Javier Blas is the FT's commodities editor
Since Glencore listed its shares earlier this year, the key questions has been when, rather than if, the world's largest commodities trading house would attempt a merger with Xstrata, the London-listed miner in which it owns a 34.5 per cent stake.
Credit Suisse, one of the banks involved on Glencore's initial public offering, believes the time for such a move is approaching. The catalyst for the talk about a takeover deal -- and the bank's note to clients -- is that Xstrata's shares continued underperformance of Glencore's stock. Moreover, Glencore would be soon freed to issue more shares if it wants as the six-month lock up from the London Stock Exchange is about to expire in a few weeks.
"The longer the relative rating gap exists, the greater the market focus on a potential transaction will likely become," the bank's mining team wrote on Monday in a note titled "Glencore and Xstrata: Merger potential ahead?". The report is by far the most detailed sell-side look at what a merger would look like and it is stirring debate in the market.
Since Glencore's IPO, the shares of the trading houses have fallen by 21 per cent, compared to a 44 per cent drop for the miner. Xstrata now trades at a 4.5 times consensus 12-month forward earnings, compared to a 6.5 times for Glencore. At Monday's close the trading house was valued at $45.5-billion, against nearly $42-billion for the miner.
A merger would create a gigantic company, with earnings before taxes and interests of $18-billion in 2011, behind BHP Billiton and Rio Tinto and ahead of Anglo American
To be sure, there are obstacles for the transaction, which Credit Suisse's team of commodities analysts acknowledge. First, the current period of market volatility may not be the best time to engage on a multi-billion takeover; second, Glencore is trading below its IPO price and executives may decide to wait for a price recovery; and third, Ivan Glasenberg, chief executive of the trader, could be against paying a premium for control and/or embarking on a hostile takeover bid.
There are some temporary factors that explain why Glencore is outperforming, including the positive effect of Mr Glasenberg buying shares and the move by First Reserve, the private equity company, to convert into equity its stake in Glencore's convertible bond. On Xstrata's side, the company has suffered after it announced some recent over-spending.
Yet, Credit Suisse presents a compelling case for a takeover in which Glencore could pay, at current market prices, a substantial premium to Xstrata's shareholders and still make money out of the deal.
The bank estimates that a Glencore-Xstrata combination would generate synergies of $246-million to $704-million, mostly through trading.
At the mid-point of $475-million, Credit Suisse says that Glencore could pay a 42 per cent premium in an all-equity deal. Of course, that leaves aside the question of whether Xstrata's shareholders would like to hold Glencore's paper, or rather prefer a cleaner exit and be paid in cash.
"At current levels, Glencore could use its premium-rated equity and pay a significant premium without a deal being dilutive," the bank says. So time will tell but the potential for a $70-billion merger is growing by the week.