Friday, 20 July 2018

Kingdom dominates Saudi IPOs

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The IPO of Prince Alwaleed's investment firm Kingdom Holding Company was the biggest IPO in the Gulf this year. By Barry Marshall.

The Kingdom Holding Company IPO dominated the Saudi market, with an issue size of more than US$2bn met by just local demand as Saudi Arabia remains a closed market. It was 50% larger than any previous IPO in the country. Despite fears that it would be unpopular because of Sharia compliance issues, it nevertheless rocked the Tadawul.

IPOs are a form of popular capitalism in Saudi Arabia, with many Saudi citizens buying shares in some of the Kingdom's most prominent companies. It has become the vogue for IPO candidates to get a fatwa to show they are Sharia-compliant. Kingdom Holding could not get one because of the nature of many of its investments.

In particular, the company owns hotels, including the George V in Paris, which sell alcohol. Other investments include holdings in News Corp, Apple and Disneyland Paris – and a helicopter, Boeing 767 and 747 and a 281-foot yacht purchased from Donald Trump in the 1990s.

Bankers say that Sharia-compliance is fundamental for debt issues and is also a growing development in the equity market, but there are still few Sharia funds likely to participate in any IPO.

The deal was the third lately to use a bookbuilding approach. Usually, Saudi IPOs sell at a set price. The current standard is that an IPO is for 30% of a company and completed at the nominal value of SR10 per share. As the regulator is developing market practice alongside this deal, the process took longer.

The structure is still new but is expected to become more common this year and next, as the authorities want a more long-term, market-driven approach that will end the turbulence that has dogged the domestic markets recently.

International investors were not able to participate in the deal. International accounts are banned from trading in Saudi Arabia and the funds that could offer indirect access are far too small to be a sufficient substitute.

Samba Financial Group, itself part of Kingdom's investments, was the lead manager of the deal. The IPO came to market mid-July, which was a tough time of year for the Saudi markets as many people go away on holiday to escape the blazing heat. It was also a challenge because of the new nature of the bookbuilding process.

The deal saw shares sold at a premium of just 2.5% to nominal value, and as a result it totalled just SR3.23bn (US$860.8m) – far below the originally envisaged US$3bn-equivalent. The price of the IPO was set at SR10.25 per share, with 315m shares to be offered representing 5% of the company.

Bookbuilding was set from nine days' market soundings with 70 accounts of VVIPs and ultra high net worth investors. This made it the largest price discovery bookbuild and generated SR4bn of demand. Subscription ran from July 10 until July 18. The stock was split equally between institutional and retail buyers. Investors could subscribe for a minimum of 50 shares but there was no maximum.

Although the offer was smaller than expected it was still expected to negatively impact on the Tadawul stock exchange in the short term, as investors ditch shares they already have to stampede into new ones.

In the end though, while the SR3.23bn (US$961m) offer was completed successfully, momentum seemed to be sluggish compared with the usual response to Saudi deals.

Possible concerns over Sharia compliance and the bookbuilding process, which led to pricing above par, might have limited enthusiasm for the transaction, but it was still 81% covered on the retail side just days away from closing. The institutional book was fully covered at the end of the bookbuild.

The number of subscribers had reached 761,000 by July 16 with total orders of SR1.3bn. So a book that ended 2.4 times covered showed investors had little concern for the non-Sharia nature of Kingdom's investments. A total of 1.25m subscribers to the deal ordered SR8.5bn of stock.

Kingdom Holding Company began trading on July 29 and rapidly appreciated despite an attempt to achieve a more realistic valuation for the firm through an institutional bookbuild.

The bookbuild led to a premium of just 2.5% to nominal value and that meant there was plenty of room for immediate returns on the stock. The shares opened at SR13.50 and by the end of the day volume totalled 25% of the deal, with the stock closing at SR12.25.

Volumes had fallen dramatically by the following Monday (ie, just a few days later) and the stock slipped to a closing price of SR11.75, but this still represented a 14.6% gain on the SR10.25 IPO price. By the end of that week in early August the stock had returned to SR12.25.

Fatwas and Sharia compliance

There were many fears that the non-Sharia status of Kingdom Holding would affect retails sales of the IPO but these fears were unfounded. Ever since the IPO had been touted in February, conservative clerics had lined up to denounce the company. In fact, Prince Alwaleed's company has frequently been a target of conservative attacks. (Incidentally, his father Talal Bin Abdul-Aziz is a leading Saudi reformer).

When the IPO opened, Cleric Mohammed al Ossaimi, who has pronounced on the religious credentials of other IPOs, said on a website that some of Kingdom Holding's investments were in businesses inimical to Islamic values, such as usury and alcohol.

The cleric cited the company's stakes in financial groups that do not comply with Islamic law, such as Citi and Saudi Arabia's Samba Financial Group, which managed the IPO. He also cited the prince's stakes in entertainment companies such as Time Warner and News Corporation and hotel group Four Seasons and Fairmont. He has been attacked before by Islamists for his Rotana Television network, which shows music and films.

The edicts might deter some retail investors but the IPO would still be oversubscribed, Mohamed al-Omran, head of the Gulf Center for Financial Consultancy in Riyadh, said at the time.

Islam has no problem with the concept of an IPO, because it is based wholly on equity. Where Islamic compliance issues do come in, it is normally to do with the operations of a particular company, especially if the business involves gambling, usury or alcohol.

A positive fatwa ruling is good publicity for companies, especially given that GCC IPOs are geared towards retail investors. There are a couple of precedents: Saudi Research and Marketing Group's IPO in 2006 was marketed as non-Sharia and was still successful.

The general perception, however, is that there are not enough individuals who would avoid buying shares in a non-Sharia compliant company to affect a sale. In any case, Prince Alwaleed is a famous household name in Saudi: he is also the 13th richest person in the world.


Nevertheless, Gulf governments across the board are trying to reform rules for initial public offerings to restore buoyancy. Markets last year were struck by a collapse that saw almost two-thirds wiped off the value of stock markets. Saudi Arabia has one of the worst performing bourses in the world.

The set pricings of shares, which at one time led to some transactions being 800% subscribed, is now putting off many firms from floating. Retail investors are some of the most active players in the GCC, but they are now losing money on IPOs. Some retails investors had even been using massive gains in market prices to pay off loans they had taken out to buy shares.

Gulf IPO regulations are seen as being obscure and out of date. They are inefficient and have not been keeping up with markets in the GCC and around the world. Although many state-owned Saudi companies are compelled to sell 30% of their value in shares, this has not led to a more sophisticated market. Instead, as a new company lines up to float, shares in previously floated companies are ditched in favour of the new one.

This has led to wild fluctuations in values. While it has increased scarce liquidity, it has discouraged companies from using the equity markets. Authorities in the UAE and Saudi Arabia are now trying out reforms to attract institutional investors and make share sales more attractive for companies.

The problem is broadly that governments in the GCC had generally created IPO regulations to suit retail investors. Popular shareholder capitalism was seen as a way of distributing wealth downwards while still creating a market economy. Many corporates in the GCC are still state-owned and, while markets are liberalising, there remain restrictions on foreign investment.

But the model of selling shares was still to a large extent dirigiste. Capital markets authorities set the offer price, which often bore little relation to demand. But, with the movement of oil prices upwards in 2004 and 2005, investors were virtually guaranteed a profit on the shares they were buying. But these were not true profits as no market mechanism – ie, a bookbuild – had determined the price.

The retail-directed frenzy caused a number of newsworthy incidents. When Sahrjah's Dana Gas sold shares in 2005, fights broke out at receiving banks. In Qatar in 2006, riot police were called in to prevent violence as an Islamic bank launched an IPO.

A bubble ensued. As with all bubbles, it was leverage that caused it. People borrowed money to buy shares, believing a quick increase in value would enable the loans to be paid off and a handsome profit made.

According to Imad Ghandour, principal at Gulf Capital: "What seemed to be a secure move for realising extraordinary returns suddenly became a risky undertaking. Several companies going public realised the dangers to be listed companies. Excessive company valuations became unsustainable. Investors are becoming more discerning about green-field startups with little or no track record. The 'anything can be IPOed' attitude is quickly becoming part of the past."

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