MarketLine Case Study

Glencore & Xstrata
Creating the fourth largest global mining company
Reference Code: ML00007-065 Publication Date: January 2013

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OVERVIEW
Catalyst
Glencore International, a commodity trading giant, is seeking to merge with diversified mining company Xstrata. The move was announced in February 2012 with the proposal accepted by shareholders in November 2012. The deal is worth $31bn and would create the fourth largest mining company in the world behind the top three of BHP Billiton, Vale, and Rio Tinto. The company would also possess leading positions in other commodities in power generation and agricultural products.

Summary
 Glencore is a company which operates in commodity markets, including mining. The company engages in both industrial activity and marketing, which allows it to safeguard against volatilities in an individual market. Further, by engaging in marketing, the company is able to adapt more effectively to adverse conditions. Glencore has demonstrated value creation in its acquisitions, with notable acquisitions including Kazzinc and Viterra. The company’s size also now allows it to negotiate big contracts, as it did with Rusal. Glencore was fast tracked into the London FTSE stock exchange during its initial public offering (IPO) in May 2011, the first company to do so in 25 years. Xstrata is a mining company which profited from Glencore spinning off its thermal coal assets, and has grown to incorporate many metals, with a decentralized strategy with expansion through acquisitions. The company has also focused on organic growth projects, investing in new sites and refining currently owned ones to extend lifelines, productivity and efficiency.  Glencore has maintained a keen interest in Xstrata, maintaining a third of its ownership since Xstrata purchased Glencore’s thermal coal assets. Glencore also accounts for a sizeable portion of Xstrata’s distribution. The merger was originally considered a merger of equals. There are many similarities between the two companies, ranging from their valuations and locations. The deal would create the fourth largest mining company with a dominant position in many commodities and vertical integration, and prominent positions in other products, such as the largest grain exporter from Europe and Australia. Mergers would provide Glencore with an avenue to focus expansion, and utilize Xstrata’s cost cutting abilities to achieve better value. Xstrata would also gain access to Glencore’s extensive network of traders and local offices to further improve their information when making decisions. The geographically diversified network of Glencore would benefit Xstrata’s coppers segment, expecting to be one of their main growth drivers in the future.  The size of the deal means it has ramifications beyond the mining industry. Further, it is less clear whether it is a merger of equals; after resistance from Xstrata shareholders, the price has been raised at the expense of the “golden handcuffs” deal which was aimed at retaining Xstrata’s management staff. Consequently, Glencore CEO Ivan Glasenberg will now be in charge of Xstrata, with the senior management team likely to depart or be seriously depleted. This could have consequences when Glencore’s top down management structure attempts to assimilate the decentralized Xstrata assets, and Glasenberg’s more cost driven approach to organic growth pitted against Xstrata’s willingness to invest. The deal is still subject to approval from competitive authorities, which could force concessions from the authorities to ensure the deal goes through. Finally, sustainability and developing countries could face further pressure due to the company’s scope across the entire value chain and allegations of unethical practices.

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TABLE OF CONTENTS
Overview ............................................................................................................................................................................ 2 Catalyst ............................................................................................................................................................................ 2 Summary ......................................................................................................................................................................... 2 Glencore and Xstrata: value creators .................................................................................................................................. 7 Glencore’s success in growth .......................................................................................................................................... 7 Marketing and Industrial sectors .................................................................................................................................. 7 Diverse product base helps to mitigate downturns ....................................................................................................... 7 Acquisitions helped the company’s growth .................................................................................................................. 8 The strength of Glencore’s IPO .................................................................................................................................... 9 Xstrata ............................................................................................................................................................................. 9 Strong acquisition and investment drive helped to fuel growth .................................................................................... 9 Emphasis on cost reductions ..................................................................................................................................... 10 Xstrata’s devolution of authority ................................................................................................................................. 11 Organic growth plans to complement M&A expansion ............................................................................................... 11 Why Glencore and Xstrata want to Merge......................................................................................................................... 12 A merger of equals ........................................................................................................................................................ 12 Glencore and Xstrata’s relationship ........................................................................................................................... 12 Glencore-Xstrata’s potential .......................................................................................................................................... 12 Metals and minerals ................................................................................................................................................... 13 New moves into fuel ................................................................................................................................................... 13 Advantages for Glencore ........................................................................................................................................... 14 Advantages for Xstrata............................................................................................................................................... 14 Consequences of the merger ............................................................................................................................................ 15 Is the deal a merger of equals or takeover? .................................................................................................................. 15 Qatar Holdings ........................................................................................................................................................... 15 Rejection of “Golden Handcuffs” ................................................................................................................................ 15 Assimilation problems .................................................................................................................................................... 16 Growth plans .............................................................................................................................................................. 16 Management styles .................................................................................................................................................... 16 The deal may require concessions to regulators ........................................................................................................... 16 The purchase of Viterra resulted in regulator intervention .......................................................................................... 16 The European Commission ........................................................................................................................................ 16 South African snags ................................................................................................................................................... 17

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Accusations of unethical practices ................................................................................................................................. 17 Conclusions ....................................................................................................................................................................... 18 Glencore Xstrata merger will complement each other well ............................................................................................ 18 Appendix ........................................................................................................................................................................... 19 Definitions ...................................................................................................................................................................... 19 Sources ......................................................................................................................................................................... 19 Further Reading ............................................................................................................................................................. 21 Ask the analyst .............................................................................................................................................................. 22 About MarketLine .......................................................................................................................................................... 22 Disclaimer ...................................................................................................................................................................... 22

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LIST OF TABLES
Table 1: Composition of Glencore's EBITDA, 2009-2011 $m ............................................................................................. 8 Table 2: Some of Xstrata's acquisitions between 2002 and 2011 ....................................................................................... 9 Table 3: Comparison of Glencore and Xstrata's key metrics in 2011, $m ......................................................................... 12

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TABLE OF FIGURES
Figure 1: Xstrata's real cost savings 2003-2011 ............................................................................................................... 10 Figure 2: Glencore's subsidiary E&P in Equatorial Guinea ............................................................................................... 13 Figure 3: Glencore Xstrata would be the most diversified mining company ...................................................................... 14 Figure 4: Activists protest against Glencore's alleged water pollution ............................................................................... 17

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GLENCORE AND XSTRATA: VALUE CREATORS
Glencore is a company which operates in commodity markets, including mining. The company engages in both industrial activity and marketing, which allows it to safeguard against volatilities in an individual market. Further, by engaging in marketing, the company is able to adapt more effectively to adverse conditions. Glencore has demonstrated value creation in its acquisitions, with notable acquisitions including Kazzinc and Viterra. The company’s size also now allows it to negotiate big contracts, as it did with Rusal. Glencore was fast tracked into the London FTSE stock exchange during its initial public offering (IPO) in May 2011, the first company to do so in 25 years. Xstrata is a mining company which profited from Glencore spinning off its thermal coal assets, and has grown to incorporate many metals, with a decentralized strategy with expansion through acquisitions. The company has also focused on organic growth projects, investing in new sites and refining currently owned ones to extend lifelines, productivity and efficiency.

Glencore’s success in growth
Glencore is a diversified commodity company which operates within different industries ranging from metals and minerals, energy products, and agricultural products. The company’s activities range from industrial production to marketing commodities from third parties with financing and logistics services. Originally a commodity trader, it has engaged in backwards integration to incorporate industrial production and a variety of natural resource assets. The company’s assets are in over 40 countries, representing a diversified trader both in products and geographically.

Marketing and Industrial sectors
Originally a commodity trader, Glencore’s expansion into the production chain permits it an opportunity to bridge the vulnerabilities of both sectors and safeguard against shocks in the commodity market. Reliance on third parties to sell their products is reduced for the marketing sector, providing the company with a completely integrated supply chain, whereas conversely any drop in demand may be stemmed by the customer relationships developed by the marketing sector helping to stifle any potential drops in demand. Substantial hedging in the marketing sector also helps to soften exposure to prices. The Industrial sector now represents the largest contributor to Glencore’s revenues, representing 64.6% of the company’s earnings before interest and tax (EBIT) in 2011. However, the success of the marketing sector varies widely; just the previous year it was worth 44.2% of the company’s EBIT. Glencore’s backward integration began with an equity investment in 1987 when the company acquired 27% of the Mt. Holly aluminum smelter in the US. Their first controlling interest was in 1988, when they purchased a 66.7% interest in a zinc/lead mine in Peru. Since then, their acquisitions have expanded to encompass farming, mining, smelting, refining and processing production assets in over 40 countries. The company aims to make the industrial sector as a standalone commercially viable, whilst also integrating it within its supply chain to facilitate its commodity trading.

Diverse product base helps to mitigate downturns
Glencore offers a diverse range of products from a variety of industries. This allows it to access a wide customer base, and maintain presence in a range of diverse industries. Glencore’s customers and suppliers number over 8,000 and span the automotive, steel, power generation, oil and food processing industries. The company’s three main verticals (metals and miners, agricultural products and energy products) offer contrasting areas where the company can compensate for different shocks to their customer base. Depending on commodity prices (which are typically volatile), the significance of individual sectors varies greatly annually. Metals and minerals remains the company’s largest segment. The different product bases help to secure the company’s revenues due to exposure to multiple outlets and reduced dependency on one particular commodity. The company’s metals and minerals sector includes zinc, copper, lead, aluminum, ferroalloys, nickel, cobalt and iron ore amongst others. The strongest products were copper and zinc (accounting for 48.2% and 38% of their 2011 mining revenues), which contrasts to other leading mining companies. Both Vale and Rio Tinto relied on iron ore for 71.5% and 49.4% of their revenues respectively the majority of their income. BHP Billiton’s largest product in 2012 was iron ore at 31.3% of revenues, with petroleum and base metals the second and third largest items respectively.

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Table 1: Composition of Glencore's EBITDA, 2009-2011 $m
Product group Metals & minerals Energy Products Agricultural Products Other Total
SOURCE: GLENCORE ANNUAL REPORTS

2009 1,572 1,407 382 568 3,929

% 40 36 10 14 100

2010 3,269 829 766 1,337 6,201

% 53 13 12 22 100

2011 3,369 1,295 15 1,785 6,464

% 52 20 0 28 100
MARKETLINE

Acquisitions helped the company’s growth
Glencore has sought growth consistently through merger and acquisition activity. Although primarily a metal and minerals trader, diversification of their interests both geographically and in terms of products has helped to secure raw materials, production and distribution channels. Large stakes have been accrued in publicly traded companies which would be significant to Glencore’s interests, including Xstrata, which Glencore held a 34% stake in prior to the deal. The company is able to leverage its size to negotiate favorable contracts with large producers, all aimed at value creation. Prominent acquisitions that the company undertook include Kazzinc, Viterra and its negotiations with Rusal. Other notable assets include Mopani, where Glencore has a 73% stake in Zambia’s second largest copper producer; and Katanga, a joint venture based in Canada but with operations in the Democratic Republic of the Congo. Katanga is primarily concerned with copper production, with Glencore owning approximately 75% of the company. Katanga and Mopani were responsible for over 40% of Glencore’s copper revenues in 2011.

Kazzinc
Kazzinc is a mineral company in Kazakhstan, which was formed by the merger of Eastern Kazakhstan's three main nonferrous metals companies. The three were majority state-owned and following privatization in 1997, Glencore became the largest stakeholder, raising its stake from 50.7% to 69.61% in October 2012. The company is a fully integrated zinc producer, with significant assets in other precious metals. Kazzinc’s sale also included the Bukhtarma hydroelectric power station to cover all Kazzinc's energy needs. Glencore’s rising stake in the company signals its importance to the company, considered in its annual report to be one of the future drivers of growth in their metals and minerals segment. It was responsible for over 68% of Glencore’s zinc revenues in 2011. It has a self-sufficient asset which comprises of considerable reserves and production capacity. The company seeks to focus it purely on precious metals, with ambitions to spin off its gold assets into another company. Kazzinc also claims it is one of the lowest cost producers in the world. Kazzinc’s developments in 2011 and 2012 have helped to spur growth in areas beyond zinc. Installations of new copper smelters are aimed to expand output and further exploration of Vasilkoskoye, Maleevsky and Riddey-Sokolvy sites have boosted mineral reserves considerably, allowing for further improvements in production. The company is valued at over $7bn.

Rusal deal
Rusal is the world’s largest aluminum producer, and also holds a controlling stake in the world’s largest nickel producer, OAO GMK Norilsk Nickel. In May 2012 Glencore negotiated a seven year deal worth over $43bn to secure aluminum supplies of over 14.5 million tons. This accounts for over a third of the company’s annual production, and has been met with some resistance from minority owners. Sual partners believe that the company is now a quasi-production unit for Glencore, tying its fortunes to the company. Glencore owns 8.8% of Rusal. However, Rusal is significantly loaded debts, requiring servicing. The company’s owner Oleg Deripaska has refused to use nickel proceedings to pay down the debt. The Glencore deal helps to secure revenue for the company to pay these debts, whilst at the same time helping to increase Glencore’s market share in the Russian market.

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Viterra acquisition
Viterra is a large agribusiness with operations across North America, Australia, New Zealand and China. Glencore agreed to the acquisition of the company in March 2012 for CAD6.1bn ($6.2bn), with the deal completed in December 2012. The rationale behind the deal was to further expand Glencore’s presence in the agriculture market. Viterra is a leading company in the Canadian agricultural products market. The presence in Australia is also a factor in the decision, allowing the company to expand its agricultural network geographically. The acquiring of grain and oil seed assets will help to propel Glencore to become the largest global trader of wheat, barley, and canola. Glencore already owns 270k hectares of farmland with a combined storage capacity of 3.8 million tons. The deal required some sacrifice to satisfy competition regulators; Agrium acquired fertilizers and retail assets, whereas Richardson International will acquire some of the North American grain handling units.

The strength of Glencore’s IPO
Glencore decided to go public in May 2011 after years of private ownership. Our listing on the London and Hong Kong Stock Exchanges in May 2011 was the largest ever IPO of ordinary shares on the premium listing segment of the London Stock Exchange and the first simultaneous London primary and Hong Kong secondary IPO. The process raised over $11bn for the company, and in the process it became the first company to be fast tracked into the London FTSE Top 100 in over 25 years.

Xstrata
Xstrata was originally Südelektra AG, a Swiss infrastructure company founded in 1926. In the 1990s, Glencore’s previous incarnation Marc Rich + Co AG became a majority shareholder. Rebranded Xstrata in 1999, the company began to focus on mining and divesting its non-strategic assets. After the company’s flotation in 2002, Xstrata began rapid expansion through acquisitions whilst simultaneously engaging in cost reduction programs. The company’s management style of decentralization also encouraged growth, with a small head office and many decisions taken by local offices. This has helped to spur the company to become the largest provider of ferrochrome and exporter of thermal coal globally, with significant market positions in copper, nickel, primary vanadium and zinc.

Strong acquisition and investment drive helped to fuel growth
The company’s flotation fueled a rapid phase of acquisitions. Beginning with the purchase of Glencore’s thermal coal assets, the management staff initiated expansions both with acquisitions and at company sites to ramp up production. Over 22 major projects have been undertaken since 2002, with the aim of providing immediate scale advantages. Diversity was also a key objective for the company to safeguard against commodity price volatilities. At the same time, some assets such as aluminum were divested in favor of other metals. Xstrata Aluminum, a result from the Falconbridge acquisition, was sold to Apollo Management Ltd in 2007 for $1.15bn.

Table 2: Some of Xstrata's acquisitions between 2002 and 2011
Company Duiker and Enex coal MIM Holdings Falconbridge 33% Stake in Cerrejon Eland Platinum holdings Resource Pacific Holdings 24.9% stake in Lonmin
SOURCE: XSTRATA WEBSITE

Price ($) $2.5bn $2.9bn $18.6bn $1.7bn $1bn $1bn $1.8bn

Year 2002 2003 2005-2006 2006 2007 2008 2008

product Thermal coal Copper, coking coal, zinc Nickel, copper Coal Platinum Coking and thermal coal Platinum
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The acquisitions have helped to exponentially grow the company and achieve leading ranks in many minerals. It claims it is one of the largest zinc and ferrochrome producers globally, the fourth largest copper producer, largest thermal coal exporter, and the fourth largest nickel producer. EBITDA has grown from $0.4bn in 2002 to $11.6bn in 2011, with a 2011 market value 100 times greater than their value in 2001.

Emphasis on cost reductions
The company’s philosophy of a decentralized efficient business has also led to emphasis on cost reductions wherever possible. The company has been able to consistently reduce their costs with focusing on productivity increases and extending the life of mines. The company strives to operate low cost mines, such as the Mangoola mine, which was opened earlier than expected. The company’s coal operations in New South Wales also implemented productivity changes to gain savings of over $230m, pushing their coal costs into the lower half of the industry curve, although this was complicated by the strength of the Australian dollar. Coal is the company’s biggest cost saver due to their position as the largest exporter allowing them to leverage economies of scale. The company claims its entire commodity businesses are now in amongst the first and second quartiles in terms of cost competitiveness.

Figure 1: Xstrata's real cost savings 2003-2011

SOURCE: XSTRATA ANNUAL REPORTS

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Xstrata’s devolution of authority
Xstrata partly attributes its success to the emphasis on decentralization, unique within the mining sector. Individual commodity segments within the company are accountable for their actions. Xstrata’s Swiss head office employs dozens rather than hundreds. Rather than take decisions from the top down, the company believes that local parties possess the best information to make decisions regarding their products. The operational managers take decisions regarding operational, environmental and community decisions in an effort to develop a better relationship with local stakeholders. Furthermore, the company believes enhanced responsibility for local parties leads to people becoming more motivated within the business as their position is more integrated than decisions from the top down. The company checks their progress with governance frameworks in areas such as sustainable development, with the decentralized model providing checks and balance to ensure balance between the group and commodity level.

Organic growth plans to complement M&A expansion
The company has also had a focus on organic growth via productivity improvements to further expand their business. This usually involves investing in current sites or new greenfield ones. Currently there are 22 projects throughout Xstrata to improve organic growth. By 2014, the company hopes that the 19 new expansions expected to be completed will push their production volumes 50% higher than 2009 whilst simultaneously reducing costs 20%. Projects such as Antapaccay in Peru and the Koniambo greenfield ferronickel operation in New Caledonia are examples of the company’s initiatives in 2012. The company’s ability to generate this growth is significant to their long-term sustainability; particularly as mergers and acquisition activity begin to decelerate with the advent of drops in commodity prices. Furthermore, Xstrata’s acquisitions have not always gone successfully; attempts to takeover Lonmin fully in 2008 and Anglo American in 2009 failed to materialize. The company’s investments allow it to gain quality strategic assets and bypassing substantially higher prices in acquisition activities. The focus on organic growth will introduce seven new tier one assets into Xstrata’s portfolio, with expansion of four already owned. The company is also hoping that 85% of their copper production will be amongst the most cost competitive in the industry, against the current 42%. The company will complement extended mine lives with brownfield expansions which will be feasible with low capital costs.

Antapaccay demonstrates Xstrata’s value creation capabilities
Xstrata’s new Antapaccay project shows how the company is capable of prudent investment and value creation. Antapaccay was included in the purchase of Tintaya for $750m in 2006. The Antapaccay transition from a pre-feasibility study to the commissioning of the project in five years demonstrates its rapid growth. The site has generated over $2.5bn EBITDA, with the purchase fee recuperated in 18 months. The company hopes over 160,000 tons of copper will be produced annually, with a mine life of over 20 years. The first batch of commercial product was completed in November 2012, on time and within budget of $1.5bn. The Antapaccay deposit’s reserves have increased 30% to an estimated total Mineral Resource of over 1 billion tonnes at a grade of 0.49% copper using a cut-off grade of 0.15% copper, including gold and silver by-products. The company is now looking further into the Tintaya region, with Corroccohuayco also being earmarked for a potential expansion to the region’s substantial mineral reserves. Mineral Resource of 324 million tonnes at a grade of 0.93% copper,

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WHY GLENCORE AND XSTRATA WANT TO MERGE
Glencore has maintained a keen interest in Xstrata, maintaining a third of its ownership since Xstrata purchased Glencore’s thermal coal assets. Glencore also accounts for a sizeable portion of Xstrata’s distribution. The merger was originally considered a merger of equals. There are many similarities between the two companies, ranging from their valuations and locations. The deal would create the fourth largest mining company with a dominant position in many commodities and vertical integration, and prominent positions in other products, such as the largest grain exporter from Europe and Australia. Mergers would provide Glencore with an avenue to focus expansion, and utilize Xstrata’s cost cutting abilities to achieve better value. Xstrata would also gain access to Glencore’s extensive network of traders and local offices to further improve their information when making decisions. The geographically diversified network of Glencore would benefit Xstrata’s coppers segment, expected to be one of their main growth drivers in the future.

A merger of equals
The merger was originally considered a merger of equals. Both Glencore and Xstrata are similar size and valuations with an established relationship between them. Both companies are highly diversified geographically, but with headquarters in Switzerland and are listed on the London Stock Exchange. The company’s CEOs are two South Africans, Mick Davis and Ivan Glasenberg for Xstrata and Glencore respectively. Despite Glencore’s bigger size in terms of absolute revenues, the company’s profit is similar to Xstrata and the two have similar asset values. Glencore is also less efficient in cost reduction methods, with more liabilities.

Table 3: Comparison of Glencore and Xstrata's key metrics in 2011, $m
Glencore Revenues Net Income Assets Liabilities Employees
SOURCE: COMPANY ANNUAL REPORTS

Xstrata 33,877 5,933 74,832 29,131 40,391
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186,152 4,268 86,165 53,830 58,000

Glencore and Xstrata’s relationship
The two companies have a strong relationship already. Glencore owned 34.5% stake in Xstrata prior to its takeover bid. Xstrata’s transformation to constant growth began when it purchased Glencore’s thermal coal assets in South Africa and Australia in 2002. Glencore CEO Glasenberg is also present on the Xstrata board. Glencore also distributes around a third of Xstrata’s products, making it a significant partner for the company’s distribution networks. Having a relationship already built, the company’s two idiosyncrasies may not be as difficult to assimilate when it comes to the actual merger of the companies under one banner.

Glencore-Xstrata’s potential
The proposed $31bn merger would create a new company with the capabilities to compete amongst the top three mining companies; BHP Billiton, Vale, and Rio Tinto through the scale economies generated. Simultaneously, Glencore’s forays into other commodities would mean the new creation Glencore-Xstrata would have dominant positions in mining, energy, and agricultural industries. The new company would also become one of the most integrated and diversified producers globally. With both companies ability to create value in both marketing and industrial activities across the supply chain, the new company will be well placed to become an industry leader. Glencore predicts that half a billion dollars in pre-tax synergies could be made in the first year post-merger.

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Metals and minerals
In the metals and minerals sector, the merger will fuse Glencore and Xstrata’s current market positions to form even more powerful controllers of market share in production. The new company based on 2011 figures would have a market capitalization of $90bn, and combined sales of nearly $220bn. Glencore Xstrata would become the largest zinc producer, and retain Xstrata’s largest thermal coal exporter and fourth largest nickel producer position. The thermal coal exporting of Xstrata would be augmented by assets such as Glencore’s Prodeco, the third largest coal producer in Colombia. Glencore-Xstrata is expected to dominate the production of thermal coal further when Prodeco is included. By 2015, the company is also hoping to become the largest copper producer with Glencore’s subsidiaries (Kazzinc, Katanga, Mopani, and Mutanda) in the same timeframe.

New moves into fuel
Glencore historically has sold oil in its marketing sector rather than produced it in its industrial sector. In 2011 the company began to produce its own oil, producing 2.8 million barrels. Glencore has begun to invest in oil resources in partnership with Noble Energy, securing two fields in Equatorial Guinea, with Aseng’s Block I commencing production first. Stakes have also been acquired in Russneft and its subsidiaries, with Glencore acquiring between 40-49% of their ownership stakes since 2005. The company now has exposure to the vast Russian hydrocarbon market. Deutsche Bank predicts that the company’s annual crude oil production will be 24 million barrels by 2015. Although this is far from the levels of oil giants such as Rosneft and ExxonMobil, it represents another attempt by the company to vertically integrate its production process and encompass as many commodities as possible. The fuel could also be used to help power mining in Xstrata’s activities. The company’s 89% stake in Singaporean company Chemoil also provides them with further access to the fuel market. Chemoil is one of the largest independent suppliers of marine fuel products, with forays into clean energy technology in the US West Coast. Provision of marine fuel specifically would also help Glencore’s logistics network, as they provide value added freight and logistics services.

Figure 2: Glencore's subsidiary E&P in Equatorial Guinea

SOURCE: www.glencore.com/eandp.php

MARKETLINE

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Advantages for Glencore
Glencore’s dominance in many markets means the company finds it hard to achieve organic growth in some of the markets it holds a lot of market share in. Conversely, Xstrata seems more than capable of achieving growth in this manner.. With the merger being able to create rapid expansion in the mining sector, this would provide Glencore with an opportunity for growth and focus. Slowing Chinese demand may yet unwind this plan, however. Xstrata’s capacity for cost reductions would also be a boon to the company; Glencore’s profit margin for 2011 was 2.3%, compared to Xstrata’s 17.5% with their tenacity for restructuring underperforming assets helping to improve the margin. The other advantages include further integration of the supply chain for the company, securing supplies for their marketing segment and provision of value creation opportunities from raw materials through to the distribution of products.

Advantages for Xstrata
Xstrata’s rationale for the deal is to enhance their opportunities to secure distribution channels in developing countries through Glencore’s extensive network. Copper in particular is an area where the company sees growth potential; they expect it to be mainly derived from developing countries for the foreseeable future. However, many of the countries where this demand is to be sourced from will have poor infrastructure, and marketing opportunities. Developing countries are responsible for over three quarters of global demand currently. By combining with Glencore this will help Xstrata’s products to be more deliverable to these countries given Glencore’s extensive network of distributors, logistics and marketers. Further, the market intelligence provided in Glencore Xstrata will be more extensive and therefore benefit the company. Xstrata’s medium term prospects include further exposure to a broader range of commodities in Glencore’s portfolio to safeguard against cyclical downturns in the mineral industry. The mergers will also accelerate the company’s growth potential; in their 2011 annual report, they believe they will gain a compound annual growth rate of 11% through to 2015, against their peers’ average of 7%.

Figure 3: Glencore Xstrata would be the most diversified mining company

SOURCE: XSTRATA ANNUAL REPORT 2011

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CONSEQUENCES OF THE MERGER
The size of the deal means it has ramifications beyond the mining industry. Further, it is less clear whether it is a merger of equals; after resistance from Xstrata shareholders, the price has been raised at the expense of the “golden handcuffs” deal which was aimed at retaining Xstrata’s management staff. Consequently, Glencore CEO Ivan Glasenberg will now be in charge of Xstrata, with the senior management team likely to depart or be seriously depleted. This could have consequences when Glencore’s top down management structure attempts to assimilate the decentralized Xstrata assets, and Glasenberg’s more cost driven approach to organic growth pitted against Xstrata’s willingness to invest. The deal is still subject to approval from competitive authorities, which could force concessions from the authorities to ensure the deal goes through. Finally, sustainability and developing countries could face further pressure due to the company’s scope across the entire value chain and allegations of unethical practices.

Is the deal a merger of equals or takeover?
The deal’s original touting as a merger of equals in February 2012 began to resemble a Glencore takeover. The original offer had to be upped in order to satisfy Xstrata’s second largest stakeholders, with the revised deal also rejecting the “golden handcuffs” deal to retain the senior management. The Xstrata chairman John Bond announced he would step down, and Glasenberg will replace current Xstrata CEO Davis after six months, with chief financial officer (CFO) Trevor Reid also stepping down after its rejection. This could have implications for the company due the loss of the staff which have been in the company since it began its expansion, potentially harming its capability for organic growth. It is unclear whether this is yet a bad thing. Glencore’s broader emphasis on a wider range of commodities will help to stem the downturn in prices happening as Chinese demand decelerates. Glencore also possesses the ability to build world-class assets in mining, so will be able to build on the progress Xstrata has made over the past decade.

Qatar Holdings
Glencore’s original offer was compromised by Xstrata’s second largest stakeholder, the sovereign wealth fund Qatar Holding, which holds a 12% stake in Xstrata. By demanding a higher price for their consent, Glencore in exchange demanded more favourable terms and compromised the management team at Xstrata which had helped to drive its growth over the past decade. The original Glencore offer envisioned 2.8 shares for each Xstrata share with the current management team retained. However, Qatar holding steadily increased its stake, and in July demanded a price of 3.25 Glencore shares. Given that the merger required 75% with Glencore’s 34% not counted, the Qataris represented a potential vote blocker. The merger was nearly derailed until talks in September 2012 (headed by former UK Prime Minister Tony Blair) saw a new deal agreed the day before the deadline. The new price of 3.05 shares was approved by the Xstrata board.

Rejection of “Golden Handcuffs”
The Qataris abstained from the retention package vote, which was aimed at keeping Xstrata’s senior management. Although nearly 80% of Xstrata’s shareholders approved the merger, a majority was not formed on the retention package. The reason this is so significant is during the decade of Xstrata’s expansion, 90% of the senior management has served consistently, with only Peter Coates and Marc Gonsalves leaving due to retirement. With three members of the senior management already on their way out, this could jeopardize the company’s growth prospects as the people who helped to steer its exponential growth may leave. However, Glencore does have some assets in metals and minerals, and given their success in developing some of the assets, the exodus may not be such a terrible thing as Glencore is more than capable of creating value independently. The deal was worth over £140m ($224.5m) for the 72 managers. This has prompted fears of a management exodus; Chairman John Bond announced he would step down for the new board after they rejected the pay package he had twice supported. Trevor Reid, the company’s CFO, also announced he would leave. Current CEO Davis is expected to be replaced by Glasenberg after six months.

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Assimilation problems
The difference in the companies’ management doctrines and growth strategies could also complicate matters. Xstrata’s heavily decentralized approach will jar with Glencore’s top-down management style. Further, Xstrata’s growth strategies rely on organic growth through capital-intensive exploration of greenfield lands, at odds with Glencore’s strategy of expansion, which has become more cost-conscious of any new exploration programs if they face any delays or cost increases, against Xstrata’s tendency to carry them out. These concerns may be allayed due to the relationship between Glencore and Xstrata already established, and any concerns regarding efficiencies may be recuperated via the synergies created by the merger of the companies.

Growth plans
Xstrata’s previous strategy for growth is concerned with greenfield investment in new sites. This is a highly capital intensive procedure prone to costs escalating or delays. Xstrata boasts that its investments are cost-effective and designed to minimize such actions. This contrasts with Glasenberg’s Glencore, which has become wary of such costly expansion, and is more fiscally conservative. Commodity prices’ downward trend means they stick to their plan of gradual expansion by purchasing undervalued assets in politically sensitive areas where other competitors may not tread. This reduces the risk of actually constructing the mine and exploration costs, although Davis insists that brownfield expansions can’t be followed without initial greenfield exploration. Glencore’s less capital intensive measure of growth could be the right approach to a global slowdown, as projected returns for new projects would diminish with higher prices.

Management styles
Xstrata credits its decentralized philosophy with the success of the company, with people on the ground taking accountability for their decisions with the company believing that their knowledge in their geography and product. Glencore is the inverse, with a top-heavy management style. The difference could lead to a shift in the way the company works, and may impair efficiencies. Given how long Glencore and Xstrata have worked together this may not represent a problem. Both companies have consistently created value in their history, and with Glencore’s wider risk portfolio, a top down approach may be necessary to co-ordinate activities.

The deal may require concessions to regulators
Although the companies’ shareholders have approved the deal, it will still be subject to ratification in Europe, South Africa and China. Glencore had to sacrifice some of Viterra’s assets in Canada to see the merger take place, and the same could very well be true for the much larger merger. This means the new company could hemorrhage value and lose some of its competitive edge. However, in November 2012 the European Commission cleared the deal requiring only for Glencore to end its zinc sales agreement with Belgian company Nyrstar. South Africa has seen a challenge from utility company Eksom regarding coal supplies, with the Chinese commission’s verdict yet to be reached.

The purchase of Viterra resulted in regulator intervention
Viterra’s acquisition required Glencore to sell some its key stakes in strategic assets to rivals in the Canadian agriculture market. Agrium is taking over Viterra’s significant fertilizer assets for $1.8bn, and Richardson is buying a significant portion of Viterra’s grain-handling business and food processing plants. HardAssetInvestor.com estimates Glencore paid a 50% premium on Viterra’s price for only 65% of its assets after concessions to the Canadian regulator. It was therefore likely given Glencore’s size that intervention would also be inevitable in Europe, causing the deal to leak value.

The European Commission
Although the deal required regulatory approval in China and South Africa also, The European Commission was considered the main barrier to the deal. The main European opposition to the deal was in the zinc market, where Glencore Xstrata would control 50% of the European market. To satisfy concerns, the company offered up several interests, including the Nordenham plant in Germany which produced 148,000 tons of zinc last year. The Commission required that Glencore dispose of its agreements with Nyrstar, including its distribution contracts and 7.79% minority stake in the company. After divesting these stakes and terminating the supply contracts, Glencore

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Xstrata’s market share drops to 34%. Although this may represent a minor irritation to Glencore as they only just renewed their Nyrstar contract last year for $700m to 2018, the commission could have required much stricter penalties. Nyrstar may also seek compensation as it seeks another trading partner or attempts to rebuild its own sales department.

South African snags
The South African competition commission initially cleared the deal, but a challenge from Eksom, the state utility company, has delayed the deal’s approval. The tribunal has been postponed until 18 January 2013 to give the parties more time to prepare their cases. Eksom’s challenge revolves around coal supplies, which is its predominant source of power generation (over 85% according to Reuters). Xstrata is already one of the largest providers to the South African utility market, and the newly merged company would provide 15% of Eksom’ coal which could affect its supply. The deal is unlikely to be halted, but may require concessions in South Africa’s market.

Accusations of unethical practices
The creation of such a large company will have implications regarding the global commodity market. By becoming the fourth largest mining company and one of the most diversified traders, Glencore Xstrata will exercise great power in many markets. Both companies have been implicated in incidents of unethical practices, although both companies strenuously deny all allegations. Glencore’s subsidiaries have been accused of tax evasion, health problems caused by pollution, environmental degradation, child labor and use of paramilitaries across developing economies by a multitude of NGOs. The list of allegations has led the managing director of the Berne Declaration to claim in May 2011 that “In terms of corporate responsibility… Glencore is still in the dark ages compared to other major mining firms”. If these allegations are true, the merger could have serious consequences for developing nations. The company strongly denies any accusations of unethical behavior. The company feels so strongly about it that when Glencore was awarded satirical prize “the Worst Company in the World 2008”, Glasenberg contacted the Public Eye awards to insist his company’s impeccable behavior and express his irritation at the award. The company annually releases a sustainability report and reiterates its commitment to ethical practices.

Figure 4: Activists protest against Glencore's alleged water pollution

SOURCE: http://theconversation.edu.au/the-most-powerful-companies-youve-never-heard-of-glencore-3663

MARKETLINE

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CONCLUSIONS
Glencore Xstrata: a recipe for success
Glencore is one of the largest and most diversified commodity traders globally. The diversification has branched beyond its primary segment of metals and minerals to agricultural products and energy and utilities. The diversification helps to soften volatile commodity prices, with Glencore’s gradual expansion using undervalued assets as its primary driver of growth, with acquisitions such as Kazzinc helping. The company’s size also allows it leverage favorable terms on contracts, such as its deal with Rusal. Xstrata’s strong growth was fostered when it purchased Glencore’s thermal coal assets in South Africa and Australia, making it the largest thermal coal exporter in the world. Since then, the company has diversified into other metals through merger and acquisition activity, with an emphasis on organic growth through greenfield exploration. The company advocates decentralization to achieve the best results, and also has a knack for cost reductions, consistently reducing them since 2003. Glencore’s interest in Xstrata has been long known, with the company possessing a 34% stake in them prior to the proposal. Glencore CEO Glasenberg sits on the Xstrata board, with similarities in their geographically diverse nature and activities. The merger would create a fully integrated mining company, from raw material extraction to marketing, with Xstrata’s activities rolled into the Glencore fold, already achieving synergies of over $500m first year after the merger. The new company would become possess dominance in market share for thermal coal, ferrochrome, zinc and prominent positions in other metals such as copper. The new company would possess strong growth potential in the metals and minerals sector, providing Glencore with an opportunity to focus its efforts and lending its acquisition’s ability for cost reductions to improve profit margins. For Xstrata, they receive an opportunity to integrate distribution networks to the primary source of demand for many of their products in the near future due to Glencore’s extensive network of traders and logistics. Concerns about the deal include the revision from a merger of equals to what resembles more a Glencore takeover; the second largest shareholders demanded an increased price, which Glencore paid at the expense of the current Xstrata CEO Davis. The golden retention plan was also rejected by shareholders, leading to fears about the possibility of the loss of many senior management staff who had engineered the company’s success over the last decade. Furthermore, it remains to be seen how well the management philosophies of the companies will be reconciled and their strategies for growth, with Xstrata’s capital hungry organic growth likely to not be accepted by Glencore which is more fiscally conservative with new projects given their propensity to overrun financially and temporally. With commodity prices decelerating in line with a slowdown in Chinese demand, Glencore is likely to impose such terms on the company, although this may not necessarily be a bad thing. Furthermore, Glencore has experience in the metals and minerals sector so although the loss of such astute managers may be regrettable, it is more than capable of steering the company. The company faces problems from competition regulators due to the size of the merger. After the Viterra acquisition, many strategic assets had to be sold to satisfy Canadian regulators. The European Commission looked to be the biggest obstacle, with further hurdles in China and South Africa. Europe surprisingly demanded only that Glencore’s agreement with Nyrstar be terminated in order to diminish its prospects in the European zinc market, when the company was prepared to sell its assets in Nordenham. South Africa has seen a legal challenge from Eksom which looks to ensure that the coal market remains competitive. China has yet to reach its verdict. The company may also have a further damaging impact on developing nations, with NGOs leveling accusations of unethical activities ranging from tax evasion, environmental degradation and labor practices. The company vehemently denies any such allegations, insisting they are sustainable in their business activities. The merger will create the fourth largest mining company globally, and one of the most diversified in terms of product provision and geographical locations. It will also be one of the most integrated producers in the industry, meaning the merger makes sense for both companies. The new company will surely exercise a strong position in many commodities.

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APPENDIX
Definitions
EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization): EBITDA is net income with interest, taxes, depreciation, and amortization added back to it, and can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. Brownfields, Greenfields: the general meaning of brownfields exploration is that which is conducted within geological terranes within close proximity to known ore deposits. Greenfields are the remainder. Greenfields exploration relies on the predictive power of ore genesis models to search for mineralization in unexplored virgin ground. This may be territory which has been drilled for other commodities, but with a new exploration concept is considered prospective for commodities not sought there before. The success rate of exploration and the return on investment is low because exploration is an inherently risky business. Greenfields exploration has a lower strike rate, because the geology is poorly understood at the conception of an exploration program but the rewards are greater because it is easier to find the biggest deposit in an area earlier, and it is only with more effort that the smaller satellite deposits are found. Brownfields exploration is less risky, as the geology is better understood and exploration methodology is well known, but since most large deposits are already found the rewards are incrementally less

Sources
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http://www.ft.com/cms/s/0/d44f8c58-50fe-11e2-9623-00144feab49a.html#ixzz2H0ED3tim Glencore press releases and annual reports, available here: http://www.glencore.com The Guardian, “Xstrata's chief financial officer quits”, available here: http://www.guardian.co.uk/business/2012/dec/04/xstrata-chief-financial-officer-trevor-reid-quits The Guardian, “Five reasons Glencore/Xstrata mega-merger is important”, available here: http://www.guardian.co.uk/commentisfree/2012/sep/10/glencore-xstrata-mega-merger The Guardian, "Glencore 'is in dark ages' compared with rivals, says NGO boss" available here: http://www.guardian.co.uk/business/2011/may/19/glencore-in-dark-ages-says-ngo-boss Hard assets investor, "The Commodity Investor: Glencore Acquisitions Ignore Shareholder Value", available here: http://www.hardassetsinvestor.com/the-commodity-investor/3580-the-commodity-investor-glencore-acquisitions-ignoreshareholder-value.html?showall=&start=1 Independent, "Glencore/Xstrata merger approved", available here: http://www.independent.co.uk/news/business/news/glencorexstrata-merger-approved-8335821.html The Local, "Glencore-Xstrata merger wins strong backing", available here: http://www.thelocal.ch/page/view/glencore-xstrata-merger-wins-strong-backing#.UObHH-TZY9Y London Mining Network, "Frankglenstrata- birth of a monster?" available here: http://www.newint.org/blog/2012/11/20/xstrata-glencore-takeover/ Proactive investors, "Glencore Xstrata merger creates group too big to ignore, reckons Liberum" available here: http://www.proactiveinvestors.co.uk/companies/news/52046/glencore-xstrata-merger-creates-group-too-big-to-ignorereckons-liberum-52046.html Reuters, "EU regulators clear way for Glencore Xstrata tie-up", available here: http://uk.reuters.com/article/2012/11/21/uk-glencore-xstrata-eu-idUKBRE8AK0L520121121 Reuters, “Xstrata, Glencore hearing in South Africa postponed”, available here: http://uk.reuters.com/article/2012/12/10/us-safrica-xstrata-idUKBRE8B90II20121210 Rio Tinto annual report, available here: http://www.riotinto.com/media/18435_financial_results.asp Seeking Alpha, "A look at Glencore's Growth Ambitions", available here: http://seekingalpha.com/article/519691-a-look-at-glencore-s-growth-ambitions Viterra, "Glencore to Acquire Viterra", available here: http://www.viterra.com/portal/wps/portal/canada/ca/news_ca/news_releases/!ut/p/c5/04_SB8K8xLLM9MSSzPy8xBz9CP 0os3hLSw8LQycTA0v_ICMzA0_PUA_kKAApwADY_1wkA6zeAMcwNFA388jPzdVvyA7rxwA5Krefw!!/dl3/d3/L2dJQSEvUUt3QS9ZQnZ3LzZfOTlIODFCNDA5 OFIxNjBJMk5NR1BKTzFIMzM!/ Xstrata annual reports and press releases, available here: http://www.xstrata.com/

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Further Reading
Glencore International AG – MarketLine Company Profile Xstrata Plc – MarketLine Company Profile Metals & Minerals- MarketLine Industry profiles

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