah, Saudi Arabia.
A seaport off the coast of the Red Sea in Jeddah, Saudi Arabia.

 

In effect, Saudi Arabia has been functioning like a large family-run company: the key positions were “family members” (i.e., princes), the accounting was less than transparent, and they conducted their business as they wanted – an approach that has been used for the past 35–40 years. A lot is changing: as the Minister of Finance stated at a recent conference in New York, when discussing the country’s new 5% value-added Tax (VAT), “setting this up was extremely difficult, as Saudi Arabia has no taxation system, so we had to build one from scratch.”

Two things changed Saudi Arabia’s dynamic: ever-rising subsidies and a falling oil price. As well, new technologies (shale oil extraction and electric vehicles) made the country’s younger leaders realize that if they wanted to protect the family business and legacy, they needed to modernize it, using global best practices, and to reinvest in their business, using funds from the global capital markets. In circumstances like this, many family businesses go public. In doing so, the families lose some control of the business, but they preserve it for the long term and retain an estate-planning vehicle for their future.

My meetings with the regulators, the stock exchange and some companies seeking to raise capital reflected this “family-run business” model: about half of each meeting was about the capital markets, how they work and what to expect. Simply put, the various parties are not used to global investors asking questions about their business model, why they use related-party companies for loans or how they plan to expand margins. Historically, the only questions they have had to address have been from the head of the family – the Crown Prince.

So, is this backdrop positive for global investors? Undoubtedly yes: in my 20 years of global investing, I have found that these opportunities tend to be very positive for patient investors. These opportunities allow investors to buy shares of good brands with strong market share that could grow aggressively with new capital. As well, if global best practices are used for cost management, we could see a strong surge in profitability, a more thoughtful allocation of capital and a greater emphasis on returns.

The frontier funds have a nearly 3% exposure to Saudi Arabian equities, and I hope to put more capital to work, given the new ideas I found on the trip. In any case, 2018 should be the most interesting year in Saudi Arabia in almost four decades.

Thanks for reading,

Adam Kutas


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