For the first time since the planned $65bn mega merger of Glencore and Xstrata, the deal looks like it faces serious headwinds. Until now, opposition came from shareholders objecting to the eye watering retention payments dreamt up by the board to ensure their own continuation in their executive roles. The chief executive Mick Davis alone, said to earn gain $173m, caused such a row that the Xstrata board sought to defuse it by amending the terms such that he receives shares instead of cash. Additionally, he would also need to identify $300m of savings. That doesn’t sound like much of a payback to shareholders. Some may say cost cutting looks like the easy part. But cutting costs while improving performance that can prove more challenging. Furthermore, the improving performance part didn’t seem like part of the deal.
Opposition arose from investors with David Cumming, head of equities at Standard Life in the vanguard furious that some $300m would go toward senior executives for a deal they had dreamt up in the first place. Still in itself, moves by the board to amend the terms ahead of a shareholders meeting in July looked like it may have defused the opposition. However, this development has taken second stage to an even bigger bombshell dropped this week by Xstrata’s largest investor the sovereign wealth fund Qatar Investment Authority (QIA). That organization has more or less demanded a higher price for Xstrata shares in return for backing the merger. Success requires approval by 75% of Xstrata’s shareholders but as Glencore cannot vote, its 34% stake in Xstrata doesn’t count meaning a no-vote from 16.75% of the remaining investors could block the tie-up. Qatar has built up a 10.4% stake in the miner over the last three years valued today at some $4bn. Having kept their own council about the purchase price (Glencore had offered 2.8 Glencore shares per Xstrata share) the QIA have announced just days before the shareholder meeting saying they require 3.25 Glencore shares in return for each Xstrata share to guarantee their backing. According to a Reuters article, at a ratio of 3.25, the offer would be worth $30 billion as opposed to $26 billion for a ratio of 2.8. A counter offer from Glencore remains a possibility and some expect they may come back with a 3 for 1 offer but so far Glencore have not made any response.
Playing a high risk game
Arguably the value of all miners has dropped since the first quarter of this year as commodity prices have slumped. Using the Thomson Reuters-Jefferies CRB index, a barometer for commodities, the index has dropped by about 14% since early February, coincidentally at the time of the deal announcement. Xstrata, as a sizable coal miner, has seen the value of thermal coal mining companies drop the most, particularly in the US where some values have dropped by 90%.
Glencore could decide to withdraw their bid and wait out the market. 12 months from now Xstrata may represent better value. Apart from the senior executives hoping for lucrative retention packages, a collapse of the deal would also wield a heavy blow to a long list of bankers acting as advisers to one side or the other, including Citigroup, Morgan Stanley, JP Morgan and Deutsche Bank. Glencore plays two roles both as miner and traders. They look at this deal with a long view. Even at a ratio of 3.25 they may decide the value holds in the long term but Glencore, largely owned by its management, and such a price would result in a 10% dilution of their shareholding. It’s likely too high a price for a firm that has prided itself on its deal-making prowess.