Thoughts on the Glencore IPO

Posted on 18/04/2011


“Glencore is a leading integrated producer and marketer of commodities. The Company is active in every step of the supply chain in metals and minerals, energy and agricultural products. Glencore produces, sources, processes, refines, transports, stores, finances and supplies commodities used by the world’s industries.”  In the year-ending December 2010 the company earned net income of $3.8bn on revenue of $145bn.  The company is currently planning to sell $9-11bn of stock via an initial public offering on the London Stock Exchange and Hong Kong Stock Exchange in a transaction that is likely to value the company at around $55bn.  The intention to float document can be viewed here, while the Glencore prospectus (at 134mb and over 1600 pages) can be viewed here.  My thoughts on the IPO are as follows:
  • Firstly, Glencore intends to use the proceeds to make acquisitions of commodity producing assets.  The directors have already disclosed that JSC Kazzinc is the first target, while 34.4%-owned Xstrata is also very likely to be of interest to Glencore.  As an investor with access to the public equity markets, there are many hundreds of commodity mining firms whose shares I can buy if I feel positive about the future of such minerals.  By investing in the Glencore IPO for this reason, I would simply be paying four times over to access such assets, firstly in Glencore underwriting fees, secondly in Glencore operating costs, thirdly in investment banking fees (paid by Glencore) for the acquisitions in question, and fourthly for the commissions charged by my own stockbroker.  I don’t see how Glencore is much more attractive than buying a basket of shares in leading commodity-producing companies?
  • Secondly, are Glencore management calling the top of the commodity market?  Historically, large IPOs, mergers and project initiations have tended to coincide with the top of the market in question.  Part of me thinks that Glencore is simply following this trend.  Although the proceeds are being used to finance acquisitions and that management are subject to lock-ups ranging from one-to-five years, such a transaction clearly smooths the path for Glencore employees to sell-down their holdings over the next few years.
  • Thirdly, Glencore’s employees and management have in the past been involved in illegal transactions.  Marc Rich, the founder of the company, was indicted in the United States on charges of tax evasion and for making illegal oil deals with Iran during the US hostage crisis.  Rich was pardoned by Bill Clinton as one of the former President’s very last acts of office in 2001.  While Rich left Glencore in 1994 (albeit having to sell-out after failing to corner the zinc market and losing £172m, nearly bankrupting the company), Glencore continues to trade in all manner of countries that appear on the lower reaches of Transparency International’s Global Corruption Barometer.  Consequently, I would view litigation and political risk as being particularly high.  Indeed, the Daily Telegraph lists a number of litigation cases that Glencore is currently facing.
  • Fourthly, the Glencore IPO and its subsequent fast-track entry into the FTSE-100 Index leads me again to consider the whole theory behind index investing.  Glencore is expected to have a market capitalisation of £34bn and a free-float of £6.9bn after its IPO.  This will gain Glencore a weighting in the FTSE-100 of 0.4% on entry, rising to 2% over time as the existing shareholders sell-down and the free-float increases.  The result of this is that index funds will be forced to buy into Glencore for 0.4% of their portfolios, and because of this, the IPO price calculation becomes somewhat circular.  If investment bankers announce that a company will IPO with a market capitalisation sufficient to gain a FTSE-100 listing, then index funds are a captive market, being required by their investment guidelines to buy at this price.  This means that the ultimate investors in index funds are committing themselves to buy into whatever companies decide to list at whatever price the companies’ investment bankers choose to sell them at.  Therefore not only are index investors inefficient in the sense that they do not take a view on the price, quality or prospects of the constituent companies, but the presence of index funds actually encourages the listing of over-priced companies on the market in question because such funds are pre-committed guaranteed buyers of the stock.  Regardless of interest from active investors, the Glencore IPO should find a sufficiently large constituency with index funds and closet/quasi-index funds.
  • Fifthly, regardless of what Glencore say about the company’s revenues and earnings not being linked to commodity prices, the company’s equity is likely to be highly volatile.  For a preview of what to expect, just take a look a the Glencore CDS price history during 2008 and early 2009, shown in the chart below.
Posted in: My Thoughts