After decades in which it hardly figured on the business horizon, tax is suddenly becoming a big issue in the Arabian Gulf.
Not only are minds being concentrated over the introduction of value-added tax (VAT) at the beginning of the next year, but we saw earlier this week how matters of tax policy can drive global investor sentiment – and media coverage – with the announcement of a new tax regime for Saudi oil companies.
Although it was not mentioned specifically in the announcement, most of the attention was focused on the repercussions of the change for Saudi Aramco, the national oil producer that is being lined up for an initial public offering (IPO) on global stock markets some time next year.
The new regime would reduce the tax rate on Aramco from 85 to 50 percent, which is much more in line with the international standards. The move represents a normalization of tax treatment in the Kingdom and an essential step in the initiative to transform the national economy away from oil dependence.
But, for a measure that would seem to be of interest to a limited number of people mainly within the tax accounting profession, this one generated an enormous number of headlines, most of them begrudgingly positive. That is a change in itself.
Unprecedented financial consequences: Ever since the IPO was first suggested, with a valuation of as much as $2 trillion put on Aramco, a lot of commentators have been looking for reasons as to why it would not happen, or why if it did, it would not reach anything like that kind of value.
Nothing is set in stone yet, and no official estimates have been issued, but if Saudi Arabia privatized just 5 percent of Aramco valued at $2 trillion, that would be by far the biggest IPO in history, releasing $100 billion of equity onto Saudi and other global markets. It would be an event of unprecedented financial consequence.
As the cornerstone of the strategy contained in the National Transformation Program (NTP) 2020 and the Vision 2030 policy documents, it has also been regarded as essential to economic change in the Kingdom.
Valuation skeptics: Skeptics were quick to argue with the valuation. It could only be reached if the Aramco holding company and its reserves were the subject of the IPO, they said; it would face opposition from within the Kingdom, it was suggested, and it would be impossible to implement because of the loss of tax revenue it would represent to the Saudi government. All those issues are being steadily addressed, and the announcement this week settles the last problem in a stroke. Reducing the tax take will certainly cut government revenue, but it will replace it with a steady stream of valuable dividends once the IPO is complete.
By most calculations, the effect on government revenue will be fairly neutral, with incoming dividend balancing out the tax revenue foregone. As one hard-nosed commentator puts it: “The beauty of this plan is that it will leave Riyadh barely out of pocket.” The big difference the change brings is on the bottom-line earnings of Aramco. By cutting the tax bill, the crucial line in the profit and loss account labeled “earnings per share” will get an enormous boost. This is the accounting item that is used as the basis for share valuations, and hence market capitalization.
The sound of financial estimates being revised upward was almost audible. Last month, the most pessimistic of the estimates so far put a value of $400 billion on Aramco, mainly because of difficulties in valuing reserves as well as the tax issue. The IPO would have pulled in a meager $20 billion – hardly worth the bother. After the tax change, nobody was anywhere near that lowly range at all. Virtually all were upward of a total market capitalization well in excess of $1 trillion, with many as high as $1.5 trillion.
Pricing in the oil price: Of course, much depends on the oil price at the time of the IPO. Some forecasts see it reaching $75 a barrel by the end of 2018, which could put a minimum valuation of $1.4 trillion on Aramco and an IPO value of $70 billion. Reuters reported that one energy consulting firm, Sanford C Bernstein of London, believed the size of Aramco oil reserves – bigger than most others in the world – could enable it to hit the $2 trillion valuation with ease, though that estimate did not weigh political risks.
There is a long way to go in the Aramco IPO story, and there will be plenty of twists and turns. But for the moment the tax reform has swung the pendulum back toward the higher end of the valuations for this transformational transaction. There are plenty of other reforms the Saudi government can initiate to enhance the value of this crucial transaction. The lesson is that the industry “experts” should not jump to conclusions before they are aware of all the facts.