Glencore-Rio Talk Pushes Industry to Evaluate Future: Real M&A

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Oct. 8 (Bloomberg) — The prospect of Glencore Plc buying Rio Tinto Group is sending reverberations through the mining industry that could prompt more deal talks.

Combining Glencore and Rio, which both confirmed they held informal discussions in July, would create a $162 billion behemoth. That such a merger would even be attempted speaks to the pressure the industry is under to cut costs and increase shareholder value amid declining prices for commodities.

A slump in iron ore gave Glencore a chance to go after a cheaper Rio and make it part of a diversified portfolio. With the deal now likely on hold for six months, Glencore could turn to other targets such as Fortescue Metals Group Ltd. Or Rio could pursue a defensive deal with a company such as Anglo American Plc, according to Sanford C. Bernstein & Co.

“This is a hell of a thing they’re proposing,” Paul Gait, an analyst at Bernstein, said in a phone interview. In the past, “we have had that kind of one action precipitate a whole cascade of events that puts a number of other guys in play.”

Glencore approached Rio in July about a merger, and Rio rejected the idea a month later. Rio Chairman Jan du Plessis says the $92 billion company is better off with its current strategy of cutting costs and returning cash to investors.

Glencore said yesterday it’s no longer actively studying an offer for Rio, and under U.K. takeover rules it will now be barred from a renewed attempt for six months unless it obtains Rio’s board recommendation, a third party makes an offer for Rio or there are other material changes.

A representative for Baar, Switzerland-based Glencore declined to comment beyond the company’s statement yesterday. Spokesmen for Rio and Anglo, both based in London, also declined to comment. A representative for Fortescue didn’t immediately respond to requests for comment.

Other Options

Rio isn’t Glencore’s only option. Fortescue, a $9.4 billion Australian iron ore producer, may provide another way for the world’s third-biggest miner to expand in the metal, according to Marc Elliott, an analyst at Investec in London.

“Glencore likes deal flow and probably has got some other irons in the fire,” Elliott said in a phone interview. Fortescue is “certainly of the scale that would give interest to Glencore.”

Other analysts have speculated Anglo could be more digestible for Glencore than Rio. The $31 billion company controls copper, coal, iron ore, nickel, diamond and platinum mines. Chief Executive Officer Mark Cutifani is open to takeover offers, the Wall Street Journal reported last month, citing an interview.

Not Ideal

Deals for those two companies have hurdles, though. Fortescue’s iron-ore business isn’t of the same caliber as Rio’s and Glencore probably wouldn’t want Anglo’s platinum and diamond businesses, said Jeff Largey, a London-based analyst at Macquarie Group Ltd. Glencore CEO Ivan Glasenberg last month scoffed at the idea he has his sights set on Anglo.

That suggests Rio may be the best acquisition candidate for the company. The pursuit is probably not over, say Elliott of Investec and Gait of Bernstein.

“It’s much easier for them to sort of step away from it and let speculation cool down for a bit,” Gait said. “The industrial logic and the strategic logic are compelling to the point of being overwhelming.”

Why Rio

For Glasenberg, Glencore’s dealmaking billionaire CEO and second-largest shareholder, the deal logic is simple. Buying Rio adds the world’s most profitable iron ore business.

“What we know of Glencore is they like to acquire assets on the cheap, and Rio has a number of tier-one assets that would be of interest to Glencore,” Randal Jenneke, head of Australian equities at T. Rowe Price Group Inc., said by phone.

This year’s iron-ore slump has made Rio a more attainable target. The company relies on the metal for almost 90 percent of its profit, and the stock has underperformed the 104-member Bloomberg World Mining Index this year. Its 13 percent slide through last week compares with a 6.4 percent gain for Glencore, which has a broader portfolio of metals including copper, coal, zinc and nickel.

“A lot of these assets have been pretty beaten up, and iron ore prices are a big part of that, so asset values are looking more attractive than they have been,” Brenton Saunders, an analyst with BT Investment Management Ltd. in Sydney, which manages A$65 billion ($57 billion) including Rio shares, said by phone. “There are operational synergies to be had as well.”

Elephants in Bed

Still, Rio CEO Sam Walsh has said there are difficulties to a merger between his company and Glencore.

“I’m just thinking of two elephants in a single bed, how do you actually make that work without one falling out?” he pondered in a December interview at the company’s London headquarters.

The biggest challenges may be reaching an agreed-upon price and obtaining regulatory approval, analysts say.

With about $6 billion of his personal wealth tied up in Glencore stock, Glasenberg tends to be cautious about overpaying for targets. His company paid a premium of 10 percent or less in about two-thirds of the deals it carried out over the last decade, according to data compiled by Bloomberg.

“I would think that a huge premium goes against what Ivan Glasenberg is about,” Tim Schroeders, a Melbourne-based portfolio manager at Pengana Capital Ltd. where he helps oversee about $1 billion in equities, said by phone. “I don’t think investors will support this unless there’s a huge premium. So there’s your stalemate.”

Premium Dilemma

BHP Billiton Ltd., the world’s largest mining company with a market value of more than $150 billion, offered Rio investors a premium close to 50 percent more than six years ago, which they rejected. Compare that with Glasenberg’s track record, and his challenge becomes clear. Rio investors would need a premium of at least 25 percent to accept a deal, Liberum Capital Ltd. wrote in an Oct. 6 note.

“This deal is not something that will happen any time soon,” said Paul Cowan, director of special situations at Religare Capital Markets in Melbourne. “Rio shareholders are not going to stomach a nil-premium merger, or even a reverse takeover with a significant premium. This deal will be held up with so much regulatory red tape, it will make the whole thing unworkable.”

Regulatory Issues

Australia’s foreign investment regulator will likely present a “major hurdle” for any deal, Liberum said. It would also face significant scrutiny from China’s regulators on the combined copper businesses, Paul Phillips, a Melbourne-based partner with Perennial Growth Management Pty, which manages about $19 billion of assets including Rio shares, said by phone.

“They’d probably make them divest some coal as well,” he said. “I don’t know whether the Chinese would be that enthralled by it all.”

Another possible outcome is that Rio seeks out a takeover of its own to act as a sort of poison pill against the Glencore offer, said Gait of Bernstein. Anglo and Phoenix-based Freeport- McMoRan Inc. would be sizeable, complementary options to consider, he said. A representative for $33 billion Freeport- McMoRan declined to comment.

“You need something that’s a little bit chunkier and also is doable,” Gait said. “Those are the two names that would come to the top of most people’s register.”

–With assistance from Brooke Sutherland in New York and Brett Foley in Melbourne.

To contact the reporters on this story: Jesse Riseborough in London at [e-mail]; David Stringer in Melbourne at [e-mail]; James Paton in Sydney at [e-mail] To contact the editors responsible for this story: Will Kennedy at [e-mail]; Beth Williams at [e-mail] Whitney Kisling