May 1, 2011 8:37 am
Commodities are hot, the IPO market is not. Understandably, therefore, the proposed initial public offering of Glencore, the world’s largest commodity trader, on the London and Hong Kong markets is generating quite a buzz. The listing, which could value Glencore at approximately $60bn, is set to be London’s largest ever and the company will probably enter the FTSE 100 on its first day of trading – the first to do so since the 1980s.
But, while obviously great news for Glencore’s banking syndicate, which is expected to earn an estimated $300m from the flotation, is the IPO good news for investors?
Glencore intends to sell 15-20 per cent of the company, raising $9bn-$11bn. Investor interest appears to be high, and, when the stock enters the FTSE 100, tracker funds will ensure an additional healthy level of initial demand for the shares. But amid the hype, several concerns remain.
The first is a perennial worry about the volatility of earnings at trading businesses. Glencore, however, is as much a producer and processor of natural resources as a trader.
In 2010, 56 per cent of its earnings were generated from industrial assets and 44 per cent from marketing activities. In this latter category, Glencore has highlighted that it rarely makes proprietary trades on the direction of commodity prices and focuses more on arbitrage trading.
Admittedly the line between arbitrage and position taking is not always clear-cut and the company’s financial information does not break down the two revenue streams.
Liberum Capital, which is part of Glencore’s IPO banking syndicate, however, has estimated that proprietary positions account for a single digit percentage of the company’s trading profits. If accurate, this would imply that no more than 4 per cent of overall company profits are generated from straight bets on the direction of commodity prices.
The next set of concerns focus on the timing of the IPO. Some view commodities as the next asset bubble in waiting and Goldman Sachs, for example, recently issued several bearish research notes on a range of commodities. The argument runs that Glencore’s partners are a savvy bunch of insiders looking to cash in at the top of the cycle. This argument is unconvincing for a couple of reasons. First, the structural supply and demand story underpinning commodities remains valid (even Goldman’s bearish research includes the caveat that the longer-term upside is intact).
Historically, real commodity prices have been in a long-term downward trend. But as Jeremy Grantham, founder and chief strategist of global asset manager GMO, writes in his April quarterly newsletter: “Accelerated demand from developing countries, especially China, has caused an unprecedented shift in the price structure of resources: after 100 years or more of price declines, they are now rising, and in the last eight years have undone, remarkably, the effects of the last 100-year decline.” Summing up Mr Grantham argues: “The world is using up its natural resources at an alarming rate, and this has caused a permanent shift in their value.”
The threat of a significant near-term correction in commodity prices should not be discounted, if, for example, China were forced aggressively to rein in an overheating economy. But equity investing is meant to take a longer-term view of a company’s prospects and also, if there were a correction, I would personally rather have my commodity exposure with a savvy bunch of insiders than in a commodity ETF.
The second rebuttal to the cashing-in argument is that Glencore’s existing shareholders will only sell $2.2bn in shares at the IPO to meet tax liabilities and senior partners will be locked in for five years. Admittedly, flotation does provide an ultimate exit route for the current partners, but succession is an issue for all companies, not just trading houses – and Glencore is hardly an entrepreneurial one-man band.
I have some personal experience in this industry, having worked at Cargill, the global agricultural trading and processing group, in the 1980s. One of the most striking aspects about companies of this type is the breadth and depth of their networks, which provide the detailed information on which their decisions are based. That would not disappear if a partner cashed in his chips five years hence.
Rather than the partners cashing in, the IPO represents an opportunity to create a currency for further acquisitions, which will allow Glencore to do larger deals.
Glencore intends to spend part of the proceeds of its IPO increasing its stake in Kazakhstan-based zinc producer Kazzinc. But the deal on everyone’s radar is a potential merger with Xstrata, the London-listed miner, in which Glencore already holds a 34 per cent stake.
Concerns about trading income volatility and partners cashing in miss the point: here is a major industrial and trading company preparing to be a driving force in the next wave of consolidation in sectors benefiting from a long-term bull market for their output.
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