Glencore opens the black box

As the chiefs of Glencore and Xstrata take to the road to address institutional investor concerns, there are other complicating factors slowing down the deal.

Glencore’s Ivan Glasenberg is going to embark on a global roadshow with Xstrata’s Mick Davis in April in an attempt to explain his group’s opaque business model to sceptical Xstrata shareholders.

Glencore is still experiencing resistance from Xstrata’s institutional shareholders to the agreed ‘merger of equals’ it announced with Xstrata last month, even though there is a takeover premium built into the terms of the share swap.

Presenting Glencore’s 2011 results overnight, which were in line with the numbers foreshadowed in the merger announcement, Glasenberg said that a lot of Xstrata shareholders aren’t Glencore shareholders and don’t appreciate the group’s asset base or its quality and see its trading activities as a ‘black box’ that they don’t understand.

The roadshow will be an attempt by Glasenberg and Davis to address the concerns about the complexity of Glencore’s trading operations and to explain how bringing its assets and operations next to Xstrata’s will create value.

Most of the complaints about the merger have been about its terms rather than the concept of bringing a traditional mining company next to a business that trades both hard and soft commodities, although Glencore’s disclosure that it had lost $US330 million on trading cotton as a result of the extreme volatility in prices might unsettle some Xstrata shareholders.

So far, however, the more vocal institutional shareholders have been arguing that they want a bigger takeover premium for their shares.

Glasenberg and Davis have plenty of time up their sleeves to try to convince the reluctant shareholders to back the merger. The regulatory obstacles alone will ensure a very protracted process.

Last week the companies announced they would formally notify the European Commission of the merger, which means Brussels will have the ability to frustrate it.

At face value the attitude of competition regulators – and it will have to gain approval in a large number of jurisdictions, including Australia – shouldn’t be a major threat to the deal.

In none of the major markets in which the combined group would operate – thermal coal, coking coal, copper, nickel and zinc – would it have a market share percentage beyond the low teens. All those markets have relatively diverse sources of supply, so the merger wouldn’t appear to lead to any undue concentration of global supply among the biggest miners.

The regulators, of course, could take a more regional approach to defining the markets, which could produce a different conclusion.

Another complicating factor is Glencore’s trading activity and whether the combination of the physical resources and the trading of them by the world’s biggest and most powerful commodity trader has the potential to give the merged group market power, although concentration of supply is a more obvious source of market power than trading, which is more an arbitrage activity than one that confers market power.

In any event, the need for the regulatory approvals means Glasenberg and Davis will have plenty of time to convince the doubters that bringing their two resource bases together and layering Glencore’s trading capabilities over the enlarged base will create the additional value that, when added to the existing premium, makes the offer compelling.

Alternatively, of course, if the transactions does get the requisite approvals from regulators and goes ‘live’, Glasenberg could tinker with the terms to get any significant dissenting block across the line.

This merger has been touted for years and was the key reason the previously quite secretive Glencore floated last year. Glasenberg, having made his play and convinced Davis of its merits, will be reluctant to let it fail.

PS – If cotton’s wild ride last year caused Glencore to lose $US330 million, India’s actions on Monday in banning cotton exports isn’t going to make this year any easier, nor Xstrata shareholders any more comfortable. India is the world’s second-largest cotton producer and the decision set cotton prices soaring.

That is, however, good news for Australian producers, with the Australian Bureau of Agricultural and Resource economics forecasting a near-doubling of Australian exports this financial year.

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