What might talk of a potential merger with Rio Tinto (LSE: RIO) mean for Glencore (LSE: GLEN) shares?
Bloomberg News reported on Thursday (16 January) that the two were in early stage discussions just over a decade after Rio rejected a takeover bid by Glencore. But the firms did not comment.
As I write this on Friday morning, Glencore shares are up around 3% in early trading, while Rio is up under 2%. So neither share has jumped in a way that suggests the City is yet giving too much credence to the prospect of a deal.
Potential deal logic
Mega-mergers are nothing new in mining. The industry’s huge fixed costs and massive capital investment requirements, combined with a boom and bust cycle for some commodities, means that strategic combinations that can build scale and cut out costs can be attractive.
Glencore’s strength in copper boosts its appeal right now, in my opinion. Demand for the metal is expected to grow strongly due to its use in renewable energy projects.
But would a deal make sense for the firms?
We saw a tie-up between BHP and Anglo American last year collapsing because of the deal structure – driven in large part by regulatory concerns in South Africa.
I think a Glencore-Rio merger could also run into sizeable regulatory challenges given how large the combined business would be. Add to that the egos involved in mining and I doubt it would be easy to thrash out a combination between the two firms with contrasting cultures.
So for now, I see the deal chatter as interesting to hear about but not yet relevant to the long-term investment case for either miner.
How deal premiums work (or not)
While some people buy shares in companies hoping for a takeover, I see that as speculation, not investing.
Buying such shares as the price moves up in expectation of a deal, only to see the price collapse after it falls through, is a real risk in such situations.
If Rio was to bid for its rival, maybe Glencore shares would be valued at a premium, to help persuade shareholders to vote for the deal. But in a straight merger, that seems less likely to happen.
More likely, Glencore shareholders would simply receive a certain number of shares in the new, merged firm in exchange for their old Glencore ones.
Are the shares a bargain, deal or no deal?
So, for me as an investor, the investment case for Glencore needs to stand on its own two feet, whatever happens to the deal rumours.
I do like its copper assets and think they could be a substantial cash flow generator in the coming decade.
But the complex business has (like many miners) been very inconsistent in terms of financial results. Last year saw revenues fall and the business crashed to a $4.3bn post-tax loss following a mammoth profit the prior year.
That underlines the volatility of mining profits due to shifting commodity prices. Currently, metal prices are high and I reckon an uncertain global economic outlook could yet push them either way.
Until we reach a point where the metal price cycle gets much lower, I do not see Glencore shares as a long-term bargain for my portfolio so will not be investing.
