The Glencore-Xstrata Merger Will Create Significant Operational Synergies

| About: Glencore Plc (GLCNF)

At long last, the $30 billion merger of Glencore International plc (OTCPK:GLCNF) and Xstrata plc (OTC:XSRAF) has been completed and the result is a new company called Glencore Xstrata plc which will employ almost 200,000 people in 50 countries with full year revenues of approximately $245 billion. One of the first priorities of the merged company is to produce savings from operational synergies of $500 million and this is expected to be achieved by closing down Xstrata corporate headquarters in Zug, Switzerland, and London and the sacking of a significant number of Xstrata middle management. More savings should become available from the reduction of major capital expenditure commitments in 2015. The 2012 pro forma for Glencore Xstrata shows that copper accounts for 33% of earnings, followed by coal with 25% and zinc with 15%. Trading in metals contributed 17% while trading in energy and agricultural commodities contributed 5% each.

Glencore Xstrata first-quarter production

Production of copper was up 18% as the newly formed company produced 321,000 tons of copper. Production from Africa alone increased by 44% as the overall growth in production was driven by its mines in Peru's Antapaccay and Mount Margaret in Australia, as well as in Katanga and Mutanda in the Democratic Republic of Congo. Capacity is being increased this year to 270,000 tons annually in Katanga and 200,000 tons in Mutanda. Coal production increased by 1% to 32.7 million tons while oil production increased by 2% to 5.4 million barrels. The company noted that its trading activity had delivered good results while the profitability on coal and oil has improved significantly. The first quarter is often weak for agriculture products but is expected to improve throughout the rest of the year.

The two companies and competition

Glencore is a global operator in diversified commodities and, in addition to metals (copper and zinc), it also trades in energy products like oil and natural gas. It also has an agricultural products business that manages stockpiles of agricultural products such as grains, sugar and cotton. Xstrata is more focused on the mining and processing of metals such as cobalt, zinc, iron and gold. It also has a coking coal operation which mines and processes coal from mines throughout the world. One major competitor that is facing the same kind of problems as these two companies is Rio Tinto (NYSE:RIO), a diversified mining conglomerate active in many areas of natural resources. Rio Tinto reported a loss of about $3 billion in 2012 on revenues of $51 billion. Xstrata reported earnings of approximately $1.2 billion on $31 billion in revenues showing a profit margin less than 4% while Glencore's $3.1 billion in after-tax earnings showed a profit margin of less than 1.5%. Both Xstrata and Rio have cash problems with negative cash flows of $5.5 billion and $6.5 billion respectively.

The Chinese problem (and solution)

The delay in the merger was caused by the concern of Chinese regulators about the sheer size of the deal. China requires large quantities of copper and Glencore is an important supplier. The Chinese were unhappy about the proposed $5 billion investment in a major copper project in Peru and since Glencore and Xstrata both operate major projects within China, the merger would not have been possible without Chinese government approval. It is believed that Glencore and Xstrata account for up to 14 percent of China's copper imports most of which comes from Glencore's Peruvian Las Bambas mine and the Chinese believed that the new Peruvian investment would give the merged company unacceptable pricing power. Fortunately for Glencore, it was prepared to sell the Peruvian mine in return for Chinese regulators approval and it now has until August 2014 to finalize the sale. It has also agreed to provide guaranteed supplies of copper, lead and zinc to China for the next eight years. The merged company can absorb the impact of the sale without any great damage to its bottom line.

The bottom line

Glencore is taking its debt load problem seriously and will refinance more than $13 billion in outstanding loans to reduce the burden of the Xstrata acquisition. It is in a reasonable position to shoulder the debt and cash flow problems of Xstrata and could find itself in an excellent position if it manages to pull this off. While there may be issues along the way, I believe that the synergies and operational efficiencies created between the Glencore and Xstrata merger will create future value for shareholders.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.