What Happens Now After Chinese Approvals?
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After a rather long back-and-forth with Chinese regulatory authorities, Swiss commodities conglomerate Glencore (NASDAQOTH: GLCNF) has finally received the country's blessing to consummate its planned merger with Swiss mining company Xstrata (NASDAQOTH: XSRAY.PK). Valued at $30 billion, the deal is one of the sector's largest-ever tie-ups and promises to reorder the way in which several key commodities are mined and sold in the Asia-Pacific region. Based on Glencore's 2012 intake of about $214 billion and Xstrata's 2012 revenues of more than $31 billion, the combined company is expected to have full-year revenues in the neighborhood of $245 billion.
In light of the deal's massive size, Chinese regulators' concerns should not come as a surprise to investors. However, Glencore's troubles do offer a glimpse into the thinking of the often-opaque Chinese regulatory apparatus. While this deal certainly offers a significant potential for profit, it should also serve as a useful framework through which investors can view other blockbuster mergers that involve Chinese assets or interests.
Glencore and Xstrata at a Glance
Glencore is a diversified miner and commodities transporter that operates on a global basis. In addition to metals like copper, aluminum and zinc, the company also manages and transports stockpiles of energy resources like oil and natural gas. It also maintains a small but significant agricultural products division that manages stockpiles of grains, cotton, sugar and other products. Examples of competitors within these other industries can be found here.
Xstrata is a more narrowly focused concern that deals with the extraction and processing of various metals like cobalt, nickel, zinc, iron, gold and lead. Like Glencore, Xstrata also maintains a coking operation that extracts and processes coal from mines around the world. It operates mines and processing facilities on every continent except Antarctica.
Comparisons with Competitors
As global mineral resources firms, these companies have several high-profile competitors. First among these is Rio Tinto (NYSE: RIO), a British mining conglomerate with a hand in virtually every viable iteration of mineral extraction.
Financially, all three of these companies have struggled in the face of growing secular headwinds in their main industry. With a 2012 loss of about $3 billion in revenues of $51 billion, Rio is clearly the worst-off of the bunch however Xstrata's financial situation is not exactly rosy. It earned about $1.2 billion on $31 billion in revenues for a profit margin of less than 4 percent. Meanwhile, Glencore's $3.1 billion in after-tax earnings equated to a profit margin of less than 1.5 percent. With respective negative cash flows of $5.5 billion and $6.5 billion, both Xstrata and Rio are bleeding cash as well. Rio Tinto has an operating margin of 22% but is hurting on the financing side. Rio is down 17% in the last 52 weeks.
What Was the Holdup?
It is no secret that the rapidly growing Chinese economy requires immense supplies of copper to maintain its expansion. As one of the world's largest producers and distributors of copper, Glencore is a crucial arbiter of these supplies. According to those familiar with the negotiations, Chinese antitrust regulators were unwilling to give their blessing to the deal in light of Glencore's $5.2 billion investment in a major Peruvian copper project. Since Glencore and Xstrata both operate major projects within the PRC's borders, the two companies would have been unable to combine without its government's approval.
It has been reported that Glencore and Xstrata collectively account for up to 14 percent of China's copper imports. In turn, Glencore's Peruvian Las Bambas mine supplies a significant portion of this amount. Since the combined company would control this mine, regulators believed that it would enjoy an unacceptable amount of pricing power in the space.
Fortunately, Glencore had long been prepared to sell off the Las Bambas mine in exchange for regulatory approval. Under the terms of the tentative agreement that it reached with the Chinese authorities, Glencore will have until August of 2014 to finalize the sale of the mine. In the event that it cannot find a willing buyer, the combined company will have to sell 100% of the mine's production to competitors that also do business in China.
Moreover, Glencore has also agreed to guarantee "adequate" supplies of copper, lead and zinc to Chinese buyers for at least the next eight years. Although this part of the deal was not anticipated, it does not seem to saddle Glencore with an undue burden. According to recent reports, the acquisition should be finalized in early May.
It should also be noted that Glencore will ease the financial burden of the Xstrata acquisition by refinancing more than $13 billion in outstanding loans. This could provide investors who worry about the company's debt load with assurances that Glencore is taking its obligations seriously.
The synergies that this deal offers should be obvious to market-watchers who have some familiarity with the mining space. Although the forced sale of the Las Bambas mine is less than ideal for Glencore, the combined company will survive the hit.
Of course, the global commodities market has been increasingly soft as of late. Investors who believe that this will continue should be wary of investing in a company with such exposure to suddenly volatile commodities like copper and gold. Then again, Glencore seems to be in a stronger position than some of its peers. If it can absorb Xstrata's debt load and cash flow woes, it may find itself in a solid position. In this case, a long position in the combined company may be the best way to play this deal.
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