Thursday, July 9, 2020

Glencore-Rio Proposal Not the Right Iron Ore Deal: Russell

Posted by October 7, 2014

The hullabaloo surrounding Glencore Plc (GLNCY)'s spurned approach to rival miner Rio Tinto (RTNTF) shows why this is probably the wrong deal at the right time.

Glencore's proposal to create a $160 billion behemoth is certainly audacious, and may even make sense for shareholders of both companies if priced attractively.

But even if it were successful, such a deal would do little resolve the key problems bedevilling the outlook for many commodity markets, and the companies that produce those resources.

The logic of Glencore taking control of Rio Tinto would be for the former to get access to the latter's iron ore operations in Australia, which are the lowest cost among major producers.

Iron ore is the missing arrow in Glencore's quiver, and the assumption behind a deal would be that the Swiss-based company would be able to use its trading nous to extract more value from the well-run Rio Tinto mines.

Assuming that all the anti-trust and other regulatory obstacles could be overcome, and that Rio Tinto shareholders could be won over, then the potential for the deal to be rewarding for Glencore is compelling.

However, the emphatic rejection of the approach by Rio Tinto's board likely means that Glencore will be unable to get a low-ball offer accepted, meaning it either has to pay more money for Rio or go hostile.

Both of those would be tough decisions for Glencore's Ivan Glasenberg, the former South African who merged secretive traders Glencore with mining major Xstrata, in a deal completed last year that was initially touted as a merger of equals but ended up with Glencore dominant.

Iron Ore Outlook the Real Issue
While Glencore clearly faces an uphill battle to make the Rio Tinto deal work, there are likely better opportunities available in mining mergers and acquisitions.

The main problem in the iron ore market is that capacity additions have run ahead of even the most heroic demand assumptions, and the market is now poised for several years of low prices.

Spot iron ore in Asia <.IO62-CNI=SI> closed at $78.90 on Monday, down 41 percent from the start of the year and close to the five-year low of $77.50, hit on Sept. 30.

More importantly, the price has slumped 59 percent since the all-time high reached in February 2011, a time when the mining majors were planning to spend billions of dollars to boost output, believing the hype that China would buy everything they could produce.

The reality has turned out somewhat differently. While Chinese import demand has grown strongly, the capacity additions have swamped this and Chinese domestic iron ore output has probably been more resilient than the major miners expected.

The only way for iron ore to rise back above $100 a tonne and stay there is for China, which buys about two-thirds of seaborne supplies, to boost demand, or for more capacity to leave the market.

China's economic growth is slowing and changing, and the chances of a demand-led revival for iron ore look slim in the next few years.

This means the adjustment will have to come from supply, and here it seems that most of the higher cost output has already left the seaborne market.

Chinese domestic output also appears to be lower, although this has yet to show up in official figures. But it also appears that many of the larger mines, owned by large state-controlled companies, are continuing to produce even though they may be loss-making.

This is likely because maintaining jobs is more important than making profits for some Chinese entities.

This leaves the capacity adjustments to be made elsewhere, and here there are plenty of candidates.

Better M&A Targets?
Taking over a rival iron ore miner would allow majors like Rio Tinto and BHP Billiton (BHPLF) to surreptitiously cut capacity in the name of maximising operating efficiencies, or some similar corporate jargon.

Fortescue Metals Group (FMG.AX), the number three producer in Western Australia state, has a significant debt burden that makes it look vulnerable.

Billionaire Gina Rinehart's 56-million-tonne Roy Hill project under construction in Western Australia will come online next year and may battle in the current low price environment.

Smaller producers such at Atlas Iron are believed to be struggling, while the $10 billion Sino Iron Project may be a candidate for a change in ownership given the protracted legal battles between the now very estranged partners -- China's CITIC and outspoken Australian mining magnate-turned-politician Clive Palmer.

Anglo American may also be regretting its decision to build the delayed $14 billion Minas Rio iron ore project in Brazil.

The point is that there are many available targets for anybody wanting to get into iron ore, or for existing players to rationalise supply through mergers and acquisitions.

The Glencore-Rio Tinto merger proposal makes for good headlines and gives day-traders something to focus on, but it may be a case of Macbeth's "sound and fury, signifying nothing".

Disclosure: At the time of publication Clyde Russell owned shares in BHP Billiton and Rio Tinto as an investor in a fund.

(By Clyde Russell, Editing by David Clarke)

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