Xstrata is slipping from Glencore's grasp

Ivan Glasenberg has until Friday to salvage the planned scrip merger of his Glencore International with Xstrata. It's not looking promising.

The merger, to create a global mining and commodity-trading giant, is to be executed through a scheme of arrangement. With Glencore unable to vote its 34 per cent stake in Xstrata and a group of shareholders led by Qatar's sovereign wealth fund and supported by Norway's sovereign wealth fund not just prepared but able to block the deal it looks almost certain to fail.

Those dissenting shareholders which have declared they will vote the merger down account for more than the 16 per cent or so at which the scheme, which requires a 75 per cent majority, will be voted down.

The Qataris have said they support the concept of the merger but not its terms. Glencore has offered 2.8 of its shares for each Xstrata share; the Qataris want an exchange ratio of 3.25:1, which Glasenberg has said he isn't prepared to concede, preferring to walk away from a merger that has been a longterm ambition.

Glasenberg hasn't declared the offer final so technically it is conceivable that he could succumb and sweeten the terms sufficiently to get the deal across the line. With most of Glencore's shares held by its employees (including Glasenberg himself), however, he is going to be reluctant to cede more value to Xstrata shareholder and has recently been talking down the consequences of failure.

Ironically the environment should have helped Glasenberg achieve his ambition. While Glencore is, both directly and via its Xstrata holding, exposed to commodity prices and its earnings have suffered as a result, it is primarily a trading business and one with a growing exposure to soft commodities whereas Xstrata is highly leveraged to commodity prices.

The steep fall in most commodity prices that has accelerated through this year should probably have made the merger and its terms more attractive but opposition to the terms has grown through the year rather than diminished.

The opposition does appear to be focused on the terms rather than the concept. There is logic in bringing together Glencore trading expertise, its market intelligence, its own resource assets and its logistics infrastructure next to Xstrata's big portfolio of producing mines. A merger would provide scale, diversification and added value.

Moreover, whether or not the merger is approved on Friday Glencore would continue to own 34 per cent of Xstrata and hold the marketing rights over Xstrata's coal production. The companies are bound together.

Given that it is improbable anyone else could compete for control of Xstrata with Glencore (assuming there was anyone else theoretically able and willing to compete) or that Glasenberg would simply cut his group's ties with the offshoot it played such a pivotal role in creating the focus, assuming the scheme is voted down, will presumably switch to whether or not Glasenberg has a ‘Plan B'.

Schemes of arrangements have the appeal of producing clean outcomes, with 100 per cent ownership.

Their vulnerability is that they have such a high threshold for success is that any significant opposition is likely to see them defeated, particularly (as is the case in the Glencore/Xstrata scheme) if the promoter has a substantial shareholding that will be quarantined from the vote, raising the threshold even further.

It is conceivable that, if Glasenberg doesn't blink before Friday and make some kind of conciliatory gesture towards the dissenting shareholders, he will withdraw to the sidelines while considering how and when to return. A more conventional takeover offer would lower the degree of difficulty for a merger and at least put Glencore unquestionably in control of Xstrata.

It is improbable that Glasenberg would consider a defeat on Friday as anything but a setback. Glencore listed on stock exchanges last year primarily to get a currency for an Xstrata bid that the market understood and could put a firm value on. The merger was no opportunistic gambit but part of a long-held ambition.

Glasenberg may well believe that if the merger is blown up Xstrata shares will tumble and that the market will get a clearer picture of the relative value of the two groups within a commodity downturn that could be prolonged, improving the odds of a successful return. That would buttress the arguments within Glencore against any last-minute sweetening of the scheme's terms.