The Commodity Investor: What Can Investors Expect from Xstrata?

Columnist Amine Bouchentouf is a partner at Parador Capital LLC, an institutional advisory firm focused on commodities and emerging markets. He is the author of the bestselling Commodities For Dummies, published by Wiley. Amine is also the founder of Commodities Investors LLC, an advisory firm dedicated to providing insightful information on all things commodities. 

Xstrata (LSE:XTA) is truly one of the most diversified and storied major mining companies out there. The company traces its roots to 1920s Switzerland, where it was a leader in power, electricity and infrastructure. Throughout the decades, Xstrata morphed into a major mining company with operations in multiple jurisdictions and a vast array of commodity products. Today, Xstrata has operations in over 20 countries and is a worldwide leader in the production and distribution of major commodities such as coal, copper, nickel and zinc.

Xstrata-Glencore or Glencore-Xstrata?

Xstrata has been in the headlines lately as its two biggest shareholders — Glencore (LSE:GLEN) and Qatar Holding — are locked in a battle over the future of the company. Glencore has had a long and complicated history with Xstrata. Back in the 1980s, Marc Rich — the disgraced financier who received a presidential pardon under Bill Clinton — was a majority shareholder in Xstrata. Marc Rich also happens to have been instrumental in launching Glencore — Ivan Glasenberg, the current CEO of Glencore, worked at Marc Rich & Company before it was transformed into Glencore. So Xstrata and Glencore share a similar and complicated history.

Today, Glencore owns about 34 percent of Xstrata and is its largest shareholder. Ivan Glasenberg also sits on Xstrata’s board, and the two companies have marketing and production agreements that cover several key commodities. Earlier this year, Glencore made an offer for the remaining shares of Xstrata that it does not own. In a fairly straightforward transaction, Glencore offered to do an all-stock deal and offered 2.8 Glencore shares for every Xstrata share it does not own. The deal was approved by the boards of both companies, but in order for the deal to go through, it needs to be approved by shareholders as well. And that’s where things start to get interesting.

Qatar: activism at its finest

Unlike Glencore, Qatar’s history with Xstrata is relatively recent. As of February of this year, Qatar Holding owned approximately a 3 percent stake in Xstrata, not a huge number, but nothing to scoff at either. Over the subsequent months, Qatar began accumulating an ever-growing position in the mining giant, spending almost $5 billion to build its current stake of 12 percent. Qatar’s position means it’s the second largest Xstrata shareholder, behind only Glencore.

As Qatar quietly accumulated its large position, it did not make its intentions known. Like an experienced hunter, Qatar quietly built up an ever-growing position until it dropped a bombshell on the market in June 2012. In an unprecedented move for a sovereign wealth fund, Qatar Holding turned activist investor and threatened to block the deal if Glencore didn’t sweeten the deal for Xstrata shareholders. Indeed, Qatar made clear that it believes Glencore’s offer of 2.8 shares is low and stated that 3.25 Glencore shares for every Xstrata share is a more reasonable deal.

Qatar went further and recruited other large minority shareholders to pressure Glencore to up its bid. Qatar Holding’s actions sent shockwaves through the market for several reasons. First, sovereign wealth funds are usually passive investors and don’t normally engage in direct shareholder activism. This may be the first case of a sovereign wealth fund acting as an activist shareholder and threatening to block a merger deal if better terms aren’t offered. Second, Qatar offered no indication prior to its June announcement that it would threaten to block the bid — and that after quietly accumulating what turned out to be the second-largest shareholder position in the company.

And the winner is…

Before we get to the winner here, let’s take a look at the losers. Arguably the biggest losers if the deal doesn’t go through will be Xstrata’s management team. The management team shrewdly negotiated retention packages with Glencore that are valued at close to $500 million for fewer than 35 executives. Indeed, this wildly generous pay package is one of the main reasons that Glencore stumbled into a shareholder revolt to begin with. If the deal doesn’t go through, the management team can say goodbye to its much-anticipated payday.

The other big loser if the deal falls through will be Glencore — not so much in economic terms as in market reputation and credibility. Glencore is known as one of the most ruthless trading firms out there. What will become of its aggressive reputation if it can’t handle a few minority shareholders? It would certainly be a major setback for a company used to operating on its own terms.

Probably the biggest winner of the bunch is Qatar Holding. Sensing an opportunity and a mispriced trade, Qatar quietly built up a sizable position in one of the world’s top mining companies. If the deal goes through on its terms, then it will have gained market respect and credibility for its activism, along with better economics. If the deal doesn’t go through, it will have proven to the market that it’s an investor to be reckoned with and will still be a main shareholder of Xstrata, receiving all the benefits that entails (dividends anyone?).

What’s an investor to do?

With a vote just days away and the fate of one of the world’s top mining companies at stake, you too can benefit from this showdown. At this stage, it’s all about who’s going to blink first. Qatar has forced Glencore into a corner and it must choose one of two options: either improve its terms or walk away from the deal.

The Commodity Investor believes that there’s a higher probability that Glencore will improve its bid. Glencore has been planning and preparing for this deal for too long and has already committed so much time and resources that it seems counterintuitive for it to walk away instead of improving its bid by 10 percent to 15 percent. Therefore, the Commodity Investor recommends buying some Xstrata shares ahead of the crucial September shareholder vote. If the deal goes through you’ll be well-rewarded, and if it doesn’t you’ll still be an owner of a world-class mining company.