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$80bn of Aramco Orders Disappear into a Black Hole

12 April 2019 by Eoin Walsh

Despite being the largest company in the world, Saudi Aramco was a new name in the credit markets, but gathered thousands of lines of commentary in both the financial and non-financial press in the last week, thanks to its highly anticipated inaugural bond issue.

For those who missed it, Aramco is a Saudi-based oil company responsible for producing one in every eight barrels of crude oil in the world, with five times the reserves of western rivals Total, Shell, Chevron, BP and Exxon combined. It is also the world’s largest and most profitable company, with EBITDA of $224bn in 2018 dwarfing that of the second largest company, Apple, at $80bn.

If those stats weren’t enough to generate a few headlines, JP Morgan, the lead manager for the deal, rolled out CEO Jamie Dimon to speak at the launch of the deal, while the size of the transaction was promised to be at least $10bn – to give this some context, the entire sterling high yield bond market is around $45bn.

When the multi-tranche deal was priced it had something for everyone, with maturities ranging from three to 30 years, a rating of A1/A+ and some $12bn of bonds available, for which investors submitted orders peaking at over $100bn, with the final book a more modest $92bn.

So what’s not to like? Well, apart from the deal pricing (unsurprisingly) being tightened from initial price talk, it seemed to tick all the boxes, and with around $80bn of orders that weren’t filled, it was pretty much guaranteed to trade well. Except it hasn’t. Depending on what tranche you are looking at, the offered price is up to a full percentage point below the issue level – not a huge drop, but still surprising.

So where have $80bn of orders gone? Disappeared into the recently photographed black hole?

It is actually not that unusual for heavily oversubscribed deals to trade poorly, for a number of reasons.  If a deal is expected to be well oversubscribed, investors sometimes inflate their orders in the hope of receiving more bonds despite a reduced allocation – a tactic that artificially increases the size of the order book.

In addition, however much the lead managers protest that they overwhelmingly favour ‘real money’ investors, bonds find their way into the hands of ‘fast money’ investors like hedge funds, who typically flip bonds to book a quick profit, and this does create a certain level of selling pressure after launch.

However, it takes a lot of inflating to produce a $92bn order book, and you would certainly expect that any bonds being sold would quickly be snapped up by investors whose average allocation was around 13%, so what has happened here? The depth of the order book has to be questioned, but with orders from the US, Europe and Asia and spread across institutions such as asset managers, hedge funds, banks and insurance/pension funds, the bonds should have been well placed.  In addition, the market in general has been well bid since the deal launched, with practically every fixed sector index showing positive returns.

Ultimately, given the strength of the issuer, we think the deal will perform well once it settles down, but for now there is certainly some head scratching going on, though we think the lead managers will still be fairly happy with the result.

The key lesson for us as bond investors is that we have to continually question the quality and depth of order books, and the impact this can have on initial pricing as well as early secondary trading. Sometimes order books that look most compelling at launch are worth avoiding, and better terms can be available in the secondary market.

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