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Glencore and Rio proposal not the right iron ore deal

The hullabaloo surrounding Glencore Plc’s spurned approach to rival miner Rio Tinto shows why this is probably the wrong deal at the right time.

Glencore’s proposal to create USD 160 billion behemoth is certainly audacious, and may even make sense for shareholders of both companies if priced attractively.

But even if it were successful, such a deal would do little resolve the key problems bedevilling the outlook for many commodity markets, and the companies that produce those resources.

The logic of Glencore taking control of Rio Tinto would be for the former to get access to the latter’s iron ore operations in Australia, which are the lowest cost among major producers.

Iron ore is the missing arrow in Glencore’s quiver and the assumption behind a deal would be that the Swiss based company would be able to use its trading nous to extract more value from the well run Rio Tinto mines.

Assuming that all the anti-trust and other regulatory obstacles could be overcome, and that Rio Tinto shareholders could be won over, then the potential for the deal to be rewarding for Glencore is compelling.

However, the emphatic rejection of the approach by Rio Tinto’s board likely means that Glencore will be unable to get a low ball offer accepted, meaning it either has to pay more money for Rio or go hostile.

Both of those would be tough decisions for Glencore’s Ivan Glasenberg, the former South African who merged secretive traders Glencore with mining major Xstrata, in a deal completed last year that was initially touted as a merger of equals but ended up with Glencore dominant.

While Glencore clearly faces an uphill battle to make the Rio Tinto deal work, there are likely better opportunities available in mining mergers and acquisitions.

The main problem in the iron ore market is that capacity additions have run ahead of even the most heroic demand assumptions, and the market is now poised for several years of low prices.

More importantly, the price has slumped 59% since the all time high reached in February 2011, a time when the mining majors were planning to spend billions of dollars to boost output, believing the hype that China would buy everything they could produce.

The reality has turned out somewhat differently. While Chinese import demand has grown strongly, the capacity additions have swamped this and Chinese domestic iron ore output has probably been more resilient than the major miners expected.

Source – The News

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