Glencore-Xstrata merger at risk of falling apart

A landmark plan to create one of the world's largest mining companies is at risk of crumbling.

The proposed $30-billion (U.S.) merger between Glencore International PLC and Xstrata PLC, which stood to reshape the mining industry and represented one of the biggest deals in the sector's history, ran into a sudden roadblock late Tuesday when a key Xstrata shareholder said it would oppose the deal unless the terms improved.

The announcement by Qatar Holdings (QH), a sovereign wealth fund that owns about 11 per cent of Xstrata, came as a shock to investors and analysts because the fund had long been considered a supporter of the deal.

The fund's about-face has now thrown the deal into question. "This news is surprising," Tony Robson, an analyst at BMO Nesbitt Burns, said in a report Tuesday, "as BMO Research (and others) had assumed QH was increasing its holdings in [Xstrata] in order to approve the deal and convert to [Glencore] stock."

Glencore owns 34 per cent of Xstrata and has been plotting to take full control for years. It finally unveiled a bid in February, offering 2.8 Glencore shares in the new entity for each Xstrata share. The deal would create a mining behemoth.

Switzerland-based Glencore, one of the world's largest commodity traders, recently acquired Regina-based Viterra Inc., Canada's largest grain handler, for $6.1-billion.

Anglo-Swiss Xstrata is a dominant miner of zinc, copper, thermal coal – and nickel, thanks to its 2006 purchase of Toronto-based Falconbridge Ltd. Together, the two would form the world's fifth-largest mining company.

Qatar had been accumulating a position in Xstrata since the proposed merger was announced, increasing its stake from 3 per cent in February to nearly 11 per cent today. All along analysts, investors and company officials believed the fund supported the deal. The backing was crucial because the merger requires approval of 75 per cent of Xstrata shareholders, excluding Glencore, at a meeting on July 12. That means a "no" vote by just 16 per cent of shareholders, or even fewer depending on the turnout at the meeting, could thwart the deal.

While some shareholders had complained about the terms of the transaction and what they felt were exorbitant retention bonuses for Xstrata executives, most analysts expected the deal to be approved mainly because of the backing of the Qatar fund. The bonuses, which will see Xstrata chief executive officer Mick Davis receive as much as $44-million in total, must be approved by a majority of Xstrata shareholders, excluding Glencore, for the deal to go ahead.

Everything changed Tuesday with the Qatar fund's announcement.

"In order to provide clarity to the market, QH announces that it has today informed Glencore that, whilst it sees merit in a combination of the two companies, it is seeking improved merger terms," the fund said in a statement. "QH believes that an exchange ratio of 3.25 new Glencore shares for every one existing Xstrata share would provide a more appropriate distribution of benefits of the merger whilst properly recognizing the intrinsic standalone value of Xstrata."

It's unclear where QH's move will leave Glencore and its feisty CEO Ivan Glasenberg. He has insisted for weeks that sweetening the bid would make the deal uneconomical. However, some analysts have suggested that if the deal doesn't go through, the share price of Glencore and Xstrata could tumble. The share price of both companies has been buoyed by the prospect of the merger and if that is gone, both will feel the full effect of falling commodity prices. Glencore's stock could drop as much as 23 per cent and Xstrata's by up to 39 per cent, according to a recent report by Merrill Lynch.