Mining Investors Can Take Their Pick

Times are a-changin' for global miners.

Glencore and Xstrata's proposed $90 billion tie-up will bring a unique model to the sector, combining mining with commodities trading. In truth, the world's biggest mining companies are already following divergent paths, from BHP Billiton's investment in shale gas and potash, to Rio Tinto and Vale's single-commodity focus. The question for investors is which model offers the most reliable returns.

Risks for miners are certainly accumulating. A hard landing for the Chinese economy would hit commodity prices hard, particularly iron ore, where China accounts for 60% of global demand. High energy and salary costs are eating into margins. Governments are also targeting the sector: The threat of outright mine nationalization lingers in places such as South Africa and Mongolia.

Against this backdrop, BHP Billiton's model is the most defensive, given its focus on a few major projects across a range of commodities in politically stable countries. Its problem lies in matching some investors' hopes for short-term returns against its desire for a portfolio to satisfy long-term commodity demand.

For example BHP's large investment in U.S. shale gas may not see a positive return before 2020 if gas prices remain subdued, HSBC estimates. BHP's heavy capital-expenditure program means its free cash flow yield could trail its peers by next year, limiting scope for higher dividends or share buybacks, according to brokerage Jefferies.

Still, BHP's balance between risk and reward looks attractive relative to its rivals. At 8.8 times expected 2012 earnings, the shares trade more cheaply than all but those of Rio Tinto and Brazil's Vale, according to FactSet. Yet Rio relies on one Australian iron-ore mine for 70% of its earnings. Vale is even more concentrated on iron ore; it accounts for more than 90% of its operating profit.

True, Anglo American is more diversified, but its political risk is higher, with around 40% of earnings generated from assets in South Africa. Glencore-Xstrata, meanwhile, is likely to grow more through acquisition. But that could take it into lower-quality assets in politically risky areas; claims that Glencore's trading arm will enhance and smooth earnings remain unproven.

Merger mania may have brought near-term excitement to the mining sector. But for investors with a longer horizon, BHP Billiton still looks a keeper.

Source: http://online.wsj.com/article/SB10001424052970204062704577222902312816094.html?mod=WSJ_Heard_LEFTTopNews

Glencore and Xstrata: Ore inspiring

ANALYSTS have been poring over the mathematics of the proposed all-share merger between Glencore and Xstrata, announced on February 7th, trying to work out which side has the better of the deal. Is one share of Xstrata, a mining company based in Switzerland but listed in London, a fair swap for 2.8 of its Swiss neighbour, Glencore, a miner and by far the world’s biggest commodities trader? Mick Davis, Xstrata’s boss, proposed a different equation for investors to ponder. “One plus one…equals 11,” was his summary of the merger’s merits.

Mr Davis, an accountant by training and a qualified cricket umpire, is generally given to more sober judgments. Perhaps he can be excused his excitement. A deal would forge the world’s fourth-largest mining company with a market capitalisation not far shy of $90 billion, and Mr Davis will be its chief executive.

The return of the mining mega-merger was no surprise. Ivan Glasenberg, Glencore’s boss, has long talked as if a merger had already taken place. His company owns 34% of Xstrata, which was formed by a spin-off of Glencore’s coal mines in 2002. Part of the motivation for Glencore’s initial public offering last year was to put a value on the company and give it a currency with which to strike a deal.

The alliance would extend Xstrata’s lead as the world’s biggest thermal-coal miner, giving it more than one-tenth of the market, and make it the global number-three in copper. With more mines in more countries, the new firm’s risks would be spread more widely. Half of Glencore’s business is buying and selling commodities. With all Xstrata’s output at its disposal, it would be better able to blend coal and ores to customers’ specific requirements and exploit price differentials around the world.

A combined company would also be able to grow more quickly than two separate ones in a business where scale is everything. It should have a lower cost of capital, which would help it buy yet more companies. Xstrata went from tiddler to giant in a decade thanks to a string of canny purchases by Mr Davis. Teaming up with Glencore’s worldwide network of traders, always on the lookout for a deal, would give it a head start over competitors. Glencore has snapped up mines in Africa and Asia before anyone else knew they were for sale. Big rivals already have to resort to pricier hostile takeovers or open tenders for new assets; the merger would make their task harder. A larger company should also be better equipped to cope with the risks of digging in countries where politics is making life more difficult for foreign miners (see article).

Size can cause problems with officials as well as create advantages. It is possible that the world’s antitrust authorities may not like the look of a merger that unites a dominant commodity trader and a leading miner of lead and zinc as well as coal and copper. Yet Glencore already sells plenty of what Xstrata hoicks out of the ground and the combined company’s market share would be up to 12% (in zinc). Trade in these commodities is highly competitive.

Of late both Glencore and Xstrata have favoured fairly small acquisitions. However, their union could be the first in another round of big mergers, of the sort that reshaped the mining industry several years ago. Mr Glasenberg has spoken of the merged company playing a “decisive role in industry consolidation”. Several analysts have identified Anglo American, the smallest of the five global mining giants, as the likeliest target, even though buying Anglo would mark a change of style for Glencore and Xstrata. Glencore has bought smaller mining companies; Xstrata’s skill lies in wringing more out of mines more cheaply by rejigging operations and financing. Anglo’s vast mines are already among the most efficient.

The merger’s logic may be hard to dispute. But Xstrata’s shareholders are unhappy. They believe that in the attempt to create a mining behemoth they are being short-changed. A couple of large institutional investors have threatened to block a deal that they believe favours Glencore. Xstrata brings better assets, a stronger balance-sheet and rosier prospects for growth, according to Andrew Keen of HSBC, a bank. Investors have had trouble understanding and valuing Glencore’s trading business. Its shares change hands for much less than their initial offer price.

Xstrata’s investors are probably hoping to improve the terms of the deal rather than to stop it. The chances are that the merger will go ahead, in which case Mr Davis and Mr Glasenberg will have broken a recent trend. Several proposed giant mining mergers have come unstuck. Efforts to merge all or parts of BHP Billiton and Rio Tinto foundered. Anglo American rebuffed Xstrata. Glencore blocked the pursuit of Xstrata by Brazil’s Vale. In mining one plus one often adds up to nothing.

Source: http://www.economist.com/node/21547284

Glencore Must Dig Deeper for Xstrata

Ivan Glasenberg is a man in a hurry.

Just eight months after Glencore's $59 billion stock-market flotation, the chief executive of the Swiss mining giant has proposed an all-share merger of equals with sister company Xstrata in a deal that could create a company worth $82 billion. Mr. Glasenberg has made no secret of his ambition to re-combine the two groups, which were split apart following Xstrata's 2002 IPO. Glencore has until March 1 to make a formal offer. But Xstrata shareholders should demand that Glencore pay a premium.




First, a deal without a premium won't be a true merger of equals. Glencore already owns 34.1% of Xstrata, whose market value was $34.6 billion at Wednesday's closing price. Add that to Glencore's own market value of $47.2 billion, and its shareholders will control roughly 58% of the combined group. What is more, around 80% of Glencore's shares are held by its employees, giving them 46% of the combined group. Though management and board responsibilities could be split equally, it seems Glencore's current shareholders will have the upper hand. Having Mick Davis, Xstrata's CEO, as the combined company's head might soothe some nerves, but investors might worry how long Mr. Glasenberg might be prepared to play second fiddle.

Second, it isn't clear a merger will create value. Cost savings are likely to be minimal, at up to $110 million, according to Credit Suisse. Glencore has previously argued that the real value of a deal lies in economies of scale, in particular the opportunity for Glencore's traders to source cheap product from Xstrata's mines. But Mr. Davis has historically questioned these benefits. At best, revenue and cost synergies could total only about 5% of expected 2012 combined net income, or about $475 million, according to Credit Suisse. Capitalized, that is worth around $4.8 billion. On the other hand, Xstrata has strong organic growth opportunities on its own that investors may be reluctant to see diluted by exposure to Glencore's low-growth trading operations.

Third, Xstrata investors may wonder why now. By Wednesday's close, Glencore's shares had fallen 18% since its May float, but Xstrata's had fallen 20%, with both stocks significantly underperforming their peers. But the outlook for the price of copper, Xstrata's main commodity, has recently started to look more bullish, rallying from October's low of $6,635 a metric ton to $8,440 a metric ton amid talk it might regain its 2011 peak of $10,000 a ton. Mr. Glasenberg is a canny trader, and the timing of his approach looks opportunistic.

But Xstrata shareholders shouldn't raise their hopes of a large premium from Glencore. The reality is that rival bidders are likely to be discouraged by the need to offer a hefty premium to persuade Glencore to sell; besides, other major miners seem set on organic growth strategies. A merger with Glencore would at least resolve what both sides agree is an unsustainable situation. But unlike Mr. Glasenberg, Mr. Davis has the luxury of time. He should use it to full advantage.

Source: http://online.wsj.com/article/SB10001424052970204662204577199023982885362.html?mod=WSJ_Heard_LEFTSecondNews