By Scott Patterson
The biggest, most complex mining deal ever broached could boil
down to a simple ratio: the price of copper versus the price of
iron ore.
Glencore PLC, the Swiss mining giant with massive copper
holdings, last year proposed a roughly $150 billion merger with Rio
Tinto PLC, among the world's biggest producers of iron ore.
Glencore's announcement that Rio rebuffed the bid on Oct. 7 set off
a six-month moratorium under U.K. law from another approach.
That cooling-off period ends on Tuesday, potentially opening the
door to more talks. The two miners had never publicly disclosed
potential terms, and Rio executives haven't encouraged new
talks.
But two factors have swung in Glencore's favor that could
encourage a deal creating the world's largest mining company and
give investors exposure to every major commodity.
Glencore's shares are up more than 15% since mid-January, when
they briefly hit their lowest level since the company went public
in 2011 amid a decline in copper prices, while Rio's have dipped
3%.
A big reason for the divergence: Iron-ore prices have continued
their long decline from highs of $190 a ton reached in 2011,
recently hitting a 10-year low below $50 a ton. Copper prices,
meanwhile, have rebounded by about 5% to just north of $6,000 a ton
in the past month.
Industry experts also don't expect to see a recovery in the
price of iron ore, a primary steel-making ingredient, anytime soon.
Caroline Bain, senior commodities economist at Capital Economics
Ltd. in London, last month forecast that iron-ore prices are likely
to hit $45 a ton by year-end as large surpluses of iron-ore
continue to flood into the market and Chinese demand cools.
Such declines have been driven by unrelenting increase in
iron-ore production from Rio Tinto and its competitors such as BHP
Billiton Ltd. and Vale SA. If production isn't curbed, prices could
continue to fall, analysts say.
"Sooner or later either [Rio is] going to have to back away from
the volume-growth strategy, or they're going to have to face the
prospect that their earnings are going to fall through the floor,"
said Sanford C. Bernstein mining analyst Paul Gait. If Rio's
earnings keep falling and its share price suffers, "they're going
to be vulnerable to Glencore, " he said.
Rio Tinto Chief Executive Sam Walsh has repeatedly said he isn't
interested in a deal with Glencore. At a February event in London,
Mr. Walsh said bluntly the merger "isn't going to happen,"
indicating he thought Glencore couldn't pay a high-enough
price.
Glencore's shares have lost about one-fourth of their value
since last July, when its chief executive, Ivan Glasenberg, placed
a call to Rio Tinto Chairman Jan du Plessis to discuss a potential
merger . Since Glencore would need to offer shares as part of the
deal, the math has become significantly more daunting for Mr.
Glasenberg.
Glencore also is heavily exposed to the price of coal, which has
stumbled for similar reasons to iron ore. Plus, any deal would face
strict scrutiny from antitrust authorities in the U.K. and
Australia, where Rio Tinto is based.
One of Glencore's main hurdles in executing a Rio Tinto deal is
its debt-heavy balance sheet. Glencore had $30.5 billion in net
debt at the end of 2014, compared with Rio's $12.5 billion in debt.
That puts Glencore's leverage ratio--net debt divided by the sum of
debt and total equity--at about 40%, roughly twice the leverage at
Rio Tinto.
That could put a cap on how much more debt Glencore can take on
to fund a Rio bid. More debt could threaten its credit ratings,
putting pressure on its trading arm, which relies on leverage to
fuel its operations.
In Glencore's favor are rebounding copper prices, which could
help push its share price higher. Mr. Gait of Sanford C. Bernstein
expects copper and other factors to help lift Glencore's share
price to nearly double where it currently stands.
Perhaps the biggest wild card is China. China's state-owned
aluminium company, Chinalco, is Rio Tinto's biggest shareholder. It
has seen the value of its 9.8% stake in the company cut roughly in
half since it made the investment in 2008. Rio in 2009 rebuffed a
bid by Chinalco to double its stake, which would have given it a
seat on Rio's board.
Those factors have brewed tensions with Chinalco, potentially
leaving Beijing open to new leadership at Rio Tinto, said Michael
Komesaroff, a long-time analyst of China and natural-resource
trends.
A person who picked up the phone at Chinalco's Beijing office
said nobody was available for comment over the weekend, which was
also a holiday in China.
Glencore in its 2013 merger with Xstrata proved it could bargain
with the Chinese, getting Beijing's approval for the deal in part
by agreeing to sell its Las Bambas Peruvian copper project to a
Chinese consortium.
China, the world's biggest consumer of copper, is unlikely to
have lost its appetite for ownership of copper mines, analysts say.
One option for Glencore would be to offer to sell one of Rio's
prized copper mining assets, such as its 30% stake in Chile's
Escondida mine.
"If the Chinese want to make it happen, it's more than likely
going to happen," said Mr. Komesaroff said.
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