Shell deal triggers fresh look at Rio

A mega-takeover in the oil sector will have fund managers immediately doing the numbers on a Glencore/Rio takeover.

Summary: If Royal Dutch Shell’s takeover bid for BG Group proceeds, it will be seen as a sign that Shell believes oil prices have bottomed. Although the iron ore price seems likely to continue falling before reaching a bottom, the threat of reduced profits could be a potential trigger for Glencore to make a fresh bid for Rio Tinto. This week also marked the end of the six-month bid-renewal moratorium, freeing Glencore to move again.

Key take-out: Fund managers are keen to see more takeover activity, and if they decide commodity prices are bottoming they have the capacity to start a feeding frenzy in the resource sector.

Key beneficiaries: General investors. Category: Mining stocks.


 

Atlas Iron – the struggling iron ore mid-cap – did a lot more than request a suspension of trading in its shares this week. It restarted the debate about when (not if) Glencore will make its next takeover move on Rio Tinto.

Despite Atlas being a mining minnow which only produces iron ore, it is that mineral which represents a common thread connecting it with two of the world’s resource giants – at a time when there are hints of other big merger deals in the resources sector.

In the oil industry Royal Dutch Shell is said to be planning a $US68 billion bid for the gas-specialist BG Group which controls one of Queensland’s new liquefied natural gas projects.

If the Shell/BG deal proceeds it will be seen as a sign that Shell believes oil prices have bottomed and now is a good time to acquire under-valued assets.

Fund managers, particularly those in London, where many of the most powerful institutional investors in both Shell and Glencore are based, are keen to see more takeover activity. After several lean years these global institutional investors are egging on management at both companies to make things happen.

A takeover bid by Shell, albeit one in the oil sector, has the potential to reverberate across the heavily-discounted resources sector.

That might not be the case with iron ore, yet, because its price (now a remarkably low $US47 a tonne) seems likely to continue falling before a bottom is reached, perhaps later this year, with declining Chinese steel production and severe over-production of iron ore weighing heavily on the sector.

But the financial stress at Atlas is a sign that low prices are biting and will also be hurting Rio Tinto which earns 80 per cent of its profits from iron ore with the threat of reduced profits a potential trigger for Glencore to move.

What's more the trading suspension contained another reminder of the Glencore v Rio Tinto situation because, coincidentally, yesterday (April 7) was the official starting date for Glencore being allowed to make a fresh merger proposal to create the world’s biggest mining company.

For the past six months the attempt by Glencore to amalgamate with Rio Tinto has been sidelined thanks to British law which requires a six-month gap between a proposal being rejected and a fresh bid being launched. 

Glencore is now free to push ahead with its unwanted merger overtures which Rio Tinto firmly rejected last year. The timing of the next move by Glencore is critical.

Based on current valuations Glencore might seem to have little chance of immediately winning a takeover bid.

Not only is Glencore a smaller company with higher debt levels but its profits have been buffeted by the same fall in prices which has hit all commodity producers.

Any merger proposal is likely to include a share-swap component and Glencore’s chief executive and biggest individual shareholder, Ivan Glasenberg, would probably prefer until swap-ratios move in his favour rather than risk being excessively watered down.

Glasenberg would also like to see the iron ore price continue its fall, waiting to see in iron ore what Shell sees in the oil price before making his move.

But that’s why the apparent collapse of Atlas Iron becomes a critical factor in Glencore’s plans because the troubles at Atlas have been caused by more than a downward leg in a conventional commodity-price cycle.

Atlas has been whacked by a deliberate flooding of the iron ore market by the world’s biggest, including Rio Tinto.

Until now most Australian investors have been prepared to accept Rio Tinto’s argument that flooding the iron ore market is a sensible business tactic with the key argument being that if Rio Tinto did not provide the ore other companies would.

Flooding, it has been said, ensures retention of market share, and apart from that the iron ore price had to fall a long way before it affected the profits of the biggest producers.

Australian investors have also accepted the argument that competition regulators in Europe, the US and China would not permit a merger of Glencore and Rio Tinto.

However, competition becomes less of an issue if Glencore promises to strip out most of Rio Tinto’s other assets, retaining only iron ore which, as I said earlier, represents 80 per cent of Rio Tinto’s profits.

Rio Tinto’s biggest shareholder, the Chinese Government-controlled business Chinalco, might even be amenable to getting its hands on surplus Rio Tinto assets in exchange for supporting a Glencore bid, especially as it once tried (and failed) to buy Rio Tinto itself.

Since speculation on Glencore and Rio Tinto has resurfaced Treasurer Joe Hockey has said a merger will not happen “on his watch”. Of course this statement does not cover a breakup scenario for Rio Tinto or what might happen should the Treasurer lose his position.  

To recap: There have been a number of recent developments which re-ignite the Glencore v Rio Tinto situation. They are:

· The passing of the six-month bid-renewal moratorium.

· The price of iron ore collapsing further than most people expected. Whereas $US50 a tonne was once seen as the low-water mark there is now talk of a fall to less than $US40/t.

· Speculation that if the price does drop through $US40/t it would even take Rio Tinto’s iron ore operations close to their profitability threshold because while the official cash cost of Rio Tinto iron ore is less than $US20/t the all-in sustaining cost is much higher.

· A growing belief that the iron ore price collapse is becoming one of the mining world’s most expensive own goals with Rio Tinto a major contributor to the pressure it’s under, a point Glencore will hammer home at every opportunity.

· The problems at Atlas and the potential removal of its annual output of 13-to-15 million tonnes of iron ore each year appearing to have been the cause of a $US1/t rise in the iron ore price overnight.

· Then there is another factor at work; fund managers desperate for deals to bolster the performance of the assets they manage.

If the money men of London decide that the commodity-price cycle is bottoming then they have the capacity to start a resource-sector feeding frenzy – and wouldn’t that be fun!