The Saudi project finance market is unique. As the focus of global project finance activity shifts to the GCC, the kingdom is leading the way with about $250bn worth of projects seeking an estimated $175bn in project finance over the next three to five years.

Beyond the scale of project finance activity under way, Saudi Arabia is notable for another reason: it is the only project finance market where stakes in certain projects in development must be sold to the public. These share sales constitute some of the biggest initial public offerings (IPOs) in the kingdom and the largest listed companies.

Shares in Saudi Arabian Mining Company (Maaden) will go on sale in 2008 and raise $2.5-2.7bn. The offering of shares in the government-owned company will boost the financial strength of the firm, allowing it to inject capital into its aluminium and phosphate projects, which will cost about $11bn in total. The shares could be priced at up to SR30 ($8), three times the usual par value of SR10 applied to greenfield ventures and government-related issues.

The vast majority of project IPOs are in the petrochemicals sector. Rabigh Petrochemical & Refining Company (PetroRabigh) is the latest such project to go public, listing on the Saudi stock exchange (Tadawul) in January following its $1.2bn IPO.

It follows the successful offerings of shares in Saudi Kayan Petrochemical Company, Saudi International Petrochemical Company (Sipchem) and Yanbu National Petrochemical Company (YanSab).

However, although high, investor demand is not the driver of IPO activity. Petrochemicals projects launched on the back of cheap gas feedstock allocations are mandated to IPO at least 30 per cent of their shares as a condition of the allocation. YanSab was the first.

Subsidised feedstock

For the government, selling shares in petrochemicals companies that will thrive on highly subsidised feedstock is a political imperative - even more so if the beneficiaries of the allocation include foreign project sponsors.

“Whoever gets such an allocation gets such an extraordinary benefit, the government says it should spread it around,” says Alan Lowe, head of corporate finance at Riyad Bank.

More IPOs are planned. Ras Tanura refinery and petrochemicals complex, Yanbu export refinery, Jubail export refinery and all Saudi Aramco joint ventures awaiting financial close are expected to offer shares on the primary market using the PetroRabigh model.

These projects are huge, with total costs of up to $25bn. The share sales are expected to result in massive retail investor demand, underpinned by anticipated substantial future profits.

“What you have in Saudi Arabia is a closed stock market that is very receptive to IPOs and anyone that has a gas allocation has a licence to print money,” says one Riyadh-based banker.

Despite a gas price revision expected at its earliest in three years' time, the government will continue to sell gas to project companies at a fraction of the international market price. Currently, gas costs $0.75 a million BTUs, compared with up to $10 in the US.

The presence of public shareholders also supports favourable feedstock prices going forward. “If you have shareholders, the government will be more careful how it prices the feedstock,” says one local banker.

For entirely private schemes such as Sipchem, which do not have the backing of either Aramco or Saudi Basic Industries Corporation (Sabic), it is a means to bolster the financial strength of the company and augment the security package that accompanies the debt finance. That has indirect benefits to the sponsor in terms of the pricing of the debt.

However, having public shareholders poses risks in the development stage of the project. The sponsor's assessment of these risks determines when the stakes are sold. “In general, IPOs are done prior to project completion,” says the local banker. “The issue is whether they can be done prior to financial close.”

The project financing market in the kingdom is again unique in that project stakes have been sold to public investors in schemes such as Saudi Kayan before the financing was completed. In other cases, such as PetroRabigh, the financing was in place before the company approached the primary market.

Launching an IPO early smoothes the path to financial close by providing comfort to lenders that the requirements of the feedstock allocation letter are met. It also permits sponsors access to the financing facility, which they cannot draw on until the IPO is complete.

Charging premiums

Even if sponsors wait until after the financing is completed to IPO, greenfield projects are still prevented from charging a premium on the share issue. In that scenario, sponsors will have borne the risks of the project until the IPO completes, but sold the shares with no extra reward.

“Sponsors generally do not want to sell part of the project to the public at par,” says the local banker. “If you are taking that risk, you want the value to be more than par.”

However, raising capital on the stock market prior to financial close necessitates putting a fixed price on total project costs to determine the size of the equity portion sold. It creates the risk of unanticipated cost over-runs, which will have to be met by the sponsor.

Regardless of when the IPO is staged, the risk of project delays and non-completion still pertain to the sponsor, which is left to bear the burden of completion support for the entire project, in which it is only one stakeholder until the project is built. In an attempt to spread the burden, sponsors have passed on the price risk to the contractor by tendering lump-sum turnkey contracts and trying to pass on delay risks to banks.

“You cannot ask the public to cover those risks,” says Lowe. “The principle concern of the lender is completion support. Once a project is completed, the payment guarantee falls away and the existence of public shareholders has no effect. Then key sponsors are expected to run and control the project, and cannot get out.”

The Capital Market Authority has been wary of greenfield issues and is more comfortable with the IPO of projects where the funding is in place. However, the Saudi Kayan greenfield IPO was able to go ahead with Sabic backing and loose bank underwriting.

For lenders, an IPO component poses little risk to the viability of a project or its ability to attract finance.

“Project finance and an IPO are separate issues,” says Toshiki Matsumura, chief financial officer of PetroRabigh. “Usually a project goes ahead on the basis of the debt ratio. The IPO is on the equity side.”

PetroRabigh's mandate to IPO was not a concern to the Japan Bank of International Co-operation (JBIC), which lent $2.5bn to the scheme. “We had already incorporated the idea of the IPO from the beginning and, more-over, it was a success for the sponsor,” says Moriyuki Aida, chief representative of JBIC in Dubai.

The provision of an Islamic tranche is a common feature on schemes that IPO, in response to concerns that Islamic scholars have issued fatwas banning investing in non-sharia-compliant investments. However, the Islamic portion of the project financing is not usually large.

“Most companies believe it is an advantage to have Islamic finance as a part of the financing mix when they go public,” says Jonathan Robinson, head of project finance at HSBC Saudi Arabia. “However, for the megaprojects, where Islamic financing represents a lower overall proportion of the financing mix, the advantages may be less.”

The eventual listing following the IPO has little effect on project companies and shares have generally performed well. PetroRabigh shares were sold with a premium at SR21 in January. The shares closed trading on 9 March at SR48.8.

Minority public shareholder representation on the board of the project is not practised in the kingdom, where project sponsors can proceed with their schemes unhindered by investor demands but with the benefit of their equity.

Table: Selected petrochemicals IPOs

nk=not known; nr=not relevant; IPO=initial public offering. Source: MEED