CORRECTED-BREAKINGVIEWS-Rio-Glencore fail sets high bar for miner mega-M&A

By Karen Kwok

LONDON, Feb 5 (Reuters Breakingviews) - Mining mega-mergers are a scarce commodity. Just ask BHP BHP.AX boss Mike Henry, who in recent years has twice tried and failed to snare Anglo American AAL.L. Rio Tinto RIO.L and Glencore GLEN.L is the latest flop to add to the list. Even copper's red-hot strategic appeal couldn’t smelt away three stubborn impurities: debatable valuations, limited synergies, and the sector's lingering trauma from past deal blow-ups.

When the $156 billion Aussie miner entered talks in January to acquire its now $75 billion Swiss rival, investors began to price in a transformational, copper-led tie-up, something like a sequel to Anglo American's $23 billion Teck acquisition. Instead, Rio CEO Simon Trott and Glencore boss Gary Nagle walked away empty-handed on Thursday, the deadline for deciding whether to take negotiations further.

One stumbling block was non-mining specific: the premium had to be covered by synergies, and here the seam wasn't thick enough. With Rio set to hold both the chair and CEO seats post-merger, Nagle was unsurprisingly digging in for a full 30% control premium. Yet Reuters reported on Thursday, citing people familiar with the talks, that Glencore pushed for 40% of the combined entity, implying a 42% premium to its undisturbed price on January 8, by Breakingviews' calculation.

In theory, there was a workable midpoint. At a 21% premium and assuming $1 billion of synergies, Rio's return on investment could have reached about 9%, Breakingviews calculates, just above RBC's 8% estimate for Glencore’s cost of capital. But meeting the Swiss group's 42% premium demand would have pushed returns below 8% unless synergies roughly doubled to $2 billion. Most analyst estimates implied less than half that, given the two miners lacked the sort of adjacent mines in Chile that Teck and Anglo boasted.

What lies behind all this is the mining sector’s history of rubbish M&A. Rio itself famously paid $44 billion in cash for Alcan in 2007, and then watched its valuation wither. That’s left investors highly wary of all but merger sure things. Glencore’s relatively opaque marketing business and coal exposure also complicate valuation. And soaring commodity prices mean both Rio and Glencore are generating enough cash to make them reluctant to sell themselves short. This is especially true given listed peers of Glencore's coal business like Whitehaven Coal WHC.AX and Warrior Met Coal HCC.N are trading near 7 times forward EBITDA today using LSEG data, up from 4 times a year ago.

The caution is arguably short-sighted. A deal would have created the world's second-largest copper producer by volume, behind only BHP, according to FactSet data. In a world where Anglo Teck and Zijin Mining are challenging BHP and Rio’s pre-eminence – and major new projects require bulky companies to take them on – that means something.

Glencore could in the future, make itself easier to buy by spinning off coal – turning into a cleaner, more copper-focused target. Both Trott and Nagle could rekindle talks, especially if one encounters difficulties. But with Anglo Teck an outlier on synergy potential, the bar for future miner M&A is getting higher.

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CONTEXT NEWS

Rio Tinto said on February 5 that it was no longer in talks with Glencore about a takeover, saying it could not reach an agreement that would deliver value to its shareholders.

Shortly afterwards, Glencore said that the terms of the potential offer involved Rio Tinto retaining both the chairman and CEO roles, and that the financial terms of the merger "significantly undervalued" Glencore even before considering an acquisition premium.

Shares in Glencore were down almost 9% as of 1600 GMT on February 5, while Rio's London-listed stock was down almost 3%.