Summer 2018

SAUDI ARABIA: A new dawn

Oil_refinerySaudi Arabia has been pursuing economic diversification since the 1970s with varying levels of success. Romil Patel looks at the petro-state’s latest efforts to expand its economy. Before 1938, Saudi Arabia’s primary source of revenue was from tourism, as the home of Islam’s holiest site. It then struck liquid gold and would experience a rapid economic transformation as the world’s largest petroleum producer. As fortunes rose, there were limited attempts to diversify the oil-dependent economy over the decades. Notable achievements include infrastructure development and significant improvements in living standards, but there was no real practical push to wean itself off its principal commodity. Riyadh’s fortunes took a tumble when oil prices collapsed in 2014, forcing the government to confront the reality that suddenly, revenues were failing to keep pace with its normal spending. The following year, King Salman acceded to the throne, but it is his son, Crown Prince Mohammed bin Salman (commonly known as ‘MBS’), who has consolidated power and emerged as the influential figure in the House of Saud. The Al Saud dynasty is said to hold a monopoly of political power and the young crown prince is at the epicentre of seismic changes. A little over two years ago, MBS, who is chairman of the Council of Economic and Development Affairs, launched Vision 2030, an economic transformation plan that aims to end Saudi Arabia’s “addiction” to oil. He outlined his determination that the country become “a global investment powerhouse”. The oil industry currently accounts for 43% of the kingdom’s GDP and 75% of its exports. But what does economic diversification mean for investment managers and how is MBS’s strategy different from previous attempts? Are you not entertained?
Driven by MBS, social liberalisation is sweeping through Saudi Arabia at a staggering pace. This year, for instance, a 35-year ban on cinemas ended with the screening of Marvel’s Black Panther. “Government-driven social and cultural liberalisation is finally opening up aspects of life, such as entertainment, sports and arts, and offers a host of greenfield opportunities to tap into a population of 30 million people,” says Akber Khan, senior director, asset management at Al Rayan Investment. “The opportunities are very significant. Selling something as apparently mundane as a cinema ticket has become a bit like selling lottery tickets – they keep running out. Some cinema operators are talking about raising ticket prices by up to 75%, to the equivalent of $35. As in most markets, early movers will benefit from supra-normal profits, helping foreign capital inflows to accelerate from a relatively low base.” It seems that a significant opportunity exists to capitalise on the loosening of restrictions in a country where approximately 70% of the population is under 30. “It’s still early, of course. Rome was not built in one day,” says Ehsan Khoman, head of MENA research at MUFG Bank. Investors are taking comfort in the visible signs of reform, such as new forms of entertainment and the lifting of the driving ban on women. The latter could be vital, as an increase in the female labour force will drive consumption and GDP growth over time, says Khoman. Vision 2030 is just over two years old and strategically, the government is looking for quick hits to maintain positive sentiment. But what has it done to convince the experts that this time, things really are different? No longer a mirage?
In order to transform Saudi Arabia into “a global investment powerhouse”, the kingdom has started laying the foundations for successful investment management. A good example is its inclusion in the FTSE Russell’s emerging market index in March. Global index compiler MSCI is expected to upgrade the country to emerging market status in June. Northern Trust’s Middle East director, Michael Slater, says: “I think that what they’re looking to do is first and foremost through Tadawul [the Saudi Stock Exchange] and what’s known as Edaa [the Securities Depository Center Company] now, which is a new CCP [central counterparty clearing house] spinoff from Tadawul. They’re putting the rules and regulations in place that gets them into the FTSE and MSCI emerging market indices.”
But, adds Slater, “We’re not done yet.” Foreign ownership accounts for only 5% of the kingdom’s $517 billion stock market at present – but an MSCI upgrade would attract more institutional money from abroad, diversifying the investor base. Riyadh’s reform plans are also aimed at luring investment from corporates – specifically Silicon Valley players – to complement their high-tech ambitions. A number of firms have stated that they want to enhance their digital capabilities in the kingdom and entities such as Apple, Amazon and Snapchat are reportedly interested in establishing a stronger presence there. “A lot of the foreign direct investment (FDI) will significantly increase as time goes by,” says Khoman, adding that it could inject confidence in tier 2 and 3 players and lead to a snowball effect. “Foreign direct investment in industries which the kingdom is starting to develop, such as tourism, technology, logistics and infrastructure, are likely to become significant, with our expectations that inward FDI flows, of $7.4 billion in 2016, at least double in the next few years.” MBS has successfully cemented his image as Saudi Arabia’s ‘salesperson-in-chief’ following a global diplomatic charm offensive in which he struck deals with Egypt, the UK, the US, France and Spain. Given that Saudi Arabia is facing the threat of a demographic timebomb, corporate giants could play an important role in Vision 2030 by bringing more locals into the private sector. This currently relies on cheap, imported labour: 90% of workers are foreigners, according to a Belfer Center paper. In December 2017, the Saudi government unveiled a $19 billion package to boost private sector growth. There are a number of signs indicating that FDI will increase significantly. These include corporates coming in, capital inflows from the kingdom’s inclusion on the FTSE Russell emerging markets index, and the trading of government bonds on the stock market (part of the strategy to make financial debt instruments much more tradeable). If the FTSE completion occurs by December 2019 and an estimated 2.7% Saudi weighting is anything to go by, MUFG Bank predicts that Saudi Arabia will attract roughly $5 billion in passive inflows. But in spite of the opportunities for foreign entities, not everybody is convinced that Saudi companies can meet the transparency levels demanded by global investors. MVP
To fund investments and realise MBS’s plan to create the world’s largest sovereign wealth fund, the government intends to sell a 5% stake in state oil giant Saudi Aramco. It believes it will raise $100 billion, raising eyebrows in certain quarters. However, pricing is quite low down the pecking order, given the complexities involved in disentangling Saudi Aramco from the state and the additional disclosures required if it is to list on foreign exchanges, such as those in the UK or US. The Tadawul is expected to serve only as the anchor market due to regulatory, legal and litigation concerns. The prospect of such a gargantuan initial public offering (IPO) on the Tadawul alone – which could be pushed back to 2019 – is no mean feat and questions remain about the biggest stock market sale in history. “Imagine the consequences if it was listed on the local exchange without a cap. Aramco would have a 35%-40% weight, skewing the index towards just one name. Regardless of the eventual weight, once Aramco is listed on the Tadawul, index earnings will become even more dependent on oil prices,” says Al Rayan Investment’s Khan. “It would be ironic that when the government is working so hard to reduce dependence on oil prices, the equity index would double up on its gearing to oil.” Other risks include how Aramco announces its level of reserves – a key part of its valuation. Beyond this, what part of the company will be listed – will it be downstream, midstream, upstream? But opportunities of this magnitude do not come around very often and as investors await a prospectus, great excitement surrounds the world’s biggest IPO. “In my entire life, this will be one of the most exciting and oversubscribed IPOs,” says Slater. ©2018 funds global mena

Executive Interviews

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Roundtables

MENA ROUNDTABLE: ‘The story is about reforms’

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Our cross-industry panel discuss the positive backdrop in Egypt, the Dana Gas controversy and the potential index upgrades of Saudi Arabia and Kuwait. Chaired by George Mitton in Dubai.

SOUTH AFRICA ROUNDTABLE: Airline syndrome

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Our panellists tell us that instead of launching competing national projects, African countries should work together for the sake of a bigger capital market. Chaired by George Mitton in Cape Town.