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More Xstrata rebels will soon break cover

by Paul Whitfield | Published February 7, 2012 at 4:25 PM

Glencore International plc's bid for Xstrata plc was the deal that everyone expected. But it's clearly not the one Xstrata shareholders had hoped for -- or deserve.

Within hours of the £39.1 billion ($61.9 billion) all-share offer, two of Xstrata's top 10 investors had come out against the bid.

"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," Standard Life Investments' head of equities, David Cumming, said in a statement.

Richard Buxton, head of equities at a second U.K. fund manager, Schroders plc, declared the deal to be "fabulous" for Glencore, "great" for Xstrata management and "poor" for Xstrata shareholders. "I'm in complete agreement with Standard Life, and we intend to do exactly the same thing," he told Reuters.

The fund managers together control about 3.6% of Xstrata's stock. That isn't enough to block the deal, but it is a good start. The merger will be implemented via a scheme of arrangement, a legal structure that needs the support of 75% of the shareholders of both companies. Glencore owns 34% of Xstrata and will not be allowed to vote its shares. That means that Xstrata rebels need just 16.5% of Xstrata's shares to block the deal.

There is good reason to believe more rebels will soon break cover. Mining industry takeovers, of which there have been plenty in recent years, tend to come with a hefty takeover premium. The average is about 30%, HSBC Holdings plc analyst Andrew Keen points out. Xstrata has tended to pay a premium of between 30% and 33% for its deals.

Glencore's offer of 2.8 new shares for each Xstrata share equates to a premium of just 8%, based on the two companies' share price on Feb. 1, the day before the deal was announced.

Tuesday's announcement offered hints that Glencore and Xstrata are sensitive to the lack of a premium. First, there was the repeated refrain that the deal is a merger of equals, which many heard as defensive and at odds with the reality of a transaction that will leave Glencore shareholders with a 55% stake in the combined company.

Second was the odd -- and at first glance contradictory -- insistence that the deal was being pitched at a 15.2% premium. That figure can only be arrived at if you use Glencore's closing price of Monday, after it had benefited from a week of deal speculation, and compare it to Xstrata's closing price of Feb. 1, before the talks were revealed.

Yet, the most telling sign that not all was well with the deal was the contortions that Xstrata CEO Mick Davis, who will take over as CEO of the post-merger group, was forced into as he attempted to justify the lack of a premium.

Speaking to analysts on a Tuesday conference call, Davis claimed that the inclusion of a significant premium could damage the prospects of the larger company. But as Davis himself remarked, "this is a share-for-share deal." The only effect of changing the ratio is to give one or the other side of the deal a greater stake in the post-merger group. The relevant fact is that given the current ratio, Xstrata's shareholders will lose control of their investment. They have every reason to expect to be compensated for that loss.

The CEO's next point was even more tenuous. "Why should one set of shareholders be advantaged?" The response to that is simple: it is Davis' job as CEO of Xstrata to seek advantage for his shareholders. Once the merger is complete he can worry about Glencore's shareholders. Right now they are not his concern.

Finally, Davis went on to recount how his view on premiums in all-share deals was informed by the work he did putting together an all-share deal for Anglo American plc. He failed to mention that the nil-premium bid collapsed in October 2009 amid opposition from Anglo American's board and key shareholders, many of which had lambasted the lack of takeover premium.

There is still every chance that Glencore will get the mining company. Because many of Xstrata's institutional shareholders are also Glencore shareholders, the exchange ratio will matter less to them.

Until that happens, only or predominantly those on the Xstrata side of the deal have every reason to fight their corner and expect more from their CEO.

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