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Glencore: The Xstrata question

One of the biggest questions vexing those looking at Glencore 's float is the future of its relationship with Xstrata , the £40bn diversified miner in which it owns a 34 per cent stake. The companies currently operate on an arm's-length basis but many expect their relationship to become closer, with a merger or takeover heavily tipped by some. But, if such a deal is around the corner, is there an arbitrage opportunity for investors? Certainly analyst Tim Freeborn of Xcap Securities thinks so. Here, he explains why.

"Glencore has accepted a serious haircut on the value of its non-Xstrata operations since it announced the plan to float. A simple strategy pre-float would be to take up the offer to capture some of this eagerness to get to market, while at the same time hedging the Xstrata element by shorting Xstrata directly.

I am negative on commodities stocks generally, given the weakness in spot prices and the ending of quantitative easing in the US. So a viable approach would be to hedge Glencore 100 per cent against Xstrata. Post-float the merger story may come back into play. But who would be buying whom? Glencore's free float will be even more limited than Xstrata's, so its shares are likely to be more volatile. If you reckon a bid for Xstrata is a formality post-merger, then short Glencore and buy Xstrata. The float creates an arbitrageur's paradise: great when markets are rising and toxic when they fall.

Glencore and Xstrata

Glencore value after IPO*63.5
Less Xstrata stake* (34.5%)-22.6
Less new money element in IPO-7.9
Implied pre-IPO value of Glencore33
Net profit in 20103.8
Less Xstrata contribution-1.6
Glencore net in 20102.2
Historic PE15.1
*Based on Glencore floating at 535p, the mid-point of the range, and Xstrata share price of 1,363p


Tim Freeborn is an analyst at XCAP.

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By Tim Freeborn,
17 May 2011

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