Abigail with attitude: Digging deeper into Glencore and Xstrata deal

By:
Abigail Hofman
Published on:

Deals are more than numbers and synergies – they’re about the people involved. If the Glencore and Xstrata deal goes through, it will have a big effect on the M&A league tables but it might also stumble over a regulatory fence on the way. Abigail Hofman dissects the possible creation of a $90 billion conglomerate

UniCredit was a key deal for the financial sector in January. In February, it was the mining sector’s turn when Glencore announced an all-share merger of equals with the integrated mining company Xstrata. When Glencore went public last May, a knowledgeable mole hurrumphed: "This is all about obtaining a proper valuation for Mick Davis  [Xstrata’s chief executive]."

Mole’s words rang in my ears as the terms of the deal leaked to the market. The transaction would create a conglomerate worth some $90 billion and the successor company would be a global leader in zinc and thermal coal as well as a top-five producer of copper and nickel.

But deals are always about more than the numbers and the synergies. In fact, they are normally about the people involved. And here you have two giants of the mining industry – the billionaire Ivan Glasenberg and the less wealthy Mick Davis. I wonder if the discrepancy in net wealth rankles with Mick? Both men are South African, in their mid-50s, and knew each other at the University of Witwaterstrand.

On the face of it, Xstrata’s management has done well. Davis will be chief executive of the new company and Xstrata’s chairman, Sir John Bond, will be chairman of the group. Xstrata’s chief financial officer also keeps his job. Glasenberg becomes deputy CEO and president.

But is the deal as promising for Xstrata shareholders as for its management? Glencore is offering 2.8 shares for each Xstrata share, a premium of some 10% to the Xstrata share price before the deal was announced. Big shareholders, such as Standard Life and Schroders, are underwhelmed. They claim Glencore needs to pay more to buy the Xstrata crown jewels. Apparently, only 16% of shareholders need to vote against the deal – Glencore can’t vote its holding – to block it.

The deal might stumble at the regulatory fence as well. Although initial press reports stated that the European Commission would not investigate the deal because it looked at the group as one entity in view of Glencore’s existing 34% stake in Xstrata, this might not prove to be correct. In late February, it was announced that the EC would be formally notified of the deal. This could lead to a lengthy competition review.

Ian Hannam, the banker at the centre of the transaction, would not be pleased by such a turn of events. But Hannam, the renowned rainmaker and chairman of capital markets at JPMorgan, is used to adversity. He used to be a soldier in the SAS. The press have made much of the appointment of former Citigroup banker Michael Klein as a "strategic consultant" to both Davis and Glasenberg. But I am sure this is Hannam’s deal. He and Davis go back years and it was Hannam who floated Xstrata in 2002.

The Glencore/Xstrata transaction, if it goes through, will have a big effect on the M&A league tables this year. So if you are a leading mining investment banker and you missed it, you had better come up with a good excuse. The banks advising Glencore are Citigroup and Morgan Stanley. Those batting for Xstrata are Deutsche Bank, JPMorgan, Goldman Sachs, Nomura and Barclays, which belatedly clambered aboard. Indeed Barclays’ leg-up was so last minute that the bank does not appear on the formal press release.

Might it be true, as a mole whispers, that Ivan Glasenberg, Michael Klein and Bob Diamond all play golf together? And of course, Barclays is a big player in commodities.

I will watch with interest how the deal progresses.

February 13 was the final day for submissions from interested parties on the Volcker Rule, which is due to be implemented in July 2012. When I contemplate the Volcker Rule, I wonder if I am reading a masterpiece of the literary nonsense genre such as Alice in Wonderland. The rule, which is part of the US Dodd-Frank legislation, is meant to restrict risky trading activities at banks that operate with US federal guarantees, including investing in hedge funds or private equity funds.

The rule is set out in a 300-page document that includes 1,347 question marks (a question mark invites comments). The rule pertains to any bank-trading activity in the US, or any US bank operating elsewhere, or any foreign bank dealing with a US resident or security. Apparently five different regulators will oversee implementation of the rule.

Something that should be simple has become so complicated that it is, quite frankly, a joke. Have you seen the March Hare, White Rabbit or the Cheshire Cat anywhere?

The problem is that a fine line separates proprietary trading (a bank buying and selling for its own account) from market-making (a bank buying and selling for a customer). For example, a trader buys an illiquid bond hoping that he will be able to sell it at a higher price to a customer in a few days. No customer appears and he is forced to keep the bond for three months before selling it at a loss to another market-maker. Is that market-making or proprietary trading?

Wall Street firms and indeed foreign firms that will be caught up in this nightmare argue that the costs of compliance will be enormous (each trade needs to be policed individually apparently) and that market liquidity will shrivel. As if to underline this point, the rule provides an exemption for market-making in US Treasury securities. Those who drafted the legislation must therefore have assumed that the Volcker Rule would adversely affect the attractiveness of US treasuries. And we all know that the US has a lot of bonds to sell these days.

However the exception does not apply to non-US government bonds, which has fuelled further tensions. Goldman Sachs in its comment letter warned that US banks might not be able to continue as primary dealers in other countries’ sovereign debt. The bank said the Volcker Rule’s exemption for market-making and underwriting might not be sufficient to "satisfy ... obligations as primary dealers of sovereign debt in non-US jurisdictions where [dealers] may, for example, be required to purchase allotments even if they cannot be resold to customers in the near term".

Paul Volcker himself wrote an opinion-editorial in the Financial Times on February 13 entitled "Foreign critics should not worry about my rule." As regular readers know, I am quite prepared to criticize bankers and banks when they deserve it but Volcker’s comments seemed to me at best self-serving and at worst disingenuous. US banks, he writes: "can continue to purchase foreign sovereign debt for their investment portfolios – should I say à la MF Global". He also pontificates, as if from Mount Olympus: "Let us not be swayed by the smokescreen of lobbyists dedicated to protecting the interests of some highly compensated traders and their risk-prone banks."

I am neither a lobbyist for the financial industry nor a highly compensated trader but I would say to Volcker that liquidity in the financial markets has dwindled substantially over the past four years and his rule will exacerbate this trend. Such illiquidity leads to significant anomalies. "In the old days," a well-placed source mused, "bank prop desks would spot these anomalies, pounce and the arbitrage would disappear. These guys no longer exist."

As a small private investor with some expertise in the bond market, where I used to work, I occasionally buy bonds. And I notice that for most off-the-run credit bonds, market-making by financial intermediaries is a figment of someone else’s imagination. Even if you buy senior western bank debt, you have to assume that selling it will be difficult and it’s best to view subordinated bank debt as a buy-and-hold investment. Bank trading desks don’t want to take risks anymore. The Volcker Rule will make this problem much worse. Pension funds might be able to bully the trading desks to obtain better prices. But the small retail investor is impotent and any more diminution in the market-making function will further contribute to the view that markets are casino-like arenas stacked against the general public.

In the past, I have commented that there is a dearth of senior women in the financial industry. This topic has gained popularity in the past few years and it is now hard to miss the cacophony of voices calling for more women in the boardroom and, in particular, more women in the financial boardroom. Because I am a curmudgeonly contrarian, I am less interested when there is a crescendo of consensus. I was thus not looking forward to a speech that I had promised to give to a group of women at a European bank. The topic was "Women in leadership in banking".

As it has been a while since I made a speech to several hundred people, I decided that perhaps less was more. So I merely talked about my own experiences in the industry. Given that I no longer need to toe the party line, I was outspoken and probably horribly politically incorrect. Nevertheless, I was both touched and shocked by the number of emails I received in the days and weeks following the speech. Women wrote to me asking if I could give them advice, if I would agree to mentor them, and sharing their own experiences. I realized that, after all these years, there is still a dearth of senior women in the industry who are approachable and can act as role models.

I am pondering what should be done about this. It’s hardly as if women don’t make outstanding business people. Let us not forget that the wealthiest person in Australia is Gina Rinehart, chief executive of Hancock Prospecting. Her personal fortune is said to be more than $15 billion and some commentators claim that if the mining sector continues to boom, she could overtake Carlos Slim and Bill Gates as the wealthiest person in the world.

And then of course there is Sheryl. No, I’m not talking about Cheryl Cole, the X Factor judge and former wife of the famous British footballer Ashley Cole, I’m referring to Sheryl Sandberg, the chief operating officer of social networking sensation Facebook. Following Facebook’s IPO, Sheryl will be worth some $2 billion. A recent profile in the Financial Times commented: "The company’s financial success traces directly to the 42-year-old Ms Sandberg." I continue to look forward to the day when a woman is running a Wall Street firm. I am dubious, however, that in the next 10 years anyone will earn eye-watering sums by working in a publicly listed bank.

When I graduated from university, most of my class wanted to work in finance because it was extraordinarily well paid and it was fun. Yes, the hours were long but there was a patina of glamour and excitement. We enjoyed what we did. Now bankers complain to me that it’s a dreary slog. It’s a slog at the junior levels working for grumpy middle-managers who are worried that they might be fired and that puny cash bonuses might not stretch to cover the upkeep on their third home: a ski-chalet in Chamonix. And it’s a slog at the senior level dealing with grumpy shareholders whingeing about limp returns and ferocious regulators demanding that you beef up your compliance departments. Investment banking looks as if it might be an industry in decline and it is certainly an industry where morale is shot to pieces.

I pondered this dire prospect for banking as I sat on a deserted beach in the Maldives, the crystal-clear Indian Ocean lapping around my toes and the sun gleaming in a pristine blue sky. Depressed by the London chill, I escaped for a week to the Four Seasons Resort in Landaa Giraavaru. The resort is paradise – a four-to-one guest/staff ratio ensures constant pampering and there are only about 100 villas on a 44-acre island.

I became obsessed by the management of the resort and what the implications were for real life away from an isolated island. All the staff I interacted with effervesced with enthusiasm and were determined to make my stay more enjoyable. Their solicitude felt genuine rather than trite as in the "have a nice day" American platitude.

Many of the staff told me what an excellent employer the Four Seasons Group was and spoke reverentially about the general manager of the resort, Armando Kraenzlin, who often seemed to have made a big difference to their lives. Remember that the catchment area for recruiting staff for this hotel encompasses countries where survival is a struggle and poverty is pervasive: Bangladesh, southern India, Sri Lanka and the Maldives itself. A restaurant manager told me how he had met Armando (they all called him Armando) in Nepal and then worked for him at the Four Seasons in Mumbai before following him to the Maldives. Another member of staff talked about how excited he was to be given the opportunity to go to France this summer with Armando on a wine course.

If you think about the core values that investment banks claim to espouse – it’s always about "putting the client first" and "building a unique culture based on teamwork". Today these values seem less and less evident and most bank employees are not proud of the institutions for which they work. If I were a bank chief executive in receipt of my annual bonus, the first thing I would do would be to fly to Landaa Giraavaru and observe how seamlessly the resort functions. I would then have a drink with Armando and see what I could learn from him about managing a "people-business" that is focused on providing outstanding service to demanding but price-inelastic clients and turning those clients into repeat users. Then I would go back to the bank and start all over again.

The Four Seasons used to be a public company. It was bought by Bill Gates and Prince Al-Waleed bin Talal in 2007. The Prince used to be a large shareholder in Citigroup. That investment didn’t work out as the shares sank in value during the financial crisis. Ironically, in my first column for Euromoney written in April 2006, I described witnessing an encounter between the Prince and Citi’s former chief executive, Sandy Weill. A mere six years have passed since then but so much has changed.

One institution that has changed forever since 2006 is Merrill Lynch. Merrill was forced into the arms of Bank of America during that fateful weekend in September 2008 when Lehman Brothers failed. And Merrill has been on my mind in the past few weeks. In late January it was announced that Christian Meissner had been promoted to sole head of the global corporate and investment banking division. Effectively Meissner has leapfrogged over his two co-heads, Michael Rubinoff and Paul Donofrio, to become king of the castle although all three men continue to report directly to Tom Montag, co-chief operating officer of the firm. I’ve never believed in the concept of co-heads, which to me shrieks: "diluted accountability". So please don’t get me started on the topic of triple-heads.

This is a coup for the shy, 42-year-old Austrian, Meissner, who joined the firm less than two years ago. Meissner is an FOM (friend of Montag): they both used to work at Goldman Sachs. Nevertheless, it is unusual for a European to enjoy such a meteoric ascent at a US firm. Opinions differ on Meissner: some cavil that he is an administrator rather than a deal-doer. Others mutter that he was part of the Lehman clique that beguiled the Japanese decision-makers at Nomura to pay over-inflated guarantees to Lehman employees. Others merely say: "Congratulations. He’s done well." I’m in the latter camp.

Of course there is a lot of jealousy that Meissner has fallen on his feet. A mole reports that a senior banker at another top firm turned puce with rage when he heard about the promotion. And renowned deal-doer Andrea Orcel, chairman of BAC’s global banking and markets division, might not be dancing for joy either. Sources whisper that Orcel and Meissner are not destined to be best friends.

However, Orcel has probably been too busy recently to focus on office politics. Orcel was the banker who bought the UniCredit bacon home to mother Merrill. In other words he won the mandate for the UniCredit rights issue that was launched in January this year. Originally viewed as a looming disaster, the issue turned out to be a welcome money-maker for those involved as the UniCredit share price bounded north shadowing, in a surreal way, the southward trajectory of Italian government bond yields. So congratulations are also in order to Orcel.

Abigail Hofman
Brian Moynihan, chief executive of the bank, is battling to fix the mess that Ken made. The bank has problems with legacy housing assets resulting from the Countrywide acquisition. Bank of America made net profit of $1.4 billion for the whole of 2011, which is disappointing considering Barclays made nearly £4 billion ($6.28 billion) and JPMorgan had record net income for 2011 of $19 billion.

Bank of America’s stock is up over 40% this year amid a showy bank stock rally from overly depressed levels late last year. But the bank’s fortunes are heavily dependent on the outlook for the US. If the economy continues to recover, Moynihan could look like a hero. If the economic data turn sour, he might not be able to muddle through.