What is happening with Glencore and Xstrata?
- For several years Xstrata and Glencore, with over 30% its largest shareholder, have been linked in rumors of mergers. This week both companies released statements to announce that Glencore has now officially started the merger procedure. As a result Glencore is required to come up with an official proposal by early March. However, analysts expect an agreement to be reached much faster.
- Glencore is the world’s largest commodity trader and also owns operating assets for several commodities, most notably copper, zinc, and coal.
- Xstrata is the world’s 4th-largest diversified miner, grown rapidly in the past decade by a series of acquisitions.
- Last year Glencore became a public company, putting an official market value on the company. This step was seen as a requirement to convince Xstrata’s other shareholders to discuss a merger.
Why does a merger make sense?
- Although the mining industry only very slowly moves in this direction it makes sense to combine raw material production and marketing and processed goods production and marketing in one company. The vertical control over the value chain provides flexibility to react to sudden opportunities in the global marketplace. The 3 pictures below illustrate Glencore’s view of these arbitrage opportunities: geographical, product, and timing arbitrage. The larger the company is and the more overlap between marketing and production, the larger the rationale for merging. Estimated synergies of the Glencore-Xstrata merger are close to $1bln annually, mainly due to increased revenues (whereas most mining related M&A is driven by cost reducing synergies).
What could go wrong?
Two important things could make the merger fail. The first could even prevent it from happening at all:
- 1. Antitrust – Glencore is the absolute market leader in trading of various commodities. Any increase of power in these areas would trigger action by antitrust regulators around the world. To get approved, the deal will have to be structured in a way that ensures both supply substitution and demand substitution; i.e. all market parties should be able to get around Glencore-Xstrata as customer or as supplier.
- 2. Corporate culture – Glencore is a company built on the two-thousand marketeers & traders, while Xstrata is run like a typical conservative mining company. Traders are typically very smart, aggressive, impatient, rational, office-workers. Miners are ‘roll up your sleeves’, ‘move the dirt’, operational guys with only very few of the highly schooled trading-types among them. To make these two groups of people not only work together smoothly, but to integrate the companies so that departmental interests and emotions are fully aligned with the larger companies objectives is going to be a major challenge, in which many employees from both sides might choose to leave the company to find a place where they are more comfortable.
©2012 | Wilfred Visser | thebusinessofmining.com
“For Glencore International, it is time for Plan C. Xstrata put the kibosh on Plan A when it refused to consider a merger with the commodities-trading giant that would have enabled Glencore partners to realize the full value of their 34.5% stake in the miner.
Investors now have ruined Plan B by refusing to accept Glencore’s ambitious $60 billion-plus valuation target, which might have allowed a quick post-IPO merger. Glencore has been forced to lower its target and must prepare for a long spell in the public markets.
Glencore’s advisers insist Mr. Glasenberg realizes the need for a realistic price that will allow it to trade healthily in the aftermarket. That would help rebuild investor confidence after the poor start to the IPO. So Glencore’s final IPO price will need to offer investors a generous discount. Mr. Glasenberg should brace himself for a price at the bottom of the range.”
Source: Wall Street Journal, May 5 2011
- The commentators from Wall Street Journal argue that the uncertainty of a potential merger with Xstrata and the politically sensitive nature of Glencore’s mining assets forces the company to offer the shares at a strong discount in the Initial Public Offering (IPO), raising less cash than previously hoped.
- Glencore is going public to facilitate further growth ambitions. In its current private structure it can not raise sufficient money for further growth. Merging with Xstrata would be an other way to solve this problem, but this requires putting a value on Glencore to decide on the new ownership structure, something Xstrata’s management and shareholders clearly are not willing to do.
- Shares are typically sold at a discount in an IPO, encouraging investors to take a share of the company and realize a paper profit in the first days of trading. However, if shares indeed go up strongly in the first days of trading and market value of Glencore reflects intrinsic value correctly, the WSJ-commentators’ prediction of a difficult negotiation with Xstrata because of skewed valuation does not hold.
- With current high commodity prices a large part of Glencore’s profit comes from its industrial assets, rather than from trading activities. Citi expects the industrial share to be as high as 60% in the next years. A relatively higher importance of production vs. trading in the company could make integration of Glencore with Xstrata and/or other mining companies smoother.
©2011 | Wilfred Visser | thebusinessofmining.com
“Glencore plans a board shake-up as the world’s largest trading house heads towards a $50bn-$60bn public listing in London in the second quarter of the year. The Swiss-based trading house is talking to many current and former executives in the natural resources world about potential roles as senior non-executive directors for its new board, according to people familiar with the discussions.
Ivan Glasenberg, the South African chief executive of Glencore, recently held talks with Tony Hayward, the former BP chief, about a role as non-executive director in the trading house. Glencore has also held talks with Chip Goodyear, the former chief executive of BHP Billiton, the world’s largest miner by market capitalisation.
Bankers expect Glencore will disclose its plans for a $50bn-$60bn IPO in mid-March, when the trading house reports its annual results. But the trader is keeping its options open and it could still seek a merger with Xstrata, the miner in which it owns a dominant 34 per cent stake.”
Source: Financial Times, January 23 2011
- Glencore is one of the world’s largest private companies. However, it is experiencing growth problems as it can’t raise money to grow by issuing more equity. Furthermore the company needs to prepare for enormous payouts to top executives leaving the firm, which could cause liquidity problems. Going public would solve these problems.
- The trading house, owning large stakes of various mining companies, showed strong profit growth for Q3 of last year, mainly driven by booming agricultural commodity prices.
- Most likely Glencore will have to perform an IPO before it can merge with Xstrata, as this is the easiest way to figure out the value of the company. Estimates of valuation of the company are based on a bond it issued at the end of 2009 and on industry multiples (PER of 14-18).
- Various insiders question the probability of success of a merger with Xstrata, as the corporate cultures of the extremely results-driven trading house and the more relaxed mining house could clash. A merger between the two companies would produce the first fully vertically integrated natural resources major, which could open the door to new ways of negotiating with clients and new types of contracts.
©2011 | Wilfred Visser | thebusinessofmining.com
“Swiss commodities company Glencore International AG Thursday said its third-quarter net profit rose 45% from a quarter earlier on higher metal prices and a particularly strong performance in its agricultural division.
Net profit rose to $979 million for the three months ending Sept. 30, compared with $677 million in the second quarter. Earnings before interest, taxes, depreciation and amortization, or Ebitda, rose 21.5% to $1.51 billion in the third quarter, compared with $1.24 billion in the second quarter.”
- EBITDA Margin for 2010 (3.7%) is not yet at the level of 2007 and 2008 (around 5%). However, the company seems to have recovered from the dramatic first part of 2009.
- Glencore is said to be one of the bidders for the Drummond coal assets in Colombia, which will cost approx. $6bn-$8bn.
- Glencore requires strong financial performance to strengthen its case for an IPO next year, which would give it access to capital to grow. It is still not clear whether the management will choose to merge with Xstrata or pursue a stand-alone IPO. The fact that current strong performance is mainly driven by the agricultural division does not help to convince Xstrata’s management to strike a deal.
©2010 | Wilfred Visser | thebusinessofmining.com
“Sinochem of China is struggling to find partners to mount a counterbid for PotashCorp and derail BHP Billiton’s $39bn hostile takeover following the collapse of talks with a potential Russian partner.
The failure of talks with UralKali, the Russian fertiliser group, is the latest setback for the state-owned Chinese chemical group after earlier approaches to a Canadian public pension fund, and Temasek, the Singapore’s investment agency.
Bankers believe Sinochem needs several partners, including non-Chinese companies, to mount a serious rival bid to BHP Billiton and assuage fears in Ottawa about the sale of PotashCorp to a Chinese state enterprise. PotashCorp is the largest global producer of mineral fertiliser, demand for which is soaring in China, India and other emerging economies.”
- The deadline of BHP Billiton’s bid for PotashCorp is November 18th. The company hopes to convince shareholders to sell over 2/3 of the shares at a price of $130/share.
- China imports approx. 4 million tonnes of potash per year, growing at a high rate. The Chinese government is afraid a takeover of PotashCorp by BHP and the resulting potential change in pricing mechanism will reduce stability in the market.
- PotashCorp has built up a shareholder plan that makes it difficult for a foreign company to assume control. The plan is mainly targeted against BHP, but makes it harder for other foreign firms to prevent the merger from taking place as well. Many Canadian officials will not be glad if PotashCorp falls in Chinese hands, therefore the Chinese government, via Sinochem, is looking for other partners.
- The probability of a competing bid surfacing is rather low, as it would have been in the interest of a competing party to announce the counterbid as early as possible. The most likely remaining alternative is a partnership between a major minor and a trading house, many of which hold strong positions in the agricultural sector.
©2010 | Wilfred Visser | thebusinessofmining.com
Vertical integration has been a significant driver of acquisitions in the mining industry in the past decades. As steelmakers and other mineral processers were trying to secure supply of resources, they increasingly decided to buy mines and mining companies. The next decade will show another interesting development. The vertical integration will increasingly include the next step in the value chain: trading.
The looming merger of Glencore and Xstrata will create the first of a new type of companies. The integrated mining, processing and trading companies will span the entire value chain of the resource world. This development is not unique. In many other industries the drive to become more customer-centric has resulted in similar moves.
The fact that a large part of the global resource production never enters the global trade and the nature of commodity markets, in which price is the key differentiator, has made the development in mining and metals slower than elsewhere. Furthermore, there is a large difference between the corporate cultures of the trading houses and the large mining companies.
Now why would the resource producers want to merge with traders? What synergies will be achieved in such a combination? The key of the answer is improvement of supplier power. A significant cost reduction and productivity improvement will be achieved by eliminating the trading department of the resource company after transferring the crucial activities to the trading house. However, most money will be made because of improved trading terms.
An exiting additional benefit in the long term could be that mines are going to produce on demand and just in time. If customer A in Japan sends its specified needs to the traders, the next step should be to translate the order into a production schedule for the mine and plant.
Consequences for mining
What will the integration along the value chain imply for miners? First of all they will slowly be forced to think more about the customer and less about the technology. Secondly, the production schedules will need to become more flexible in order to be able to deliver what is demanded. Finally, as the new company will be able to better respond to changes in commodity prices, more mines will start aligning their output volume with demand. In the extreme case this will mean that more mines will temporarily be shut down or sleeping mines temporarily opened again.
Concluding: Mining will become more flexible. Vertical integration including trading houses will not cause a revolution in the industry, but it will change priorities and slowly make the mining industry a more customer-centric environment.