Glencore Should Scale Back IPO Hopes

http://online.wsj.com/article/SB10001424052748703937104576302790134323546.html

By ANDREW PEAPLE And SIMON NIXON

For Glencore, it's time for Plan C. Xstrata put the kibosh on Plan A when it refused to consider a merger with the commodities trading giant that would enable Glencore partners to realize the full value of their 34.5% stake in the miner.

Investors have now scuppered Plan B by refusing to accept Glencore's overly ambitious $60 billion-plus price target that might have paved the way for a quick merger post-IPO. Glencore has been forced to lower its target price to between $48 billion and $58 billion and must brace itself for a long spell in the public markets.

Glencore's partners might wish they could simply scrap the IPO and try to re-engage Xstrata in merger talks. After all, going down the IPO route has already forced them to accept substantial dilution, even greater following the price cut. A series of self-inflicted public relations gaffes will have confirmed their worst fears about exposing this traditionally secretive business to public market scrutiny. But there is no certainty Xstrata boss Mick Davis would agree a deal even at a much lower value—or that he could win the support of his shareholders who remain suspicious of the benefits of integrating Glencore's trading business with Xstrata's mining assets.

So Glencore boss Ivan Glasenberg has little option but to plough on with the IPO. The snag is that even at the midpoint of the new price range, Glencore's valuation still looks punchy. Although Mr. Glasenberg has secured $3.1 billion of support from cornerstone investors and the deal has been cleverly constructed to maximize investment from passive index-tracking funds, he still needs to find up to $6 billion from active investors. That's tough in today's markets.

At $53 billion, Glencore would be valued at 8.8 times Citi's forecast of 2011 earnings of $6 billion, itself a company record. That valuation puts it in line with Xstrata's 8.9 times, but ahead of Rio Tinto's 7.4 times. While its mining assets have strong production-growth profiles, they are often located in politically difficult areas. Glencore's marketing arm is supposed to cushion commodities-price fluctuations, but its earnings fall just as hard as those of its industrial arm in bad years, such as 2009. Glencore's return on equity averaged 12.5% in the last three years, above Xstrata's 10%, but below Rio's 21.4% and BHP Billiton's 30.1%.

Glencore's advisers insist Mr. Glasenberg realizes the need to set a realistic price that will allow it to trade healthily in the aftermarket as a way to rebuild investor confidence after the poor start to the IPO. But to achieve that, Glencore's final IPO price will need to offer investors a generous IPO discount. Mr. Glasenberg should brace himself for a price at the bottom of the range.