Glenstrata giant - it won't be that easy

By Alex Brummer, February 16, 2012

Proposed and completed mergers of mining giants do not have a happy history in modern times. A succession of deals including the proposed 2010 BHP Billiton takeover of Potash of Saskatchewan, BHP's offer for Rio Tinto in 2007, Rio's attempt to link with Chinalco in China 2009 and Xstrata's tilt at Anglo-American in the same year came to nothing.

And the deals that have gone ahead, including Rio Tinto's $35.5 billion takeover of Canada's Alcan in 2010, have rarely gone to plan. Rio, a British-based mining group with a history dating back to the 19th Century, was recently required to write down Alcan's value by $8.9 billion in a move which angered investors. It is against this tortuous background that the thermal and copper mining giant Xstrata, run by Mick Davis and its Swiss relation Glencore, run by fellow South-African émigré Ivan Glasenberg, are seeking to bring their companies together in a $90 billion deal.

The idea of merging Glencore and Xstrata to form a company which the City has nicknamed "Glenstrata" comes as no shock. It is what the financial community has been expecting ever since Glencore floated shares on the London Stock Exchange last May, turning Glasenberg into a multi-billionaire. Glencore - which holds 34 per cent of Xstrata's shares - has been the biggest shareholder in the mining group since it broke away from its Swiss-based parent in 2002.

Under the leadership of Mick Davis it conducted a lightning series of takeovers which saw its value increase from $600 million to $59 billion. It has turned into one of the world's leading natural resource firms. By taking Glencore public last year Glasenberg gave his commodity group a "currency" in the form of quoted shares which would allow him to bring together the parent and offspring in a "friendly" deal - a merger of equals.

But agreeing on terms and the executive structure of the new enterprise was never going to be easy.

Obstacles to the merger remain substantial

Glasenberg and Davis have known each other for a long time. They first met at Wits University (Witwatersrand) in Johannesburg where Davis was a part-time lecturer in accounting. The slightly older Glasenberg was a student.

The media idea that somehow Davis taught Glasenberg all he knows about reading accounts may be seductive, but is apocryphal. When news of the deal first emerged it was thought that the hardest part of the transaction would be forging a management structure. In the end it was decided that Davis, with the longer experience of running a public company, would be chief executive and Glasenberg his deputy. Chairman would be Sir John Bond, the former executive chairman of HSBC. Carving out a management structure which could accommodate two such powerful figures as Davis and Glasenberg was difficult enough. Convincing the City that the transaction is one which is made in heaven is proving even harder.

Big battalion investors quickly decided that Xstrata was a more valuable enterprise than Glencore. Davis's operation is based on extraction of natural resources and the earnings generally are reliable. In a world of fast-growing emerging markets demand for thermal coal, copper and other minerals is insatiable. Glencore also controls valuable mining assets in Africa and beyond, but its principle business - dating back to when it was founded by the controversial financier Marc Rich - has been trading commodities from corn to copper.

Its earnings are far more exposed to the vicissitudes of global markets. Xstrata shareholders demanded a premium for their stock and a modest increase of 8.5 per cent to 15.5 per cent. But what has quickly become clear is that several major shareholders including Standard Life, Schroders, Royal London and Fidelity Worldwide Investments believe this premium is not enough.

So Davis, Glasenberg and a big team of investment bankers may well have to go back to the drawing board. But even if financial terms can be agreed (and because of the structure of the transaction it only requires 16.5 per cent of outside shareholders to defeat it) the obstacles to the merger taking place remain substantial.

The deal places a large part of the world's thermal coal, copper and zinc in the hands of Xstrata as well as a number of other minerals. A deal also means that the combined company will have control over the whole chain of production from the mines to refining to marketing. Moreover, its dominant position in commodity trading could potentially lead to conflicts of interest. At the very least, the deal - if it goes through - will be reviewed by the European Commission on competition grounds. But national authorities across the world, especially those with big resource interests will also be interested. Whether the deal is completed or not "Glenstrata" and its constituent companies will remain an overwhelming force in commodity markets and the principals - Glasenberg and Davis - among the super-rich.

What is remarkable in Davis's case, is that despite running one of the world most complex and largest businesses, he remains a stalwart of community development through the Jewish Leadership Council. Others in a similar position might have left the petty disputes and egos of British Jewry behind many years ago.

Alex Brummer is City Editor at the Daily Mail

Last updated: 11:57am, February 16 2012