MUCH TO NOTE

Saudi Arabia 2017 | FINANCE | REVIEW: CAPITAL MARKETS

As Saudi Arabia gears up for the Aramco IPO, the largest such offering in history, investors are discovering that there is far more to the Saudi markets than meets the eye.

In April 2016, Deputy Crown Prince Mohammed bin Salman disclosed the Saudi Vision 2030 plan, a road map that lays down the strategies for a historic transformation of the Kingdom's economy to reduce its dependency on oil exports and modernize its capital markets by opening it up to international investors. Over the last four years, Saudi Arabia's capital markets have been marked by turbulence. A period of high investor confidence gave rise to several IPOs between 2013 and 2015, but this was followed by a period of depressed markets impacted by the fall in crude oil prices in 2016. Market turnover reached SAR20 billion (USD5.3 billion) a day and then dipped to under SAR2 billion (USD533 million) within just a couple of years, during which period the price of a barrel reached USD100 and then fell below USD30.

With the objective of increasing FDI to 5.7% of GDP by 2030 from the current level of 3.8%, the Saudi Stock Exchange (Tadawul) was first opened to foreign investors in 2015, with a set of regulations that defined a Qualified International Investor (QFI). The criteria were later eased to be effective as of the second half of 2017. Accordingly, a foreign institution will be able to register as a QFI if it manages global assets of a value of at least USD1 billion, down from USD5 billion under the previous regime. QFIs will be able to own up to 10% in a single stock (up from 5%), if allowed by the listing rules, and up to 49% of the capital of a listed asset will be open to foreign investors (up from 20%). Moreover, as the Tadawul is currently expanding the scope and variety of its traded instruments, QFIs are thus able to invest in not just shares but also exchange traded funds (ETF), bonds and mutual funds, and real estate investment trusts (REIT).

Introducing small caps into the market

Recognizing that SMEs are the most important agents of growth, the Kingdom's Vision 2030 sets the target of SMEs' contribution to the GDP to 35%, up from 20%. As a result of this strategy, in February 2017, Tadawul launched a parallel market called Nomu, announced as an alternative trading platform with a lighter set of rules for smaller companies, many of which are Saudi family businesses. For companies to list on Nomu, they are required to have a market value of at least SAR10 million (10 times smaller than what is required in the main market), a minimum of 35-50 shareholders, and at least 20% of shares publicly owned. Nomu will also open to QFIs. Al Hassan Goussous, CEO of Albilad Capital, told TBY in an interview that the number of listed companies is expected to explode: “It will happen because the second market will encourage these investors. First, for family businesses to give up 30% of their company is quite significant. The second market says 20% is enough; it does not want to deal with thousands of shareholders. For the second market, the minimum number of shareholders required is 50, so it will get them used to being listed. Do not forget that the government actually wants to do this. There are going to be quite a few government entities that will list—they are ready to list and they will list. That is part of the reason I say Vision 2030 is a gift to investment bankers.”
Alistithmar Capital CEO Hesham Hussain Abou Jamee explained to TBY that although the opening of Tadawul to QFIs was expected to boost liquidity, reduce volatility, and improve corporate governance practices in the corporate sector, the unfavorable economic and geopolitical scenario has not allowed the translation of these prospects into reality. However, he firmly believes that sooner or later we will witness the positive impact when QFIs start entering the market in visible numbers. He added that, “An increase in liquidity and reduced volatility will also encourage small and mid-cap companies and family business houses to expand their capital base and business by listing on the exchange. In fact, as the Tadawul will list these small and mid-cap companies in the alternative market, it will eventually prepare them to migrate to the main market.”

Privatization as an essential Vision 2030 program

One of the main programs announced in the Vision 2030 plan is the “Privatization Program.” HSBC has predicted that Saudi Arabia's privatizations will likely result in about 100 new IPOs in various sectors, including mining, healthcare, and retail. But what the investment banking world has been waiting for is the privatization of Saudi Aramco through the floating of up to 5% of shares in what is expected to be the world's largest IPO, in late 2018. It is estimated that the operation will raise USD100 billion, although the valuation of the company will need to be established once engineering studies reveal oil reserves and the cost structure of the oil giant. Nevertheless, the privatization is expected to create the necessary resources that will be used to diversify the economy through the Public Investment Fund (PIF), a move that will help achieve the 2030 target of non-oil government revenues to rise from SAR163 billion (USD43.4 billion) to SAR1 trillion (USD267 billion).

REITs

REITs are among the new financial instruments introduced into the Saudi capital markets as a means to diversify the economy and support liquidity and depth in the equity market. Saudi Arabia introduced its first REIT laws in October 2016, indicating a minimum trust size of SAR100 million, with at least 75% of the assets invested within the Kingdom. Three REITs have already been listed on the stock exchange: the Riyadh REIT, Al Jazira Mawten REIT, and more recently the Jadwa REIT Alharamain Fund.

CEO Abou Jamee of Alisthitmar Capital told TBY about the potential that REITs represent for the sector: “Our funds are among the top-three performers of the last two years, strengthened by the fact that we launched two equity and two real estate funds last year. We have launched a new fund of about USD133 million for a 40-floor luxury, high-end building with sky-villas, penthouses, and apartments in Al-Khobar. It will be first-of-its-kind project in the Kingdom, right on the Arabian Gulf's shoreline.”

REITs are thus a powerful tool for the development of the real estate sector by opening it up to small investors, thus contributing to the Kingdom's target of boosting the non-oil sector while addressing the current housing shortage in Saudi Arabia.

Debt Markets

In October 2016, Saudi Arabia's sovereign debt issuance reached USD17.5 billion, with the biggest emerging market bond issue to date. The bond issue was oversubscribed as demand reached USD67 billion, suggesting the potential of both the sovereign and corporate bond market for the region. The phenomenal demand reflected the global appetite built up in a world of negative bond yields. The Kingdom was thus able to address a budget deficit that reached 16% of GDP in 2016 resulting from the collapse of oil prices. The success of the operation suggests that the region will be able to attract more debt capital in the future, both sovereign as well as corporate.

Reaching out to global markets

For Goussous, this is just the beginning of a diversification trend of financing tools for private companies as more and more companies will look into capital markets for financing needs, and not only because of low oil prices: “This is a natural progression for any economy, as we are moving from an emerging market to a semi-developed and developed market. Many companies were dependent for their financing on just traditional banking facilities and that cannot sustain any growing economy. Large and small companies need to move away from just banks, so they will need to go through the various financing sources. They are either going to need to become a public company so they can add capital and invest, or they will probably need to go with their sukuk.”
As the Kingdom implements necessary regulatory reforms to bring the market up to international standards of governance and transparency, such as the proposal of a new Bankrupcy Law that will support the Vision 2030, the possible inclusion of the Tadawul in the MSCI Energing Markets Index in 2018 will trigger the awaited inflow of international funds.

Although the impact of these reforms will only be felt in the medium term, the leadership behind the new strategic direction has been well perceived by investors, as testified by Alistithmar Capital's Abou Jamee: “It is also evident for the last several months that the capital markets seem to be finally disassociating from the volatility in oil prices. This to me is very positive. The Saudi leadership is committed to reducing the dependence of the economy on oil; the Saudi Vision 2030 clearly lays the path for the vision. The market, in my opinion, has also recognized this change.”