Copper at heart of probable Rio bid for Glencore: RBC

Investors are increasingly expecting Rio Tinto (NYSE, LSE, ASX: RIO) to make an all-share offer for Glencore (LSE: GLEN) in a deal driven by the will to control future copper supply, RBC Capital Markets said.

A premium of 15% to 30% to Glencore’s early January share price could get the transaction done and prevent BHP (NYSE, LSE, ASX: BHP) from bidding for the company, RBC mining analyst Ben Davis said Friday, citing recent conversations with investors. That could value Glencore at up to $87 billion (C$121 billion). Securing copper – not creating near-term value – is the key rationale for the transaction, Davis stressed.

Glencore and Rio said last week they were holding preliminary talks about combining some or all of their businesses in a tie-up that could create the world’s largest miner. Possible scenarios include an all-share merger between the companies, Glencore and Rio said Jan. 8. Glencore’s market capitalization is about $76 billion, while Rio is worth about $145 billion.

“Clearly the mining cycle is alive and well,” Davis wrote in a note. “A merger of Glencore and Rio Tinto that was thought by many as an unserious conversation just over a year ago, has now found its sweet spot after a strong copper rally, heightened resource scarcity fears and an Argentina turnaround. The deal has momentum and given the respective share price reaction of both stocks, the market is expecting a firm offer to be made.”

Topping BHP

A combined “GlenTinto” would leapfrog BHP as the world’s largest mining company by market value, while significantly boosting Rio’s long-term copper exposure at a time when electrification-driven demand growth is colliding with a thin project development pipeline.

Copper prices have set multiple records in recent weeks as supply disruptions and U.S. trade uncertainty fuel a sharp rally for base metals.

Rio, which expanded into lithium last year with the $6.7-billion acquisition of Arcadium Lithium, expects commodities output to rise about 3% a year by 2030 as new assets such as Guinea’s Simandou iron ore mine and Mongolia’s Oyu Tolgoi copper complex start producing. New lithium projects should also lift production, CEO Simon Trott said last month.

Glencore’s copper assets are the real prize for Rio. They include a 44% share in the Collahuasi copper mine – a Chilean joint venture with Anglo American that investors see as its crown jewel, he wrote.

While Rio has “got a lot right” in recent years in developing Oyu Tolgoi and Simandou, “the growth beyond this current phase is far less exciting with projects either too small to make a difference or still in the development phase or stuck in courts,” Davis wrote. Those include copper assets such as Resolution in the U.S. and Nuevo Cobre in Chile.

As a result, Davis said he expects Rio to offer a 27% premium to Glencore’s “undisturbed,” or pre-announcement, share price. On Friday, he raised his target price for the stock to 530 pence.

Glencore fell 2.6% to 478.20 pence in London Friday, valuing the company at about £56 billion (C$105 billion). Rio rose 0.7% to A$148.25 in Australian trading for a market capitalization of A$216 billion (C$201 billion).

Shares of both companies have gained ground since news of the negotiations came out.

Simple is best

Most investors agree that Rio should keep the deal as simple as possible to avoid repeating the mistakes BHP made when it bid for Anglo, Davis said. This means bidding for all of Glencore – including its coal business. 

With BHP also in the market to add copper assets, “Glencore finds itself in a strong position,” Davis wrote. “We believe they’re a willing seller, assuming they are compensated for a loss of control, and will entertain any sort of deal structure.”

After dumping the last of its coal assets in 2018, “Rio might have to get its hands dirty again,” the analyst said. “However, we don’t believe it would be that hard to get rid of coal later down the line. Glencore already did the work, placing their coal business into a separate Australian subsidiary.”

It’s possible that BHP could jump in if Rio’s bid is too low, though investors see Rio as the better owner, Davis said. BHP will probably stay on the sidelines unless Rio offers a premium of less than 20%, he added.

“It is a more difficult deal for BHP after coming fresh off two bruising encounters with Anglo American. It already has copper growth options in Argentina and would likely have to sell down coking coal assets for competition concerns,” Davis wrote. “BHP already has its hands full and while it would prefer Rio Tinto not to have Glencore’s copper pipeline, it can always go after smaller targets.”

Cost savings

The greatest debate among investors has been on the potential synergies of the proposed Rio-Glencore combination, Davis wrote.

Savings could include marketing spending, shared central services and head office costs, with total estimates among investors surveyed by RBC ranging from $3.7 billion to $10.4 billion. That’s well below the $17 billion required for the deal to break even in case of a 27% premium, Davis said.

“Part of the attraction of a takeover is taking out costs and with a takeout of this size we expect there will undoubtedly be some overlap,” he wrote.

“The attraction of the takeover of Glencore – securing copper options at typical takeover multiples relative to their own and unseating BHP as the world’s largest miner – is sufficient to incentivize Rio Tinto to move forward with the deal. We expect synergies will be identified and likely used by the market, but we are somewhat circumspect of the potential and the costs of implementation.”

Culture clash

The key for Rio will be its ability to avoid “dis-synergies,” or hidden costs from the deal as the combined entity will lack the flexibility of its past. Industry competitors have already started poaching Glencore staff, and it’s unclear what impact this would have on the business if many left, Davis said.

“The benefits from economies of scale are not infinite and there will be a significant clash of cultures from trying to push these very different companies together,” he wrote. “The entire command structure of Glencore will likely have to be dismantled, as marketing goes from running the show to being a bolt on to the business.”

Both companies are already in cost-cutting mode.

Glencore said last year it had already identified $1 billion in annual savings to be fully delivered by the end of 2026.

Rio, meanwhile, said last month it was targeting a 4% annual reduction in unit costs through 2030 while conducting strategic reviews of its iron, titanium and borates businesses. That effort is advancing as planned, with the next stage focused on testing the market for the assets, Rio said Dec. 4.