Rio Tinto is on Glencore chief Ivan Glasenberg’s wish list, but a takeover attempt at current prices would blindside the market, fund managers say.
Mr Glasenberg has an impressive history of buying assets at the bottom of the market and riding the cycle up.
He has been quick to talk down iron ore this year, amid dramatic price falls and a huge increase in production by the majors. Speculation that Rio could be on acquisition-hungry Glencore’s radar has been bouncing around in investment circles for the past few weeks but some funds see it more as a thought bubble than a short or event medium-term prospect.
Pengana Capital fund manager Tim Schroeders said Rio is no doubt on Mr Glasenberg’s wish list but Swiss giant Glencore was unlikely to make a play.
“Where the two companies currently sit market cap wise, I doubt whether Glencore would be that aggressive,” Melbourne-based Mr Schroeders said.
Rio Tinto has a market value of $109.2 billion while Glencore is worth £47.1 billion ($84.8 billion) .
But Mr Schroeders pointed to the merger talks between Glencore, Xstrata and Vale in the wake of the financial crisis, saying “from an intention perspective Glencore would love to have the quality asset base of any of the top-three iron ore players”.
“They would love to be in iron ore longer term without spending the significant capital needed for a greenfields development” he says.
Resources fund managers say there would be “massive regulatory issues” around a Rio-Glencore tie-up.
“Let’s face it, they (Glencore) had to sell Las Bambas to do Xstrata (merger), what would they have to sell to do Rio?” one fund manager said.
“They couldn’t even pull off the nickel merger with Vale in Canada.”
Rio was named in a report this week by Wall Street brokerage Bernstein Research as a logical deal for Glencore, which is one of the few big resources companies contemplating acquisitions. Senior analyst Paul Gait wrote that the key problems in the mining industry, as identified by Glencore, included “too much iron ore” and Rio Tinto is too cheap.
“But these are all issues that are eminently fixable,” he wrote. “All that [is] required is to hand the world’s best mining assets to the world’s best management – and Glencore are making a pretty strong case that they, more than anyone else, understand what it will take to drive value in today’s market.”
Mr Schroeders says the internal view at Glencore is that it has superior management to Rio and BHP Billiton.
“The argument within Glencore is that management have had to work harder because of (the company’s) lesser-quality assets and their internal belief is that they do it better than BHP and Rio because they are not blessed with wonderful assets.”
Arnhem Investment Management’s Neil Boyd-Clark said it was important to note Glencore’s assets were of a lesser quality than Rio’s.
“Rio has some outstanding long-life, low-costs assets, so in an environment where commodity prices are coming under pressure it is likely to be the Glencores of the world that are struggling a bit more.”
Mr Glasenberg has pulled off a string of acquisitions in the past three years, including miner Xstrata and African oil and gas explorer Caracal.
He makes no secret of the fact the miner and commodities trader will pursue deals at a time when most of his rivals are divesting and returning cash to shareholders.
London-based Anglo American had been widely speculated to be at the top of Mr Glasenberg’s list of takeover targets. However, the Bernstein report questions the “validity of this belief”.
“The vulnerability of Anglo was essentially predicated upon management’s historic inability to address core operational concerns” Mr Gait says.
“But, under [CEO] Mark Cutifani, this is no longer the case.
“The biggest issue now facing the mining industry is not so much operational as strategic. And we believe that some of the most important strategic challenges are those currently faced by Rio Tinto.”
Rio Tinto has the world’s lowest-cost iron operations in the Pilbara region of Western Australia. The price of iron ore has fallen by almost 40 per cent in 2014. However, about 90 per cent of Rio’s underlying earnings came from iron ore in the six months to June, as chief executive Sam Walsh ramps up production in the Pilbara.
Mr Gait argues this presents Rio with a strategic problem. Noting that Rio’s iron ore assets are worth an extra $US1.5 billion every time the price of the steel-making ingredient rises by $US1 per tonne, he says a critical test will come at the end of this year.
“If the price recovers (as we expect) it will, of course, strengthen Rio Tinto’s position,” Mr Gait says.
“If it continues to decline then it will be painfully clear that their strategy of volume over price has failed. In which case a new approach will manifestly be needed.
“But irrespective of the way iron ore plays out in the short term, the long-term value proposition requires greater capital discipline, and no one has been a more consistent advocate of this than Glencore.”
He argues a merger of the larger Rio with Glencore would give Rio shareholders “the best of both worlds” – exposure to existing iron ore cashflows and the chance to share in potential upside in Glencore’s coal, copper and nickel mines should commodity prices improve.
“A Rio Tinto-Glencore combination would create market leading positions in iron ore, copper, nickel, zinc and coal as well as significant optionality around a number of lesser metals and minerals,” Mr Gait writes.
“Moreover, it would create the biggest and most diversified mining company on the planet. It would be a Glencore-Rio combination that would quickly become the ‘most own’ stock for anyone looking for mining exposure.”
He argues a combined business could borrow against Rio’s iron ore assets to increase capital returns by as much as $US50 billion.
“In a few years’ time Rio Tinto shareholders might well find themselves in the position of being asked to pay a premium to acquire the growth options that the company currently lacks outside of iron ore,” he says.
Read more: Rio Tinto touted as Glencore takeover target