LONDON -- Is Glencore's (LSE: GLEN.L) offer for Xstrata (LSE: XTA.L) fair? Qatar Holdings doesn't think so. Along with several institutions, it's holding out for better terms. Just 16.5% of investors have to vote against the deal to block it, and with the Qataris owning above 12%, it's looking increasingly likely that it will fall through.
That may be bad for Xstrata shareholders in the short term, but they stand to do better in the longer term. And it might just create a buying opportunity.
Fair exchange, or gravy for insiders?
Glencore offered 2.8 of its shares for each Xstrata share. The Qataris want 3.25. Which is fairer? Commercial negotiation between the two company boards should settle at the right answer.
Unfortunately, negotiations haven't been conducted between two equal parties. Glencore has a 34% shareholding in Xstrata and three members on its board. They don't vote on the deal, but it creates an inequality of information that must have made price negotiation somewhat one-sided.
More significantly, investors were outraged that under the agreed terms, Xstrata's management would receive 173 million pounds in retention payments, just for turning up. Xstrata CEO Mick Davies would pocket at least 30 million pounds of that. The terms have since been adjusted to make some of it performance-related. But Davies does so well out of the deal that his objectivity is questionable.
What of independent chairman Sir John Bond? He is set to become chairman of the combined group, so he does well out of the merger, too. Xstrata's senior independent director, former BP boss Tony Hayward, also gets that job at the combined group.
So Xstrata's shareholders have every reason to question whether the board is really committed to their best interests. That's effectively what the Qatari sovereign wealth fund, and some vocal shareholders such as Schroders, are doing. If the shareholder revolt is successful, they might well seek to clean out the board.
Times they are a-changing
The 15% premium to Xstrata's share price that the offer represented never looked generous. Since then, the outlook for commodity markets has softened further and the whole sector has slipped. Glencore's share price has dropped 15% since the deal was agreed in February.
Xstrata's price has dropped 24%. Reflecting the market's doubts that the deal will be consummated, it's trading at a 10% discount to the implied merger terms.
Nevertheless, the possibility of a deal -- which Liberium Capital recently put at 40% -- may be a factor buoying the price. So if that goes away in next month's vote, Xstrata shareholders might suffer in the short term.
But longer term, Xstrata should have good growth prospects -- and better ones than Glencore's. It's developing more than 20 projects that together aim to increase production volumes by 50% and reduce average operating costs by 20% by 2015. Whatever the outlook for commodities, the value in efficient, low-cost mines should eventually out.
So Xstrata's share price might fall initially, but its longer-term prospects look good. It could be a buying opportunity.
Hard landing
The fall in mining's shares is a cyclical trend that echoes the knock-on effect of China's slowing growth, plus fears of a possible hard landing, on commodity markets. It's hitting earnings, and causing development projects to be canceled or delayed. BHP Billiton (LSE: BLT.L), down 11% since Glencore's February bid, has recently scrapped its $20 billion Olympic Dam project in Australia.
Anglo American (LSE: AAL.L) is down 32% over the same period, but some of that is attributable to investor disquiet over bungled negotiations over ownership of its Chilean copper mine. That's now been sorted out, which might see confidence -- and the share price -- recovering.
Rio Tinto (LSE: RIO.L) has fallen 24%, reflecting its greater exposure to iron ore prices, which have fallen by nearly a quarter in the last three months alone.
There are lots of opportunities in the mining sector, but, as with all cyclical industries, stock picking and timing make all the difference. It's one of the Motley Fool's top sectors of 2012. I recommend that you read the free report, which you can download to your inbox here.
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