Growing impact of combined entity to be ‘focal point’ of change
The merger announcement from Glencore International PLC and Xstrata PLC this week turned heads because the combination of a commodities trading
powerhouse and a major miner, especially those of such size and scope, is a rarity, but if the move succeeds, more may follow.
“Trading houses are going to be the T-Rexes on the mining space from now on,” said Christopher Ecclestone, mining strategist at Hallgarten &
Company LLC, dominating offtake and elbowing the “old mine finance banks out of the way.”
“Trading houses match buyers and sellers and they have the finger on the pulse. Like a discount store, they can always move product by cutting prices.
Miners just don’t have that facility” unless they’re enormous like BHP Billiton or Rio Tinto, he said.
So Glencore and Xstrata may be just the start of a “fascinating new evolution,” said Ecclestone.
On Tuesday, Glencore, the world’s largest commodity trader, and Xstrata, one of the biggest miners, agreed to an all-share merger of equals that would
create a $90 billion natural-resources giant.
“Full integration of an upstream miner and a downstream marketer/trader like Glencore provides a bigger platform for a company to grow through
acquisitions,” said Brian Hicks, co-manager of U.S. Global Investors’ Global Resources Fund. “It would create something similar to an Exxon or Chevron
of the mining space.”
Valued at $48.4 billion including net debt, the deal would be the largest mining sector deal ever, if completed, according to Dealogic.
“The merger of these two already giant-sized companies would create a unique Herculean combination,” said David Millard, chair of law firm Barnes &
Thornburg’s business practice, based in Indianapolis.
The merged entities would “be the number one in coal and zinc together [and have] key market positions in copper, lead and nickel,” he said. “The
combination is unique because it combines a diverse group of resources and pipelines with one of the world’s strongest commodities marketing businesses.”
The move comes on the heels of growth in mining sector mergers and acquisitions, which have climbed over the past two years in number and deal values,
data from Dealogic show.
In 2009, the industry saw 1,915 mining sectors deals valued at a total of $64 billion. By 2011, that rose to 2,714 deals, with a value of almost
$169 billion, according to Dealogic.
“An increase in mergers and acquisitions and one of this record size is monumental for the commodity sector,” said Jeb Handwerger, editor of market
analysis provider GoldStockTrades.com.
“We expect the producers or developers of natural resource assets to have more access to capital,” he said. “This is just the beginning and a huge
step. We may see an increase in bidding wars and large miners looking for growth through M&A activity in the natural resources sector.”
So “get ready for a lot of developments in industrial and precious metal mining in 2012,” Handwerger said.
Clearing the hurdles
The Glencore and Xstrata merger still has to clear regulatory hurdles but most analysts expect the deal to close, potentially paving the way to
stronger growth in mining sector M&As.
“An argument regulators should expect to hear is that Glencore and Xstrata should be viewed as already being one company because of Glencore’s
existing 34% ownership of Xstrata,” said Barnes & Thornburg’s Millard.
Still, “antitrust regulators from the world’s top economies which are, by and large, commodity buyers, will review this closely,” he said, referring to
the effort to gain approval as a “daunting task.”
Michael Bechara, managing director at Granite Consulting Group in Brewster, N.Y., said that “one area that may raise eyebrows for regulators is the
potential loss of transparency in markets in which the combined entity has a strong position.”
Transactions between the companies had been executed at “arms length,” he said. “The combined entity may not provide the same level of openness.”
And there may be certain commodities, such as thermal coal or zinc, in which the combined entity’s size will “attract regulatory attention,” said
Daniel Rohr, a senior equity analyst for Morningstar Inc., but “I wouldn’t expect it to be a deal killer.”
And while the combined entity will have a large presence in some commodities, “it wouldn’t be of the scale where I’d expect to see material pricing
power,” he said.
Sparking a trend?
As for whether the merger marks the start of another round of deals in the mining industry, not everyone agreed.
“Many in the industry seem to think this is the opening act in another round of consolidation. That may very well be the case. These things tend to
come in waves,” said Rohr.
But investors need to ask themselves if consolidation makes economic sense, he said, adding that he doesn’t think it does.
From the perspective of shareholder value creation, there’s little evidence to support the idea that a $90 billion company will be better at creating
value than a $60 billion company, he said, referring to the value of the combined entity versus Xstrata’s value before the deal.
“Mega acquisitions destroy value for the acquirer because they tend to overpay. It’s a classic ‘winner’s curse’ outcome,” he said. The merger with
Glencore values shares of Xstrata at a 15% premium over Xstrata’s closing price on Feb. 1.
Rohr said he doesn’t really see any sort of pattern or trend emerging in terms of merger activity, particularly because Glencore already owned 34% of
Xstrata so the firms were “already deeply intertwined in a number of regards.”
“I don’t view this much-ballyhooed ‘new model’ as a sign of things to come,” he said.
Brien Lundin, chief executive of Jefferson Financial and editor of Gold Newsletter said the merger is really about synergies.
And while he expects to see other deals “where majors acquire resources and earlier-stage production from smaller outfits,” none will likely be as
large as the Glencore/Xstrata tie-up.
For now, the record-breaking merger of Glencore/Xstrata will continue to turn heads as investors take on the “who’s next” scenarios.
The combined entity’s growing impact in the industry will be a “focal point of change in the mining world,” said Julian Phillips, an editor for
Its influence may “eventually challenge the likes of BHP Billiton to be the largest [mining company] in the world,” he said.
The merger, if successful, will also highlight challenges in the mining space.
Base and precious metals miners “need to find or replace mineral reserves and extend mine life, so they will buy smaller exploration players in the
space or seek geo-diversification to reduce political and tax or confiscation risks, which the mining industry is famous [for] in history,” said John
O’Donnell, chief knowledge officer for Online Trading Academy.
Against that backdrop, the industry will see a “continuation of this enterprise consolidation,” he said.
Merger deals the size of Glencore’s and Xstrata’s, however, may not be in the offing.
“While we have seen some small and mid-sized deals in the precious metals sector, there have been no large deals in the past couple of years,” said
Jeffrey Wright, senior research analyst with Global Hunter Securities.
This trend will continue, “with the larger producers looking at smaller companies to replace or secure future production in the coming years,” he said.