Glencore Incentive Remains as Rio Raises Profit While Debt Falls

Oct. 16 (Bloomberg) — Ivan Glasenberg has plenty of financial reasons for Glencore Plc to make another offer for Rio Tinto Group, the world’s second-biggest miner.

Besides transforming his company into the second-largest exporter of iron ore, paying Glencore’s traditional premium of about 10 percent for Rio with its own stock would boost the Baar, Switzerland-based group’s earnings by 21 percent this year and 2.9 percent in 2015. It also would allow the accountant- turned-billionaire chief executive officer to cut Glencore’s net-debt ratio by 54 percent, according to data compiled by Bloomberg.

Glasenberg approached Rio in July about a merger, and the London-based company rejected the idea a month later. Glencore said this month that it’s no longer pursuing Rio and is barred in most circumstances from another offer for six months under U.K. takeover rules.

The $160 billion entity created by the merger would usurp BHP Billiton Ltd. as the largest mining company with a top-three position in the production of energy coal, iron ore, copper, zinc and aluminum, data shows. A slump in commodity prices to near a five-year low as growth slows in Europe and China would give Glasenberg room to increase Glencore’s bid, making him less likely to be discouraged after Rio spurned his first approach.

“A potential deal would help Glencore materially de- leverage the business,” Richard Knights of Liberum Capital Ltd. in London, who is the top-ranked analyst covering Rio according to Bloomberg and has a sell rating on the stock, said by phone. “What Glencore would want to do is to wait till next year for iron-ore prices to drop further and the commodity cycle to turn in their favor so that they can launch a bid with a big premium.”

BHP Rejected

Glencore may restart talks early next year, Tony Robson, an analyst at BMO Capital Markets Ltd., wrote in an Oct. 14 report. Glasenberg could offer as much as a 28 percent premium for Rio in an all-share deal before it becomes dilutive to Glencore’s net present value, he said.

“Glencore has more to gain than Rio Tinto,” Robson said. A deal is unlikely “without a sizable premium to Rio Tinto’s current share price and would need the approval of some key investors.”

In 2008, Rio rejected a 44 percent premium offered for a takeover by BHP Billiton Ltd. Alberto Calderon, a former BHP executive, said Rio investors would demand a premium of as much as 30 percent, putting it at a cost at which Glencore might balk. That view was echoed by Don Argus, BHP’s chairman at the time of the Rio bid, who told the Sydney Morning Herald last week that Glencore would have to pay “dearly in a premium.”

Cost Savings

Assuming a 30 percent premium and zero cost savings, an all-share deal would cut Glencore’s earnings per share by 6.4 percent next year, the data show. Still, a further decline in iron ore prices and Rio’s shares would allow Glencore to afford a higher premium, according to Knights.

Glencore’s traditional 10 percent premium is derived from deals over the past decade, two-thirds of which have taken place at a premium of 10 percent or less, according to data compiled by Bloomberg. That’s below the mining industry’s 2014 average of 39 percent, according to the data. They were dominated by the $29 billion acquisition of Xstrata Plc, where Glencore paid a 4.8 percent premium, the data shows. The company paid a premium of 33 percent when it bought Viterra Inc. for C$6.1 billion ($5.4 billion) in 2012.

The boost to earnings excludes the benefit of any cost savings the deal would bring, which Deutsche Bank AG estimates at $5 billion before tax.

Cash Machine

A combination also would more than double Glencore’s earnings before interest, tax, depreciation and amortization margin to 10.8 percent, the data show. The merged entity’s net debt, including Glencore’s trading inventories, to trailing 12- month Ebitda ratio is 2.3 compared with 5 for the Swiss company, according to data compiled by Bloomberg.

In rejecting Glasenberg’s July approach, Rio Chairman Jan du Plessis said the London-based company is better off sticking with its strategy of reducing costs and returning cash to investors under 64-year-old Australian CEO Sam Walsh.

In an August interview, a month after Glencore’s initial approach, which was only revealed last week, Walsh said the company was a “cash machine” thanks largely to its iron-ore business that generates almost 90 percent of its profits.

Rio declined to comment for this story. A spokesman for Glencore also declined to comment.

Xstrata Deal

After being rebuffed by the board, Glencore queried Rio’s biggest investor, Aluminum Corp. of China, to gauge its interest in a potential deal in the next year, people familiar with the matter said last week.

“There is a chance that a merger between Rio Tinto and Glencore may go ahead in the long term, given just how much sense it makes,” Investec Plc analysts led by Marc Elliott wrote Oct. 7. “A merger would strengthen Glencore’s balance sheet and deliver greater diversification to Rio Tinto’s shareholders from what has become a largely iron ore miner.”

Through a series of deals over the last decade, South African-born Glasenberg has transformed Glencore from a little- known commodity-trading firm into a diversified global mining group. The 57-year-old’s biggest deal so far, the acquisition of Xstrata in 2012, made the company the world’s fourth-largest mining group at the time. With significant operations in copper, nickel and coal, the only major commodity it doesn’t figure prominently in is iron ore.

Commodity Slump

Iron ore, the world’s most traded commodity after oil, has slumped 39 percent this year and traded at a five-year low last month. An expanding glut of the steel-making raw material, driven by record expansions of mines in Australia and Brazil, has hurt prices and crimped margins for producers.

The Bloomberg Commodity Index diminished 12 percent last quarter, the most since 2008, on rising supplies of everything from oil to corn and as a stronger dollar made raw materials more expensive in other currencies. The Bloomberg World Mining Index of 104 stocks is down 5 percent this year.

European Central Bank President Mario Draghi said last week there are signs the region’s recovery is losing momentum, and that expanding the ECB’s balance sheet is the last monetary tool left to stave off deflation in the euro area. Federal Reserve minutes showed the U.S. economy faces the risk of a global slowdown, while the International Monetary Fund last week cut its forecast for world growth.

China is the largest user of commodities from soybeans and copper to iron ore. The nation’s economy will expand 7.3 percent this year, the least since 1990, economist estimates compiled by Bloomberg show.

Market Vision

Against this global economic backdrop, Glencore’s CEO is seeking to consolidate his influence with what would be the mining’s industry’s biggest transaction. Glasenberg is Glencore’s second-biggest shareholder with an 8.3 percent stake, valued at about $5.5 billion.

“The only thing that is clear” is that Glasenberg is always ahead of the market, former BHP executive Calderon said in an interview with Channel 9’s Financial Review on Oct. 12. “In terms of a merger of equals, is it good for Glencore? It’s pretty fantastic. Is it good for Rio Tinto shareholders? It’s unlikely.”

Rio investors will see their company’s net debt to Ebitda ratio rise to 2.3 from 0.8 and their Ebitda margin slump by more than two-thirds if the two companies are combined, based on an all-share offer with a 10 percent premium, data compiled by Bloomberg shows. The Ebitda of the merged group would be $31 billion, almost triple that of Glencore.

Commercial Logic

“The strategic and commercial logic behind the combination is compelling,” Paul Gait, an analyst at Sanford C. Bernstein, wrote in an Oct. 14 report. A “modest” 20 percent premium for an offer funded 75 percent by new shares and the remainder in cash would boost earnings by 16.4 percent between 2014 and 2017, he said.

Glasenberg, who was once an Olympic-standard competitive walker, honed his reputation as a skilled negotiator and charismatic dealmaker over 30 years in the commodity trading business since joining Glencore’s predecessor firm, Marc Rich & Co. in 1984.

“This deal has got so much more to play out,” Evan Lucas, markets strategist in Melbourne at IG Ltd. said by phone. “It’s likely to roll on for at least the next two years. We don’t think Glencore is done yet.”

Peter Grauer, the chairman of Bloomberg LP, the parent of Bloomberg News, is a non-executive director of Glencore.

–With assistance from James Paton in Sydney and Shin Pei in New York.

To contact the reporters on this story: Jesse Riseborough in London at [e-mail]; Dinesh Nair in London at [e-mail] To contact the editors responsible for this story: Will Kennedy at [e-mail] Dylan Griffiths, Randall Hackley