The Glencore/Xstrata merger could be a transformative deal.
A year ago, very few people had even heard of Glencore (LSE: GLEN). I certainly only learnt about the company when it went public and became a constituent of the FTSE 100 in May 2011.
It's amazing how it had remained under the radar for so long, as the business is the world's largest commodities trader. The company currently has a market capitalisation of £33 billion. But, not content with that, Glencore is aiming to create a new mining leviathan.
A merger of equals
A few days ago it was announced that the company was in talks to merge with Xstrata (LSE: XTA). The all-share "merger of equals" would create a £50 billion rival to BHP Billiton (LSE: BLT), the world's largest mining firm.
Xstrata is already the world's fourth largest mining company, and is a major producer of coal, copper, nickel and zinc. It is a Swiss-based business with substantial operations in eighteen countries, including Australia, Canada and South Africa.
The transaction would be the largest ever in the commodities industry. It is driven by Glencore chief executive Ivan Glasenberg, who has been eager to clinch a major deal. In fact, he is so keen for the deal to go through he is happy to be deputy to Xstrata's Mick Davis in the merged company.
There is a strong logic to this deal, as the two firms have been closely linked for years. Glencore already owns 34% of Xstrata, and Xstrata acquired Glencore's coal assets in 2002.
Greater than the sum of its parts
This mining merger is different to others that have been mooted in the past. When BHP Billiton attempted to take over Rio Tinto (LSE: RIO) in 2008, it was simply a case of making savings from the greater economies of scale.
That is not the primary reason for the 'Glenstrata' merger. While Xstrata is a pure miner, Glencore's strength is in the marketing and trading of commodities -- there is not a great deal of overlap.
Instead, this merger is all about vertical integration. What do I mean by 'vertical integration'? Well, basically, the merged company would be involved in all stages of the mining supply chain, from locating the deposits, extracting the minerals and transporting them round the world, to then marketing and trading these commodities.
This is a model which works well in the oil industry. Royal Dutch Shell (LSE: RDSB), for example, searches for oil deposits, extracts the crude, transports it, refines it and then markets and sells the end-product, often in its own petrol stations.
Vertical integration improves efficiency, and also prevents hold ups and bottlenecks in the supply chain. This is the first time such a model has been tried in the mining industry. As such, it is a potential game changer. For once, the newly created company is likely to be greater than the sum of its parts.
Are there more deals to come?
But I don't think the newly merged firm will stop there; I suspect it will seek out further acquisitions. Indeed, there has recently been more M&A activity across the whole of the booming mining sector, and this trend looks set to continue, as cash-rich businesses rush to replace depleting reserves.
Who could be next? Well, Anglo American (LSE: AAL) was the subject of a failed bid by Xstrata in 2009, and it would be the most obvious target for the newly merged company. Its portfolio of mining assets in diamonds, copper, iron ore and platinum would complement Xstrata well.
Could an acquisitive Glencore gobble up other companies in the same way Vodafone (LSE: VOD) did in the 90s? Time will tell.
For the moment though, Glencore has enough on its plate making sure it can satisfy the demands of both Xstrata shareholders and the regulators. If it succeeds, then this really could be a transformative deal.
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> The Motley Fool owns shares in BHP Billiton.
