There are some very funny things going on in Xstrata’s rights issue today. Here’s the statement:
In addition, the planned Rights Issue, together with Glencore’s ongoing support for Xstrata, have provided Xstrata with an opportunity to acquire Glencore’s world-class, cash generative Prodeco coal operations in Colombia for a consideration of $2 billion. These low-cost, premier quality operations benefit from significant growth potential and will consolidate Xstrata Coal’s global leadership in thermal coal and strengthen our strategic position in Colombia, to supply both the European and US markets.
The elusive Glencore owns 35 per cent of Xstrata anyway. It’s a stake they clearly do not want diluted: they are fully subscribed to the rights issue. Which explains Prodeco. In selling Prodeco, Glencore raise the money to buy the Xstrata rights. Except…
“However, Xstrata and Glencore failed to reach full agreement on an appropriate valuation of the Prodeco assets and as a result the transaction includes a Call Option, under which Glencore may buy back the Prodeco assets from Xstrata at any point up to the first anniversary of the closing date, for a total cash consideration of $2.25 billion, plus the net balance of any cash invested by Xstrata and any profits accrued but not distributed to Xstrata.
In other words, this is not a clear cut agreement. It isn’t a decision which Glencore are totally happy about. Rather, it’s one they’ve been forced into by timing, and want the option to go back on. Whichever way you look at it, Glencore, it would appear, don’t have the cash on hand to subscribe to $2bn of Xstrata shares, so they’ve had to sell assets.
If you wanted confirmation of that, here’s Mick Davis, Xstrata CEO, speaking to analysts this morning:
[Glencore] decided it was not a desirable option to draw down on headroom.
Davis added that the whole deal really was very good from Xstrata’s point of view though.
Indeed, as Trevor Reid, Xstrata’s CFO, told analysts, the “lion’s share” of Xstrata’s existing EBIT for 2008 came from thermal coal operations. Acquiring Prodeco then – a thermal coal operation – potentially promises to boost that cash-generative profile.
To wit: if Xstrata keep Prodeco, then they get an asset they wanted anyway. And if they dont keep Prodeco, they get $250m plus profits from the operation over the year. (Xstrata wont be able to book Prodeco earnings straight away – IFRS rules prevent incorporating EBIT while the call option is in place)
What is the actual likelihood that Glencore will buy Prodeco back?
Here’s the curious phrasing from Mick Davis: They will, he says…
…if they are able to marshal the finances.
A conditional sentence which very much draws attention to the negative. Hardly a vote of confidence in Glencore’s position.
One final quirk to muddy the waters further:
The Effective Date for the acquisition will be 1 January 2009.
An accounting trick?
Here’s a reminder of Glencore’s 5yr CDS:
