Glencore raised $2.5 billion in new equity last month, in an effort to reduce debt and protect the investment-grade credit rating that is vital for its signature marketing business. This is the trading business that distinguishes Glencore from other mining companies and moves commodities – its own and other producers’ – around the globe, while standing ready and eager at short notice to divert cargoes and snap up any price premium offered by purchasing managers anywhere in the world.
The company’s poor first half earnings, depressed by falling commodity prices and weak demand especially from China, provoked fears among both equity and debt investors about the company’s high leverage and forced it to announce a package of measures to reduce net debt by $10 billion by the end of 2016.
Even as it announced the recapitalization Glencore management cast fears over its balance sheet as overly pessimistic but succumbed under pressure from shareholders, even though they will be hurt most by the first steps undertaken to reduce debt: that dilutive equity raising and cuts to dividend payouts of $2.4 billion. The company has also undertaken to reduce working capital, cut capex, raise money from asset sales and further cut its loan book.
The equity raise was quickly and neatly done, taking advantage of a brief equity rally to price at £1.25 with much self-congratulatory talk about the quality of investors committing to the book alongside existing owners, including senior Glencore executives. However, the shares hit £1.00 days later before then suffering a further collapse to 75p as Euromoney went to press at the end of September.
Glencore remains a geared play on commodities in a declining commodity market. Owning its shares is now like owning options, rather than straight equity. Analysts have begun to discuss circumstances in which a failure of commodity prices to rebound could leave the shares worthless. Banks are no doubt analyzing the collateral and security against their loans carefully and even their position in the creditor hierarchy. Five-year CDS spreads have spiked, touching 750bp at one point, with bonds trading on price rather than yield indicating distress.
It must be all the more uncomfortable for bankers to recall the company’s $11 billion IPO in May 2011.
Never has Euromoney encountered such embarrassing fawning by the investment banking community as that lavished on Glencore’s bosses at that time, variously described as the best management team most bankers had ever encountered. This was way beyond the normal sycophancy displayed to big fee payers and no doubt reflected underlying envy and respect at the vast personal fortunes created by a few leading figures in a trading business, just as Wall Street was being forced to shutter most of its own.
Bankers offered to explain the brilliance of the firm’s trading model while evidently doubting Euromoney’s capacity ever to fully grasp it.
What did these managerial geniuses deliver to the public stock markets? The IPO was priced at £5.30 and has never closed above that level. The near 85% decline to September 2015 contrasts with a 20% rise in the FTSE 100 over the same period. That IPO had been partly to raise permanent capital to protect the ratings so essential to the trading business and to reassure the army of banks that lent to Glencore and from whose ranks the leaders of that equity deal were selected for a particularly big payout. But a large part was geared up to acquire industrial assets just as demand peaked.
Today, it is permissible to question the geniuses. Analysts are not convinced that the $10 billion of debt cuts are achievable – no-one should place much faith in the hoped-for $2 billion in asset sales – and even if they are, wonder whether they are enough to hold net debt/ebitda down within the three-times range required to maintain its investment grade. The ratings agencies hold the company there for now but have it on negative outlook and are keeping a close watch on the copper price in particular.
Debt sustainability all depends on earnings.
Glencore has always said that its little-understood marketing business can profit in bear, as well as bull, commodities markets. Yet even at Morgan Stanley, which along with Citi led both the IPO and the recent $2.5 billion share placement, analysts say: “However, we find it hard to find data that corroborates the long-term earnings power of Marketing.”
It’s perhaps a shame Glencore went to all that effort to become more of a miner less of a trader. If commodity prices recover, it might yet outperform. If they don’t, it will do the opposite. And any investors who still listen to Wall Street’s slavish brown-nosing of Ivan Glasenberg deserve whatever they get.