Glenstrata - Glencore proposes merger with Xstrata

Yesterday morning’s business news has been dominated by the proposed merger of Glencore and Xstrata. Glencore’s 34% holding of Xstrata shares had made a third party approach for Xstrata very difficult if not impossible.

Xstrata bought coal mines from Glencore in 2001, and after going public in 2002, it grew by a series of acquisitions, including the purchase of the Canadian nickel producer Falconbridge in 2006. Although Xstrata had a market capitalisation of c. $50bn, Glencore’s market capitalisation was $45bn.

This proposed merger could result in wave of takeovers and mergers in the mining sector similar to those after the merger of BHP and Billiton in 2001. The FT suggested that other mining firms including Anglo American and Freeport-McMoRan might respond by buying up rival firms.

Glencore employs c. 54,000 staff in the extraction, shipping and refining of raw materials including coal and metals. Xstrata mines copper in South America, zinc in Spain, and ferrochrome and vanadium in Australia and South Africa. Both firms have been operating in primary markets which have recently grown quickly as a result of China’s rapid transformation.

Ironically, Reuters noted that Xstrata failed to acquire AngloAmerican in 2009, in an attempt to break into the highly profitable trade in iron ore.

If the merger did go ahead, discussions would have to settle who would be appointed to the new board of directors. The FT speculated that Mick Davis, current chief executive of Xstrata, and Ivan Glasenberg, his counterpart at Glencore, are nearing a deal to split their roles in the new company, but no formal agreement had been made this morning.

Of course any merger would also lead to redundancies not just at board level, but in Head Office operations, IT, accounting and support staff would be expected, staff would face a loss of remuneration, status, seniority, promotion prospects and job security. The hidden costs to morale and motivation become hard to quantify. A merger also begs questions about the compatibility of corporate cultures.

On Wednesday, Xstrata shares rose by c.10 per cent to £12.31 in London on Wednesday, while Glencore rose almost 5 per cent to 452.55p.

The merged company would control 32 per cent of the internationally-traded market for thermal coal, used to fire power stations, either as a producer or trader. It would be the world’s largest producer of zinc, with 15 per cent of global production and the world’s third-largest producer of copper behind Codelco and Freeport-McMoRan. According to Credit Suisse analysts, about 19 per cent of its 2011 earnings would be generated through commodities trading.

There were some questions about the degree of synergy in this deal; would the costs of the merger offset the gains?

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