Rio Tinto plc Rejects Glencore PLC On This Occasion… But Will It A Second Time?

A merger between Rio Tinto plc (LON:RIO) and Glencore PLC (LON:GLEN) won’t be easy to structure; will Glencore go for Anglo American plc (LON:AAL)?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Rio TintoThe mining sector just got what it needed to receive a fillip. Guess what? A big takeover story. 

Rio Tinto (LSE: RIO) confirmed on Tuesday that it had rejected a merger proposal from Glencore (LSE: GLEN) earlier this summer. “The Rio Tinto board confirms that no discussions are taking place with Glencore,” Rio Tinto added.  

Analysts suggest that a deal may take place by mid-2015, however. As M&A talk comes back with a vengeance, which miner is the best buy right now? Well, the answer may well be Anglo American (LSE: AAL)! 

A Glencore/Rio Tinto “Merger”

The deal would be structured as a merger, but it would essentially be a takeover of Rio by Glencore. It would hold strategic merits, as the assets base of Rio appeals to Glencore. 

Glencore stock trades at 8x and 7x adjusted operating cash flow for 2014 and 2015, respectively. Rio stock trades on forward trading multiples of about 5x into 2015, which means that Rio management will unlikely be able to negotiate a terrific deal for its shareholders. 

The high valuation of Glencore means that Rio shareholders would be offered a very small cash component if the deal takes place. In fact, between 60% and 80% of the takeover price would be financed by Glencore’s equity. The deal would likely value Rio in the region of £65bn, excluding net debt.

For Glencore, such a large takeover would make lots of sense. Meaningful cost and revenue synergies are up for grabs at a time diversified miners need to shed assets to become more efficient and preserve cash flows. 

Divestments: The Tricky Bit? 

Royal Bank of Canada told its clients on Tuesday that if a deal occurs, Glencore would “have the potential to nearly double its free cash flow generation potential from 2015 onwards,” adding that Glencore “could further enhance cash flow generation from currently underperforming businesses via cost synergies (Hunter Valley thermal coal assets), restructuring (copper business) and potential spin-offs or divestments (aluminum)”.

The broker also pointed out that Glencore “should be able to overcome any anti-trust issues”, given that Glencore could undertake divestments just as it did in the past when it merged with Xstrata. This may be the tricky bit: the mining sector is in trouble and needs consolidation, which means that plenty of assets are on the market and sellers do not dictate prices.

Economically, a Glencore/Rio tie-up has its own attraction. Analysts at Exane BNP Paribas suggest that a deal done at a 20% premium to Rio’s current valuation would yield a 12% accretion in earnings per share. Earnings accretion could be about 20% if the combined entity hits its high-end annual synergies target, according to my calculation, but that also depends on the loss of earnings from possible disposals. 

So, what’s next? It’s a tough market for miners. The performance of Rio stock is still under pressure for the year in spite of a 6% surge on Tuesday. Anglo American stock, meanwhile, is flat year to date. 

Of course, a takeover of Anglo would cost less than half that of Rio. Anglo’s relative valuation is line with Rio’s, although Anglo offer less value in terms of cost and revenue synergies than its largest rival. It could also be argued that BHP Billiton may show interest for certain assets once its corporate restructuring is done and dusted. In order to know how the competitive landscape will change, though, we’ll likely have to wait until next year…

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

If interest rate cuts are coming, I think these UK growth stocks could soar!

Falling interest could be great news for UK growth stocks, especially those that have been under the cosh recently. Paul…

Read more »

Investing Articles

Are these the best stocks to buy on the FTSE right now?

With the UK stock market on the way to hitting new highs, this Fool is considering which are the best…

Read more »

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »

Investing Articles

Are HSBC shares a FTSE bargain? Here’s what the charts say!

There are plenty of dirt-cheap FTSE 100 banking stocks for investors to choose from today. Our writer Royston Wild believes…

Read more »