Glencore and Xstrata: Do mergers work?

7th February 2012

The combination of the two giants would create a unique colossus – the world's fourth largest natural resources company. It would also be the number one in coal and zinc, with expectations of becoming the independent producer of copper within four years.

But there is already opposition from the mining group's largest independent shareholders, who say the terms undervalue Xstrata. In some ways the deal looks more of a takeover of Xstrata by Glencore.

Schroders said it would vote against the deal as it was currently "not compelling". Richard Buxton, head of equities at Schroders, said in the Guardian: "This is not acceptable. It is not compelling or attractive for Xstrata shareholders and we will vote against. If they keep describing it as a merger of equals, why don't Xstrata shareholders get 50%? We continue to think Xstrata's assets and growth profile are superior to Glencore. We had an opportunity to purchase Glencore shares at flotation and chose not to. That was the right decision."

Under current proposals, the merger would only go ahead if it received 75% approval among Xstrata shareholders excluding Glencore. Therefore, rebel shareholders would have to speak for just 16.5% of shares in the mining group to derail the merger – so it remains highly uncertain.

But what would the deal mean for shareholders?

As in a typical takeover deal, Xstrata shareholders are to be offered a premium. Glencore, which already owns 34% of Xstrata, has offered 2.8 shares for each Xstrata share. This ratio puts a greater relative value on Xstrata shares than most investors expected, representing a 15.2% premium to Xstrata's share price of £11.20, ahead of news of the talks leaking.

Normally, companies pay premiums for control. So this deal -described as a ‘merger of equals' -would see many of the top executive jobs go to Xstrata's management team. However, those in the Glencore camp have argued this should mean that a very small premium should be paid.

But shareholders typically value more highly what share they get in the new company. If it stands at 2.8 – then Glencore's shareholders will get 56% of the enlarged group with just 44% going to Xstrata. Xstrata's shareholders also complain that Xstrata earnings are higher quality and will be diluted.

But aside from the detail of who would get what, would a merger be a success?

Plenty of mergers don't work, of course. Those who advocate mergers will argue that the merger will cut costs or boost revenues by more than enough to justify the price premium, but while this sounds simple, things can go wrong.

Historical trends show that roughly two thirds of big mergers will disappoint on their own terms, which means they will lose value on the stock market, according to Investopedia. The motivations that drive mergers can be flawed and efficiencies from economies of scale may prove elusive.

Asserting shareholder rights

UK shareholders, who in many cases over the years have proved docile in such situations, have recently become more aggressive in asserting their rights and desires during these changes.

For example, back in 2010 insurer Prudential was forced to abandon its pursuit of the Asian unit of American International Group Inc. after Prudential shareholders refused to condone the $35.5 billion price tag. A year earlier, Xstrata's effort to merge with rival Anglo American PLC was thwarted by Anglo American shareholders precisely because it included no takeover premium.

Considering management style

In this case, Xstrata Chairman John Bond, Chief Executive Mick Davis and finance chief Trevor Reid would keep those roles at the combined company, with Glencore CEO Ivan Glasenberg becoming deputy CEO.

However, even though Mr  Davis is popular with Xstrata shareholders and has a longer track record running a public company than Mr Glasenberg, who just took Glencore public last May, it isn't clear that the management plan will be enough to make up for the lack of a full takeover premium, stresses the Wall Street Journal.

They have each run their respective businesses in an impressively entrepreneurial style, with Xstrata turning $500m of equity into $59bn since 2001, and Glencore turning $1.2bn into $50bn over 18 years.

But, as Robert Peston points out on his BBC blog, that kind of success usually requires a leader with drive and ego. "So it may well be a challenge for the redoubtable Mr Davis and Mr Glasenberg to suppress the individualistic instincts that generated so much success in the past and work together as a team."

Some mergers are a perfect fit of two companies which complement each other's strengths, have obvious benefits and enable the companies to make massive economies of scale – but this is no small task. It may sometimes hard to shake off the impression that some managers just like the idea of being in charge of ever bigger conglomerates.

Needless to say bankers, lawyers and accountants make a fortune from M&As and can often make a quick killing from the premium that the bidder is willing to pay for their shares in order to take control of the company – if it works in their favour. M&As are part of the way the stock market functions, and they encourage change and reorganisation – but they can fail in a spectacular fashion.

Why do some mergers fail?

Paul J Siegenthaler, author of Perfect M&A's, describes some of the reasons M&As fail here. A few examples:< /p>

No common vision: In the absence of a clear statement of what the merged company will stand for, how the organisation will operate, what it will feel like, and what will be different compared to how things are today, there is no point of the convergence on the horizon and the organisations will never blend.

Poor governance: Lack of clarity as to who decides what, and no clear issue resolution process. Integrating organisations brings up a myriad of issues that need fast resolution or else the project comes to a stand-still.

Weak leadership Integrating two organisations is like sailing through a storm: you need a strong captain, someone whom everyone can trust to bring the ship to its destination, someone who projects energy, enthusiasm, clarity, and who communicates that energy to everyone.


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