The news that President Ben Ali of Tunisia was taking up residence in Saudi Arabia is exactly what I expected. It’s indicative of the stabilizing influence of the Kingdom in regional politics, playing a role to which few other nations can aspire. Nichol Sarkozy apparently designated France as a “no fly” zone, a concession to the Tunisian population in his country; Italy likely has its hands full with the frequent comings-and-goings of Muammar al-Gaddafi; and Malta is too close and too small. International diplomacy was in high gear on January 14.

Saudi Arabia is a regional monolith. The official statement related to the Tunisian leader’s arrival is rich with nuance. “The [Kingdom] stands totally alongside the brotherly Tunisian people and hopes that they will close ranks in order to overcome this difficult period in their history.” This beneficent construct underscores Saudi Arabia’s patronal position in regional politics, while tacitly projecting its economic might. This is a country that painstakingly cultivates its relationships, overt and otherwise.

-- Invest in the Kingdom

At a time when oil exceeds $90 a barrel, investing in Saudi Arabia may be a reasonable investment proposition. Indeed, the story is far more complex than front-running the oil price. A quick visit to the General Investment Authority’s website helps make the country more transparent than commonly perceived, at least outside the region. (See www.sagia.gov.sa/en). Check out “The Hard Facts” under “Why Saudi Arabia?”

One key issue in Saudi Arabia is the supply and affordability of residential units. Owner-occupied housing stock is constrained because of the historical lack of mortgage regulation; the majority of Saudi citizens live in rental units. The Real Estate Development Fund has traditionally funded housing construction, but the size of the economy may now exceed the REDF’s capacity. It was set up in 1974 during the first global revaluation of oil prices, in part to recycle petrodollars. Those days of basic development policy are well behind us, providing an array of commercial and investment opportunities.

Saudi Arabia is not included in most frontier market stock indices largely because of restrictions on foreign ownership of company shares. Regulators, however, set up a swap market in 2008, through which non-GCC residents can own certificates representing shares held by a local entity. It’s a rational system, with the major banks being the obvious beneficiaries of this transaction business. The arrangement now appears ready to evolve to something closer to direct foreign ownership.

Saudis have legitimate concerns about foreigners owning assets in the Muslim heartland, deferentially expressed in their desire to avoid inflows of so-called “hot money.” And that’s unlikely to change materially, in my view. There are some opportunities such as the liberalized real estate guidelines in zones such as King Abdullah Economic City, sensibly located on the opposite side of Jeddah from Mecca.

If anything, with the Saudi Riyal pegged to the US dollar, the Kingdom runs the risk of seeing an asset bubble with three-month rates now at 0.75% and the strongest budget surplus in the world (except for Norway), at 3.1% of GDP. But the Saudis have been there before and they’re likely to do a pretty good job of mopping up that liquidity by issuing bonds to pay for infrastructure development (including transportation links and sewage systems). We note that the Saudi Arabian Monetary Agency, the country’s central bank, is well regarded internationally. Saudi Arabia was identified as one of the top ten least risky sovereigns worldwide, based on financial market data, in a quarterly report on global sovereign debt issued in early January by a unit of the Chicago-headquartered CME Group.

-- Structure and Size

The Tadawul (Saudi stock exchange) can be volatile because much of its volume is controlled by retail investors day-trading off their cell phones. Individuals are said to be responsible for as much as 90% of market volume by shares, accordingly to one brokerage specialist with whom I spoke. But with a price-to-earnings ratio of about 15 times trailing earnings at this time, it is difficult to argue that the market is overvalued on the basis of absolute international comparisons.

Market capitalization is approximately $350 billion, between the size of the Turkish and Italian exchanges. The breakdown of market segments is about what you’d expect: 37% petrochemicals, 27% banks and financial services, and 10% telecom. The largest stock in each sector is SABIC, Al Rajhi, and STC, respectively. At the other end of the spectrum is the miniscule hotel and tourism sector at less than 0.2% of market capitalization. (See www.tadawul.com.sa for complete data.)

-- Overcoming Myths

We think Western and Eastern investors tend to avoid the market because of its lack of transparency and misconstrued stereotypes. These are views generally held without context. Tremendous shifts in the economy have taken place since King Abdullah ascended to the throne in 2005, and social reforms continue to evolve. To cite a personal example, I interviewed an exceptionally talented Saudi woman for an office position in Riyadh a couple years ago, although her brother did come along for decorum. Many global observers for whatever reason seem to think that women are prohibited from working there.

In an international environment where fiscal recovery dominates the OECD agenda, we think Saudi Arabia is a pretty strong story. On its website, the OECD asks selected governments, “What action is your government taking to bolster public finances, while upholding growth and services?” Included are comments from finance ministers of France, Germany, Korea, Indonesia, and Mexico, whose budget deficits range from -7.8% to -1.4% of GDP. There is no need to solicit Saudi Arabia’s spokesman on these matters.

 

(c) Codexa Capital

www.codexacapital.com