16 February 2012 – Shareholders in Xstrata Plc shouldn’t expect that a takeover by Glencore International Plc will deliver a windfall if the history of the deals that created two of its biggest rivals is any guide.
Rio Tinto Group’s London shares gained 0.5 percent in dollar terms in the five years after the company was formed in 1995, a time when aluminum producer Alcoa Inc. more than doubled, data compiled by Bloomberg show. BHP Billiton Ltd. climbed 270 percent in dollar terms in Melbourne in the five years after the largest mining company was created in 2001, trailing the quadrupling of Freeport McMoRan Copper & Gold Inc. and the sevenfold surge at Vancouver-based Teck Resources Ltd.
Glencore’s 23 billion-pound ($36 billion) offer for Xstrata to establish the fourth-biggest mining company behind BHP, Vale SA and Rio Tinto has sparked criticism from shareholders who say the premium offered doesn’t value the coal producer’s outlook. The terms of the bid mean Xstrata holders with 16.48 percent of the stock can block the deal.
“Mergers and acquisitions generally haven’t delivered a great deal of price appreciation across the board,” Peter Hickson, Hong Kong-based head of commodities research at UBS AG, said by phone. “In the case of mining companies, you’ve just got to be really careful as performance is very much colored by prices and conditions.”
Glencore, the world’s largest publicly-traded commodities supplier, offered 2.8 of its shares for each one in Xstrata to acquire the 66 percent of the Zug, Switzerland-based company it doesn’t already own. Schroders Plc and Standard Life Plc oppose the terms. Fidelity Worldwide Investment called for the bid, described by RBC Capital Markets analysts as a “lowball” proposal, to be revisited.
“The norm is that they usually subtract value,” Peter Major, an analyst at Cadiz Corporate Solutions in Cape Town who’s been covering the mining industry since 1989, said by phone. “More often than not, I think three-quarters of the time, it’s value destructive.”
Rio Tinto was created when London-based RTZ Plc merged with Melbourne-based CRA Ltd. in October 1995. BHP Ltd., based in Melbourne, bought Billiton Plc in an all-stock deal, announced in March 2001.
Since its listing in 2002 in London, Xstrata more than tripled. In the five years after its market debut, it had a total annual return, including reinvesting dividends, of 39 percent. That compares with the 6 percent annual return on Rio Tinto’s London shares in the five years after it merged with CRA, and with BHP’s 23 percent annual return in Australian dollars in Melbourne after it bought Billiton in 2001.
Fidelity, which holds at least 1.5 percent of Xstrata, said Feb. 10 that while it supports the bid “in principle” the terms “need to be revisited.” Royal London Asset Management Ltd. owner of about 0.4 percent of Xstrata, last week said the company needs to prove to holders the takeover will be beneficial for investors.
“The consistent feedback we have received from Xstrata shareholders is that the current offer of 2.8 does not reflect a sufficient premium,” Credit Suisse Group AG analysts led by London-based Liam Fitzpatrick said in a Feb. 13 report. “There are a number of valuation issues but we believe the unknown quantity of Glencore is as big an issue as any with investors.”
The investor concerns about the premium have been given more weight by the fact that Glencore won’t be allowed to vote its 34 percent stake in Xstrata, according to the U.K.’s takeover code, putting the final decision into the hands of the shareholders who control the rest of the company.
Xstrata Chief Executive Officer Mick Davis signaled Feb. 7 when the deal was announced that he expected shareholder backing for the combination of his company’s mining portfolio with Glencore’s global trading and storage network.
“This merger is the logical next step for two complementary businesses, each with an outstanding track record of shareholder value creation, entrepreneurial management and a proven ability to spot valuable opportunities and capitalize on them,” Xstrata said in an e-mailed response to a request for comment on this story. “Glencore Xstrata will be the most diverse major resource group, combining two complementary industrial businesses with the best commodities marketing business in the world to create a company capable of delivering enduring value in a changing industry landscape.”
Ivan Glasenberg, CEO of Glencore, said the deal establishes “the most diverse major resource group, combining two complementary project portfolios and pipelines with the best commodities marketing business in the world.”
A Glencore spokesman declined to comment for this article.
Glencore’s bid represents a premium of about 8 percent, below last year’s average of 23 percent for mining deals. Shareholders in CRA received bonus shares for agreeing to merge with RTZ, which held a 49 percent stake in CRA, equating to a premium of about 7.5 percent, based on the share issue. BHP paid an 11.4 percent premium in shares to win control of Billiton in 2001.
“In the time around 2001 the commodity world was still very much a depressed world,” Mike Salamon, a founding director of Billiton who led the integration with BHP, said in an interview. “It was not a high-growth world. It was a consolidation world.”
To be sure, Rio Tinto and BHP shares outperformed the Morgan Stanley Capital International World Materials Index in the five years after their creations and have continued to outperform since then. Salamon pointed to the scale of the company created by BHP’s takeover of Billiton being an advantage for shareholders.
Mergers “are driven by the opportunities that you unlock,” said Salamon, 56, now executive chairman of Czech coking-coal producer New World Resources Plc. “When China came along in a big way from 2003 onwards there was no one better placed to participate in that in just about every business than BHP Billiton.”
BHP’s merger with Billiton was one of the few deals to create value, Cadiz’s Major said.
The deals also created opportunities for executives in the target companies to lead the bigger groups. Rio Tinto was led by Leon Davis, the former head of CRA, from 1997 to 2000. Two former Billiton executives have been chief executives of the combined company — Brian Gilbertson and Marius Kloppers.
“It’s a very nebulous, subjective thing, but it’s like two heads are better than one on a lot of problems,” Gordon Toll, who was group mining executive for Rio Tinto in London until 1995 and wasn’t involved in the merger talks, said in an interview.
The premium offered by Glencore is the second-lowest for any mining deal worth more than $5 billion, according to data compiled by Bloomberg. Glencore can afford to offer at least 3 shares, increasing the takeover premium for Xstrata to 16 percent, and still add to earnings, according to Jefferies Group Inc.
The terms “don’t appear to equivocally reflect the superior growth outlook for Xstrata and its superior asset base when looking at it in comparison to Glencore,” said Tim Schroeders, who helps manage $1 billion in equities at Pengana Capital Ltd., including Xstrata shares.
“It’s the promise,” UBS’s Hickson said when asked why shareholders would still agree to mergers that offer limited price appreciation. “Maybe, just maybe, Xstrata and Glencore may deliver where BHP and Rio Tinto didn’t.”