Glencore needs a little privacy

If a fire sale of assets now ensues, Mick Davis might be able to help.
Could Mick Davis save Glencore?

That might seem like an odd (or churlish) question to ask: After all, it was Glencore’s decision to buy Xstrata, the mining behemoth that Davis built, which saddled the commodity trading firm with a lot of the debt now weighing on its shares.

The latter slumped 27 percent on Monday to about 70 pence each after Investec Securities released a report speculating that depressed commodity prices could wipe out Glencore’s equity value. That report came just days after one from Goldman Sachs throwing doubt on Glencore’s investment-grade credit rating – a big deal for a trading firm. The shares sank below 100 pence for the first time since 2011’s initial public offering, when they priced at 530 pence apiece.

That 87 percent drop since the IPO makes Glencore the worst-performing major mining stock aside from Vale – which at least has the excuse of being listed in Brazil. Apart from Glencore’s balance sheet having made its stock a pinata for analysts, the crisis raises a more fundamental question: Should Glencore exist in its current form?

Glencore’s trading savvy was supposed to mean it could make money whatever the market climate, giving investors a smoother ride. Bringing Xstrata’s mines fully in-house was meant to make the ride even smoother.

That hasn’t really happened. Looking at earnings per share over the past eight half-yearly periods, Glencore’s swings have been tamer than at Rio Tinto or fellow problem child Anglo American, but wilder than at BHP Billiton. And since its IPO, Glencore’s stock price has been more volatile than all three of those rivals.

The big culprit is debt, which topped $50 billion at the end of June, up from $35.5 billion at the end of 2012, just before Glencore bought the 66 percent of Xstrata that it didn’t already own. Even using Glencore’s own measure, which adjusts Ebitda and treats $17.7 billion of “readily marketable inventories” as cash equivalents, its leverage stands out. Glencore reported net debt of 2.71 times trailing Ebitda at the end of June. In comparison, BHP and Rio stood at 1.19 and 0.8 times, respectively, according to data compiled by Bloomberg.

That debt leaves Glencore vulnerable to falling prices of copper, coal, zinc and nickel. Its plan to cut the burden by $10 billion, including a recent $2.5 billion rights offering, has been brushed aside.

A further share sale at today’s price, about half where new shares sold just a couple of weeks ago, looks infeasible. For the average investor, the sharpest trade Glencore has made in the past five years was selling $10 billion worth of shares in its own IPO. Similar to some other trading firms that went public, the very act of selling itself was in hindsight Glencore’s clearest signal that the commodities supercycle had peaked.

But if the timing on that trade was spot on, its purchase of Xstrata was an act of hubris. That deal valued Xstrata at about $45 billion, and the merged company is now worth about $15 billion. Just like Rio with Alcan or, more recently, Freeport- McMoRan’s disastrous foray into oil and gas, Glencore bought high and now scrambles to deal with the consequences. Its descent from the rarefied – and opaque – heights of commodity trading house to the ranks of the all-too-cyclical listed mining sector appears complete.

When Glencore was private, a bad bet on, say, buying a stake in a mine risked losing the capital invested – unfortunate, but ultimately containable. Now that Glencore is listed, any ding to its credibility as a canny trader ripples through the valuation of the entire company. A year ago, its enterprise value was almost 8 times estimated Ebitda, far above the range of 4.5 to 5 times at which its London-listed mining rivals traded. Today, at 5.1 times, it trails all of them save Anglo.

Ironically, if a fire sale of assets now ensues to shore up confidence, Davis might be able to help – himself mostly, but maybe also Glencore’s shareholders. Xstrata’s ex-boss now runs X2 Resources, a vehicle backed by private money and sovereign wealth to essentially build another diversified metals and mining company that likely wouldn’t look too dissimilar to what Davis built at Xstrata.

Assuming X2 can still tap its committed equity in today’s market – and private money should in theory be more willing to weather the current storm – it should at least be interested in taking a look at Glencore’s coal and copper assets. And, hey, due diligence shouldn’t take too long with this potential buyer. In its report last week, Goldman even raised the possibility of Glencore being taken private again. If so, maybe X2 could potentially chip in for an equity stake. That would, ironically, reverse the positions that held before Glencore bought Xstrata.

One intriguing aspect of X2 is that it first announced its fundraising two years ago today, but, despite the crash in asset values since then, it has yet to make a single acquisition. If Mick finally takes the plunge, then that could signal the bottom is in. Equally, if X2 and its backers stay on the sidelines, then things really are as bad as mining investors seem to think.

©2015 Bloomberg View


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