By mid-June, the first qualified foreign investors (QFIs) will be preparing to invest in securities listed on the Saudi Stock Exchange (Tadawul). This will complete the process of market opening that commenced a year ago, when the regulator, the Capital Market Authority (CMA) announced the Tadawul would be opened to non-Saudi entities.

The opening provides a tantalising prospect for foreign investors, who are now able to access the region’s largest and most mature market – one that boasts a $578bn market capitalisation, and that it was previously only possible to access through equity swaps and exchange-traded funds.

With a stack of firms preparing to float on the Tadawul this year, there is – in theory at least – a real chance for foreigners to capture some of the latent dynamism in the Saudi private sector.

IPO prospects

The initial public offering (IPO) pipeline for 2015 is likely to be as attractive as last year, which was a record in terms of value thanks largely to the $6bn flotation of National Commercial Bank (NCB). There is a mix of companies from different sectors preparing to float on the exchange.

“Activity in the early part of this year has been pretty solid, with at least two IPOs closing in April,” says one Saudi investment manager. “On average, there’s been one a month since the start of the year, which is more than in any other year, including last year with the massive NCB IPO.”

The recent spate of listings has been much smaller in scale than NCB’s. That of Saudi Company for Tools and Hardware, which in April announced a flotation in which it was looking to raise $134m – representing 30 per cent of its share capital – is more typical of the size.

Poultry firm Al-Wataniya is also planning a stock market float, while Islamic investment and advisory firm Alkhabeer Capital has applied for a listing in order to fund the expansion of its discretionary management business. Meanwhile, power and telecom cables firm Riyadh Cables has appointed Samba Capital to help manage its IPO. Even Prince Alwaleed bin Talal’s Kingdom Holding Company is considering a series of listings, although not until 2016.  

In numbers

18 per cent Year-to-date increase in Tadawul All Share Index

14 per cent Month-on-month increase in Tadawul’s total equity market capitalisation at end of April

Tadawul=Saudi Stock Exchange. Source: MEED

The number of IPOs in the pipeline is promising, says Fahad Alturki, chief economist and head of research at the local Jadwa Investment. “Above all, it’s a reflection of the solid performance of the Saudi private sector in the past five years. Despite what is happening in the oil market, the fact that the government is maintaining an expansionary fiscal policy will push this performance. That is going to be reflected in the number of IPOs.”

Recent major Saudi stock market listings 
Company Sector Size of offering ($m) Date
Abdul Mohsen al-Hokair Group Leisure 220 03-Jun-14
Al-Hammadi Company for Development & Investment Healthcare 168 17-Jun-14
National Commercial Bank Banking 5,998 02-Nov-14
Electrical Industries Company Industry 194 17-Nov-14
Umm al-Qura Cement Company Industry 73 05-May-15
Source: EY

Industry sources report several clients are considering embarking on an IPO journey later this year. The big activity is likely to be in the third and fourth quarters of the year, as the impact of the market opening is fully digested.   

Certain limitations

The attraction of raising funds through the capital markets will be even stronger in light of the 15 June opening to foreign investors. However, there are caveats, given the restricted ability of non-Saudis to gain exposure to local IPOs. 

Foreigners will be excluded from subscribing to public share sales directly, in light of a government policy imperative to ensure ordinary Saudi investors derive the maximum benefit from the process. The CMA’s emphasis on ensuring small investors are able to make a good margin on their investments in IPOs means there is unlikely to be any possibility of direct exposure for foreign investors in the near future.

Instead, foreign investors will only be able to participate in IPOs mediated through mutual funds. These currently number 12, but more and more firms are unveiling IPO funds in Saudi Arabia. Indeed, there are now three times as many as there were at the start of 2014.

Pipeline building

The Tadawul is seeing a substantial pipeline of deals in which investors will be in a position to gain exposure through the fund structure, with the sector bias tilted towards financial services, industry, healthcare and transport. In the healthcare sector, for example, Dr Soliman Fakeeh Hospital, which is one of the kingdom’s largest private medical facilities, is preparing an IPO of 30 per cent of its shares to follow the Saudi market opening.

These firms are ambitious, growth-oriented entities that are able to capture the Saudi economy’s robust fundamentals and, importantly, are not too closely correlated to the oil market.

As the local Aljazira Capital noted in an assessment of the Saudi IPO market, share offerings still provide high returns to investors, beating market returns in the short-to-medium term in every recent listing.

For Saudi retail investors, IPOs have been made more compelling as a result of the CMA’s recent regulatory tweaks. New caps are limiting the risk and rewards available through investing in IPOs, as opposed to ordinary market investments. As Aljazira Capital notes, the unique case of risk and reward in the Saudi market, as well as the limited number of IPOs, tends to trigger a surge in liquidity towards the stock, making almost every flotation worthwhile as an investment option.

Activity in the early part of this year has been pretty solid, with at least two IPOs closing in April

Saudi investment manager

The sheer size of the Tadawul makes IPO investments particularly attractive. The market capitalisation is as big as all the Gulf equity markets combined and liquidity is likely to grow exponentially. Jadwa predicts that within a couple of years Saudi Arabia is likely to be included in US-based MSCI’s Emerging Market Index, with as much as $40bn-$50bn of total foreign inflows beckoning.

The market’s recent performance has been solid. At the end of April, the Tadawul All Share Index (TASI) closed at 9,834 points, an increase of 12 per cent over the close of the previous month. On a year-to-date basis, the TASI has shown an 18 per cent increase – this at a time of historically weak oil prices.

The bourse’s total equity market capitalisation reached $576.13bn at the end of April, an increase of almost 14 per cent on the end of March. The TASI’s recovery was underpinned by a smooth royal succession in January (which led to two salary bonuses to public sector employees) as well as the more recent stabilisation in global oil prices.

This marks a break from most Gulf stock markets’ recent negative performance, with the Saudi market having been affected by retail investor jitters over the prospect of lower oil prices precipitating a contraction in state expenditure, which in turn would hit corporate profits. 

The TASI’s strong performance suggests a broader optimism about the market’s future prospects. However, the experiences of Qatar and the UAE regarding their initial inclusion in the MSCI Emerging Markets Index, which was followed by an immediate slump in value, may also be repeated in Saudi Arabia.

The Saudi stock market opening is only one driver for increased activity. The Tadawul is also a beneficiary of a recently introduced measure to tax undeveloped land. This move, made in January in the wake of King Salman bin Abdulaziz al-Saud’s inauguration, is expected to drive capital away from real estate and into equities.

King Salman’s evident commitment to pushing ahead with large-scale industrial projects and economic diversification will underpin local corporates’ positive performances, in turn feeding through into more robust IPO activity as the private sector is handed a larger role in the kingdom’s economy.

Focus on equities

The fall in oil prices prompted much fevered speculation that the authorities might delay the opening of the market. The fact that they did not is a confidence booster, says Jadwa’s Alturki. It sends a strong message to investors locally and internationally that Saudi Arabia is robustly backing the fundamentals that will support the market and that it will stick to the timeline announced earlier.

The big activity is likely to be in the third and fourth quarters of the year, as the market opening impact is fully digested

“The Saudi stock market is not isolated from global stock market trends, and with global equity markets responding positively to quantitative easing (QE), the market has more or less followed that trend,” says Alturki. “We are unlikely to see massive capital inflows due to QE, but it has a sentimental impact.”

As businesses in the kingdom both large and small prepare to list their shares on a stock market that is seeing unprecedented global attention, the kingdom will have to get used to the unusual glare of publicity on its capital market. This comes with additional responsibilities for the CMA and corporates alike.

Rules for qualified foreign investors

Qualified foreign investors (QFIs) include banks, brokerages, fund managers and insurance companies that have at least SR18.75bn ($5bn) in assets under management and have been operational for a minimum of five years.

Each QFI (including affiliates) can only hold a maximum of 5 per cent of issued shares of any one listed company.

The maximum proportion of shares in any one listed firm that can be owned by all foreign investors (including resident and non-resident, swaps and QFIs) combined is capped at 49 per cent.

The maximum proportion of shares in any one listed company that can be owned by all QFIs combined is capped at 20 per cent.

Swaps and QFIs can only own up to a maximum of 10 per cent of the aggregate stock market value of all listed companies.