Weighing the Odds of a “Glentinto”

Weighing the Odds of a “Glentinto”

Weighing The Odds Of A “Glentinto”

Whether Glencore makes another run at Rio Tinto after its $160 bn informal bid was rejected a couple of months ago may depend, to a large extent, on the state of the global economy. A lot could change in six months, the period the giant commodities trader must wait under UK takeover rules before making another offer for its even larger mining counterpart.

The price of iron ore – which represents the majority of Rio Tinto’s earnings – has slumped about 40% to US$80 per tonne this year in the face of weakening demand from Chinese steelmakers. If the glut continues (and Rio Tinto has been accused of worsening oversupply by expanding production), Rio Tinto’s shares, already down about 13% YTD, will continue to wilt. In that case, shareholders may grasp at whatever Glencore has to offer.

CEO Ivan Glasenberg has made it known that Glencore intends to grow by acquisition. In 2012 the Swiss trader acquired Xstrata for US$30 billion in an all-share deal, combining its trading business with Xstrata’s mining operations to form a diversified business across several commodities, including copper, nickel, zinc and coal.

Gaining access to Rio’s iron ore would be the icing on the cake. Rio is the largest shipper of seaborne iron ore and the biggest single producer of the steelmaking commodity in Australia. “Glentinto” would be the world’s largest mining company, a powerhouse to eclipse BHP Billiton.

But if the global economy gathers steam and iron ore demand accelerates as a result, Rio Tinto shareholders would have little to gain by tying their fortunes to Glencore, other than a buffer against the cyclical nature of the commodities business that economies of scale can provide. And the deal has other potential flaws and obstacles:

Political Risk

 

Although Rio Tinto does have operations worldwide, including Zambia, Sierra Leone and Mongolia, the company’s assets are concentrated in the relatively safe jurisdictions of Australia and Canada. A merger would expose Rio’s shareholders to Glencore’s assets in politically risky countries such as the DRC and Colombia.

The Chinese Factor

Aluminum Corp. of China (Chinalco), which owns 9.8 % of Rio, would have to agree to surrender its shares to the deal. Why would a company based in China, the biggest market for iron ore, give up the strategic advantage of having ready access to the steelmaking ingredient? Moreover, Chinalco is embroiled in a corruption probe that muddies the waters. The company’s vice president resigned last year and its chairman was just replaced by the mayor of Chengdu, Ge Honglin.

Culture Clash

Rio Tinto is known for its commitment to innovation and exploration. It’s technology and innovation group employs 700, while the exploration division hovers around 500. These initiatives do not warrant much attention in Glencore’s disclosure and, while the once private company may be less forthcoming than its peers, there is no reason to believe Glencore is interested in participating in activities that have such a high risk to reward ratio.

Content Shareholders, For Now

Shareholders have little incentive to sell. Rio has been able to provide a dividend yield of about 4% despite falling iron ore prices by maintaining relatively high profit margins. It is aggressively slashing both its operating and capital expenses to the tune of US$5.3 billion from operating costs and about US$8 bn from Capex over two years. In addition, president Sam Walsh has indicated he will stay on to lead the company, quashing rumours of his departure and the leadership vacuum that would create.

While Glencore has stated that it no longer interested in the merger anyway, several analysts believe the company is just waiting to pounce again. If the global economy fails to accelerate in 2015 and iron prices remain stagnant or continue to drop, Glencore may be able to make a move on shareholders weary of waiting for a recovery.

But if that recovery were already underway, why would shareholders want to trade in a company with a future as bright as Rio Tinto’s?