Too big to succeed?

VIDYA RAM, THE HINDU BUSINESS LINE

The Glencore-Xstrata merger is on the rocks. This conforms to a recent pattern of numerous mega mergers not working at all.

August 26, 2012:
Barely six months after it was announced with all the fanfare that usually accompanies such news, it’s safe to say that the future of the mega merger of Glencore, the London-listed commodities behemoth, with Xstrata, the Swiss miner, is looking decidedly shaky.

Glencore’s Chief Executive Ivan Glasenberg may be trying to downplay the significance of the developments — insisting this week that the $90 billion (Rs 500,000 crore) merger was far from a “must-do deal” — but it’s quite clearly a blow.

Glencore has had its sights on a merger with Xstrata — in which it currently holds a 34 per cent stake — for several years now, and the prospect of it was certainly one of the reasons behind the company’s decision to list on the London Stock Exchange last May. (Its share price has fallen 32 per cent since.)

Glencore estimated that the deal — which involved the offer of 2.8 Glencore shares for every Xstrata one — would generate EBITDA savings of Rs 2,770 crore in the first full financial year, create a “powerhouse” in the global commodities world, and give it control over vast swathes of global copper, thermal coal and zinc production.

STRING OF FAILURES

Now, the chances of the deal look increasing bleak, with Qatar, which holds a 12 per cent stake in Xstrata, standing by its demand for 3.25 rather than 2.8 Glencore shares for each of the miner’s. A number of other shareholders are also calling for revised terms, and the chances are high that these opponents may garner enough support to block the deal at a meeting of Xstrata shareholders on September 7.

Should the merger fail to happen, it would be one of a string of failed mega mergers in the sector. Back in 2008, BHP Billiton finally admitted defeat in its attempts to merge with Rio Tinto, while two years later, attempts to join their West Australian iron ore businesses also floundered. BHP’s next attempt to acquire the Potash Corporation of Canada proved equally fruitless, as did Xstrata’s own attempt to take over Anglo American.

Other sectors too have seen similarly touted propositions end in nothing: Earlier this year, exchanges NYSE Euronext and Deutsche Boerse failed to pull off their merger plans, while two years ago, a deal between IBM and Sun Microsystems collapsed.

UNDERLYING FACTORS

Regulatory issues can often stymie merger plans, as can the firm intentions of governments to keep certain sectors national.

The former certainly played a part in the exchanges’ decision to give up on plans to join forces, after the European Commission insisted that it would only give the deal the go-ahead should substantial parts of the businesses be sold off.

The takeover of Potash Corporation by BHP Billiton was blocked outright by the Canadian government for failing to meet the nation’s “net benefit” test for a foreign takeover.

German utility company E.ON’s attempts to merge with Spain’s Endesa eventually went nowhere, after facing several obstacles put in its way by the Spanish government (and despite efforts by European Commission authorities to prevent protectionism).

The financial crisis has also put paid to some plans: Rio Tinto and BHP Billiton would have expected to have to sell assets when they sought regulatory approval to join forces, but they did not reckon with the hostile environment — which saw commodity prices crash and would have made getting an attractive price for those assets extremely difficult.

Often, pricing issues have proved more divisive than ever expected: The IBM-Sun Microsystems collapsed over pricing issues and stipulations for Sun Microsystems executives even before ever facing any of the potential regulatory challenges.

STUBBORNNESS AT WORK

The Glencore-Xstrata deal has seen rumblings of discontent from the get-go: A Rs 1,500-crore retention package for senior Xstrata executives as part of the deal riled shareholders, and continues to be an issue, even after some concessions were made (making it an all share, performance related payment).

It is also a process marked by stubbornness: Neither Glencore nor Qatar budged in their demands, despite the fact that there appears to be widespread acceptance that improved terms would hardly be inappropriate.

“We believe that Glencore is far from being close to overpaying for what is a diversified miner with a large and credible growth pipeline already in execution mode in commodities that Glencore also likes,” wrote analysts at BNP Paribas in a recent note, adding that the demand for improved terms was “far from extravagant.”

What many of the failed or failing deals seem to share is a certain forethought: Qatar may have taken several months to reveal its opposition to the Glencore deal terms but one would have thought that in a deal of this magnitude — done at considerable cost to the companies and their shareholders — more of an effort to get major shareholders on board before it all commenced, would have been made.

(The same could be said of those that failed due to regulatory reasons — regulators over the years have demonstrated their willingness to reject a deal outright, or demand conditions that change the fundamental commercial logic of the deal).

NO MAGIC BULLET

A number of studies over the years have raised questions about the logic of mega mergers. For example, a 2000 study by two economists, Fariborz Ghadar and Pankaj Ghemawat, in the Harvard Business Review, which examined past deals in industries across the world, sought to debunk the “myth” that bigger was better.

They found that mega mergers weren’t resulting in consolidation and dominance of a market, as niche, newer and more nimble players entered the market and that there were better ways of coping with globalisation than simply growing bigger with larger acquisitions.

It’s easy to find examples of mergers gone wrong to support that argument — such as Daimler’s $37-billion acquisition of Chrysler (the company sold off an 80 per cent stake in the brand for a fifth of that value nine years later), or Rio Tinto’s 2007 acquisition of aluminum business Alcan, which left it saddled with large debts.

Still, the apparent lure of the mega deal — browbeating the competition, dominating markets, generating zillions in efficiency savings, not to mention the prestige — doesn’t seem to wane.