Glencore, Xstrata face investor activism

VANCOUVER — A deal that could be viewed as the flagship transaction in natural resource mergers and acquisitions is facing heavy criticism from a group of activist investors, as prominent shareholders of mega-miner Xstrata PLC (XTA-L) question the inherent value in a US$39-billion take-over offer from Swiss-based trading house Glencore International (GLEN-L).

Initially announced in February, the potential merger came as no surprise considering Glencore held roughly 34% in Xstrata and had taken itself public via a US$10-billion initial offering in May 2011, which pegged Glencore’s value at US$59 billion.

The proposed merger — which would see Glencore exchange 2.8 of its own shares for every share of Xstrata — met with early investor discord as Xstrata institutional shareholders Standard Life Investments and Schroders PLC (SDR-L) announced intentions to dissent during voting in an attempt to achieve more favorable conditions.

“Although we see some merit in the merger of Xstrata and Glencore the proposed exchange ratio clearly undervalues Xstrata’s assets and future earnings contribution,” David Cumming, Standard Life’s Head of Equities told Reuters in early February. “It is our intention to vote against the deal unless the merger terms for Xstrata shareholders are materially improved.”

Standard Life and Schroders held roughly 3.5% of Xstrata’s outstanding shares when the deal was announced in February, and in order to block the transaction under British securities law would need to rally 16.48% in investor support.

Glencore’s offer was viewed as discounted by a majority of analysts. Bank of Montreal (BMO) Capital Markets calculated that the 2.8 share ratio bid was 15% share destructive to Xstrata investors, but 20% accretive to Glencore shareholders. BMO analysts estimated an appropriate offer would entail Glencore upping its bid to a share ratio between 3.5 and 3.75 based on 2011 profits and net present values.

“For Xstrata shareholders the bid ratio is dilutive, further highlighting the unlikelihood that a deal will be reached at its current proposal,” wrote BMO analyst Tony Robson in February. “A higher bid ratio is still accretive for Glencore, which allows the company to further sweeten the deal if necessary.”

It seemed unlikely that minority shareholders like Standard Life and Schroder could rally the support needed to overthrow the merger, until a wildcard in the form of Qatar Holdings joined the fray in late June. The direct investing vehicle for the Gulf state of Qatar had quietly amassed an 11% interest in Xstrata, which at first glance appeared to be a bid to acquire a stake in Glencore when the merger was finalized.

Qatar Holdings is under the guidance of Ahmad al-Sayed, a U.S. and European educated Qatari lawyer who previously acted as general counsel for the Qatar Investment Authority. Qatar Holdings controls an investment fund valued in the range of US$100 billion and is known for acquiring stakes in high-profile assets like Harrods department store in London and the Porsche-Volkswagen automotive conglomerate in Germany.

Though not known for investor activism, Qatar Holdings issued a press release on June 26 indicating it would oppose the Glencore-Xstrata merger on grounds that the premium being paid on Xstrata represented a poor return for current shareholders. Qatar Holdings stated that “though it saw merit in a combination, a share ratio of 3.25 would be a more appropriate premium for Xstrata shareholders.”

The number is in line with industry speculation, as Bloomberg statistics show that the current offer values Xstrata at 6.2 times its EBITA, which represents the fourth-lowest multiple in a mining takeover valued over US$5 billion.

“Qatar’s push for an increase in the Xstrata bid ratio puts Glencore in a difficult position,” notes Robson in a June 29 research update. “Increasing the bid is dilutive relative to current market expectations while to walk away leaves Glencore’s balance sheet exposed to credit rating downgrades.”

BMO Capital Markets labels the transaction challenge a “lose-lose” situation for Glencore, which must decide between increased dilution from a larger bid for a Xstrata versus balance sheet issues, capital expenditure challenges, and a potential US$470 million “break-up fee” if the deal collapses.

Qatar’s actions have emboldened other Xstrata investors to threaten hold-outs in favor of a better deal. New York-based Knight Vinke, another top-20 shareholder, joined the battle on July 3 when the asset manager released a statement supporting demands for Glencore to increase its share-ratio bid.

Knight Vinke reportedly holds 0.7% in Xstrata, and feels the offer represents “no premium to shareholders for a transaction that appears to represent a change of control.”

Xstrata is revising an executive bonus plan valued at US$270 million after investors began to protest in early June, and escalating shareholder activism has forced both Xstrata and Glencore to delay votes on the merger planned for mid-July.

Neither company has announced a date for the re-scheduled shareholder meetings.