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Oct 24, 2015


Industry News

Ivan Glasenberg faces major test amid Glencore’s shaky future

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LONDON — The Globe and Mail

The partners at mining and commodities trading giant Glencore PLC earned a fortune buying into the “stronger for longer” China story. That bet has been looking shaky for a couple of years and downright precarious since January, when copper – Glencore’s most important commodity – went into the tank and stayed there.

In early January, copper futures plunged almost $1,000 (U.S.) a tonne, to $5,400, taking them to their lowest level in more than five years. Glencore’s shares tripped into the sinkhole with them. Since then, copper prices have lost another 5 per cent or so, a bewildering scenario for Glencore’s normally unflappable traders and executives.

“It’s just not making sense,” Glencore chief executive officer Ivan Glasenberg told analysts on the company’s earnings call on Aug. 19. “We’ve never seen copper inventories down at these levels and prices, because, [at] these levels, you normally have a much higher copper price.”

But the naturally bullish Mr. Glasenberg insisted everything would be okay. He spoke too soon. And for that, he is fighting to restore his reputation as the savviest trader on the planet. He waited until September, nine months after the bottom fell out of the copper market, to reveal a sweeping restructuring program. Investors punished the heavily indebted company for the delay.

Why did he wait so long? People close to the company say Mr. Glasenberg did not believe a restructuring was needed, partly because he was convinced – and is still convinced – that copper prices would not keep dropping. and partly because he believed the commodities trading and mining business model, built on high debt leverage, was fundamentally strong.

“There may have been too much hubris there, even though the management team is very strong,” said David Neuhauser, managing director of the Chicago investment firm Livermore Partners, which piled into the shares when they hit their lows.

Mr. Glasenberg stayed the course even as the Glencore sell-off accelerated through August. The situation became critical on Sept. 28, when a reputable Anglo-South African investment firm, Investec, said that Glencore’s equity value “could evaporate” if commodity prices did not rise and the company did not undergo a “substantial restructuring.”

Suddenly, some investors wondered whether Glencore could become the mining world’s version of Lehman Brothers. The Investec warning sent Glencore shares down an astounding 29 per cent the next day, hitting an all-time low of 67 pence ($1.03) on the London Stock Exchange – 87 per cent below their 2011 initial public offering price of £5.30 ($8.11 U.S.), which had valued the company at £73-billion. While they have since bounced back to about £1.28 on the back of a hastily announced restructuring program, they are still down 60 per cent over one year. Glencore’s value today is £17-billion, a quarter of its flotation price, and the company reported a loss of $676-million in the first half of the year.

The company is now busy shedding assets and debt in a hurry to quell fears that the business is dangerously overleveraged in a soft market. In recent weeks, it has sold $2.5-billion of new shares, cut two dividend payments, shut copper mines and curtailed zinc production, while reassuring investors that its balance sheet and liquidity position are adequate and contain no hidden time bombs.

One of its biggest divisions, the agricultural business that includes Viterra Inc., Canada’s biggest grain handler, is recruiting outside investors and may see Canada’s biggest pension funds buy up to 30 per cent – Glencore likes the business and wants to keep control. The deal is expected early next year. Another deal, this one expected imminently, may see a stream of precious metals income from Glencore’s Latin American copper mines bought by Canada’s Franco-Nevada Corp. and Silver Wheaton Corp.

In spite of the recent bounce-back in the share price, the restructuring effort is just starting and has yet to fully prove itself. Investors have always had trouble evaluating Glencore’s hybrid business model and fear that the formidable machine created by Mr. Glasenberg is less robust than advertised.

Glencore’s unusual, perhaps unique, trading and mining combo was supposed to be an unwavering and powerful money spinner; it has instead proved fallible. In a September note, Deutsche Bank’s mining research team said Glencore’s “emergency actions” to shore up the balance sheet should remove some investor anxiety, “but do not provide longer-term equity investors with any confidence on the equity story for the company.”

A mining executive who did not want to be identified said that Mr. Glasenberg should have moved far more quickly to reduce Glencore’s debt load and shore up confidence. “In January, he could have sold assets, he could have done a rights offering,” he said. “In times of stress, you can’t keep everything, you can’t kick the can down the road. The aura of Ivan is vanishing.”

Another mining expert was not afraid to go on the record. Michael Komesaroff, a former Rio Tinto executive who owns Urandaline Investments, an Australian mining consultancy, said in an interview that he is not surprised that Glencore has been an underperformer.

Five years ago, when it became obvious that Glencore wanted to merge with Xstrata, he predicted that melding a trader with a miner would create problems. “The cultures are so different,” he said. “Mining is long-term, ponderous and time-consuming. Trading is overnight and the compensation models are entirely different.”

An urge to win

Ivan Glasenberg is one of the most respected and feared executives in the commodities business.

He almost never gives interviews and guards his privacy jealously. But since Glencore’s 2011 stock market listing, and its purchase two years later of Xstrata PLC, the mining biggie that bought Falconbridge in 2006, he has been forced into the open, at least partly.

People who know him say that, for a man who would rather cut off his hand than talk about his personal life, he is oddly chatty, always enthusiastic and, often, profane.

The terms most used to describe him are “highly aggressive,” “ultracompetitive” and “demanding.” By all accounts, he is not easy to work for. In an interview with The Wall Street Journal in May, 2013, just after Glencore’s IPO, he said work-life balance doesn’t exist at Glencore. “We work,” he said. “You don’t come here to take life easy. And we all got rich from it, so, you know, there’s a benefit from it.”

His wealthy friends include Russian oligarch Oleg Deripaska and Peter Munk, the founder and former chairman of Toronto’s Barrick Gold Corp., who once urged Mr. Glasenberg to consider merging Glencore and Barrick (the idea didn’t go far with Mr. Glasenberg, in good part because gold is one of the few commodities Glencore does not trade). Mr. Glasenberg is a frequent visitor at Port Montenegro, the Adriatic superyacht marina and real estate development in Montenegro whose key backers include Mr. Munk and Mr. Deripaska.

Mr. Glasenberg is 58, was born in South Africa and trained as an accountant. He and his wife, Elana, have a daughter and a son. His overriding urge to win was highlighted 15 years ago, when he gave an interview to a magazine published by the University of Southern California’s Marshall School of Business, where he earned an MBA in 1983. It said that Mr. Glasenberg became the race-walking champion of both South Africa and Israel in his youth. In 1984, he was bound for the Olympics in Los Angeles, but couldn’t compete for South Africa because it was bounced from the Games – punishment for its apartheid policies. He appealed to Israel and missed landing on the team only because of a technicality related to his Israeli nationality.

Trim and compact, he runs for an hour every day in and near Zug, the low-tax Swiss canton south of Zurich favoured by the discreetly rich. It is where Glencore runs its global operations.

Mr. Glasenberg’s natural competitive instincts were honed by Marc Rich, the founder of Glencore’s ultrasecret and notorious predecessor company. Mr. Rich, who was born in Belgium and died in 2013, got his start as a trader in the United States before moving to Switzerland. He was the most wanted fugitive in U.S. history until his pardon by former U.S. president Bill Clinton on his last day in the White House in 2011. Known as “El Matador,” he made fortunes in trading commodities and pioneered “combat trading” – securing the trading rights to commodities from pariah states or countries in turmoil.

His company, Marc Rich + Co., traded with Iran during the hostage crisis, South Africa during apartheid and Libya and Cuba during the U.S. trade embargoes. In 1983, he was indicted by U.S. federal prosecutor Rudolph Giuliani (later mayor of New York) for racketeering, tax evasion and trading with the enemy – Iran – among other sins. His companies pleaded guilty to some charges and paid $200-million in penalties. But the Justice Department never got their man, thanks to Mr. Clinton’s inexplicable generosity.

Mr. Glasenberg joined Marc Rich’s team in 1984 and became head of coal trading in 1991. In 1994, facing an internal revolt, Mr. Rich sold the trading business to its managers, led by Willy Strothotte. The carve-out was recast as Glencore, which was short for global energy commodities and resources. Mr. Strothotte, who would later become chairman of both Glencore and Xstrata, was replaced as Glencore’s CEO by Mr. Glasenberg in 2002.

By then, Glencore was becoming a powerhouse, trading everything from aluminum to zinc. By 2008, it had revenue of $152-billion, well more than double those of BHP Billiton Ltd., the world’s biggest mining company. But there would be more to come, for Mr. Glasenberg was just getting started.

The Glencore IPO, the biggest on the London Stock Exchange, came in 2011, turning Mr. Glasenberg, who owns 8.4 per cent of Glencore, into an overnight multibillionaire and his trading chiefs into billionaires or close to it. In 2013, after several years of on-again, off-again talks, Glencore bought the 66 per cent of Xstrata that it did not already own.

Mick Davis, the Xstrata CEO who was to become the CEO of the merged company, had a falling out with Mr. Glasenberg and left to form a private equity-financed mining company called X2 Resources. The two men, who were friends for decades, are now said to have no love for one another.

Mr. Davis is said to be still angry that Mr. Glasenberg nixed the potential sale of Xstrata to Brazil’s Vale SA in early 2008, just before the financial crisis. If the deal had gone ahead – there was no formal offer from Vale – it would have valued Xstrata at a phenomenal $90-billion, about 30 per cent more than Xstrata’s trading price at the time.

Neither Mr. Glasenberg nor Mr. Davis would comment.

Mr. Davis’s departure made Mr. Glasenberg the king of commodities, a man who moved markets, dined with prime ministers, finance and economy ministers, and oligarchs. In 2014, the company had 181,000 employees and contractors in 50 countries, revenue of $221-billion and was one of the world’s top producers of copper, coal and grains. It traded dozens of commodities, from aluminum and grains to oil and zinc, and had more than 100 ships in its fleet to transport the goodies around the world.

But while Mr. Glasenberg and Glencore exuded unfathomable power and connections in the commodities world, something was clearly wrong inside the company. Since the IPO, the shares have fallen relentlessly. But sagging commodities prices, the result of industry-wide overproduction and waning growth rates in China, could explain only part of the story. To be sure, all mining companies have been in high-speed retreat but only a few of them backtracked as far Glencore. Rio Tinto is down 19 per cent in the past year; BHP Billiton is down 32 per cent. Among the biggies, Anglo American PLC and Brazil’s Vale, each down 55 per cent, are the ones that come close to matching Glencore’s value loss.

What went wrong?

In brief, way too much leverage, for sure, and possibly culture clashes. Glencore in effect admitted to the first – it’s cutting its debt by a hefty $10.2-billion – but would deny that the wildly different operating style and mindsets between traders and miners conspired to make a bad situation worse. On the contrary, they would argue that the market intelligence gleaned by the traders allows Glencore to adjust mine production fairly quickly to try to keep the market in balance. For instance, the commodities glut is forcing Glencore to shrink copper, coal and zinc production.

Some mining consultants and executives beg to differ, observing that the cost-cutting at the mines has been extreme. Glencore has stripped about $2-billion a year of annual costs out of the old Xstrata empire and recently all but shut the old Xstrata division, whose 230 engineers in Canada, Australia and South Africa developed and sold the most advanced smelting equipment. Tech advisers close to Xstrata Technology, however, say the division no longer had a lot of work simply because no new base-metal mines are being built anywhere.

Built on leverage

On paper, Glencore seems to have a no-lose business model. In effect, it is a closed value loop that, to use its own words, gives it “a presence at every stage of the commodity chain,” from mine to customer. It extracts value at every stage.

Largely through Xstrata, Glencore owns mines. Together Glencore and Xstrata own much of infrastructure that goes with the mines, including rail lines, ports, warehouses, concentrate blending facilities and smelters. It also owns or leases the ships that take the finished product to customers.

As the miners mine, Glencore’s traders move the commodities from one part of the world to another, hedging their prices along the way. Their job is made easier by soaking up market intelligence. Because Glencore owns, say, thermal coal mines in Australia, which are near coal mines it does not own, it has a pretty good idea of Australia’s real-time coal output and shipments. The insights usually allow its traders to make winning trades, whether markets are up or down. For example, if they learn that India suddenly needs a load of thermal coal for its electricity-generating plants, Glencore can divert a coal-laden ship from Australia to India and reap a premium of a few bucks a tonne for speedy delivery.

While trading is more often than not a reliable money spinner, it has some off years and this is one of them. In 2015, Glencore expects a fall in trading EBIT (earnings before interest and taxes) to $2.5-billion to $2.6-billion, from a reported $2.8-billion in 2014, although it expects the profit range to eventually recover to $2.7-billion to $3.7-billion a year.

The reality on the trading side is that margins are always thin and can drop when commodity prices fall, as they did precipitously in the first half of the year in the metals and minerals division. The margin squeeze revealed in August partly explains the share plunge. Rival miners say that thin trading margins is one of the reasons Glencore decided to go big into mining, through Xstrata, where margins are fatter and the growth potential higher.

Thin trading margins, of course, explain only part of Glencore’s downturn. High debt – or leverage, to use analysts’ argot – can take a lot of the blame. Glencore has always been highly leveraged, all the better to boost returns on equity. “Glencore was built on leverage,” said an executive who knows the company well.

By 2012, Glencore’s net debt had soared to $24.1-billion and would rise to an astounding and potentially crushing $38-billion after the 2013 purchase of Xstrata. While Xstrata was bought with shares, not cash, Glencore inherited Xstrata’s debt of $16-billion. A big chunk of the debt fell away when, in 2014, Glencore sold Xstrata’s Las Bambas copper mine in Peru for $7-billion. Still, at the end of June, Glencore’s net debt stood at $29.5-billion – way too high when commodity prices were falling.

If “readily marketable inventories” (RMI) – the commodities and products piles in warehouses – are included, the debt would be $17.7-billion higher at the end of June, taking it to $47.3-billion. Glencore doesn’t consider RMI real debt because the inventories are liquid, can be turned into cash quickly and are normally protected by hedges. But some investors evidently took a different view.

As Glencore’s share fell, rumours swept through the market in September that Glencore’s bankers were on the verge of withdrawing credit lines that had been extended to the trading side – hence the “Lehman” fears. When investors rummaged through the balance sheet, they realized the mining side was carrying a lot of debt too. Then came the Investec report and the shares collapsed. Glencore went into emergency mode and, on Oct. 6, issued a “funding fact sheet,” which said the company had ample liquidity – more than $10-billion – and no financial covenants on any of its funding. The shares, which had already bounced off their bottom, climbed.

Glencore has vowed to cut net debt to $20-billion or less and has already used a $2.5-billion equity sale to launch the shrinking process. While the effort has restored some confidence, it still has a long way to go; Mr. Glasenberg has to convince investors that the trading-mining business model will work and that he has been an efficient spender of capital.

A couple of small acquisitions seem to have detracted from his M&A record. The acquisition of South Africa’s Optimum Coal Mines in 2012, for about $750-million, proved to be ill-timed. Falling coal prices have forced it to close the mine and put it into bankruptcy protection. In the same year, Glencore paid $1.4-billion for Caracal Energy Inc. to gain access to its oil and gas assets in Chad. This year, plummeting oil prices forced Glencore to write off $790-million of Caracal’s value.

Mr. Neuhauser, of Livermore Partners, agrees that Mr. Glasenberg waited too long to raise new capital and shrink the company by selling assets and closing production, which made the company a big, slow-moving target for the hedge funds. But he thinks the worst is over and that the shares will keep rising as Glencore’s debt, and hence risk profile, comes down. “We won’t see these lows again,” he said. “But some of the lustre has come off the [hybrid] business model, for sure. With an oversupply of commodities, this is where that model gets tested.”

The same can be said for Mr. Glasenberg.

Follow on Twitter: @ereguly