Morgan Stanley digs deep to pass Glencore challenge

The most eye-catching feature of the current market for initial public offerings (IPOs) is just how many of them have failed to cross the starting line. So the large and successful listing of Glencore, the Swiss-based commodity trading and mining group, was a tonic for the market and indeed the London Stock Exchange, which hosted it.

Glencore has long been a very private, enigmatic business, still tinged with the spirit of its founder, fabled trader Marc Rich, who was obliged to sell out to his management in 1994. Investors and bankers have spent many idle hours musing over its flotation possibilities, but the first sign of a tangible plan appeared in December 2009, with news that Glencore had privately placed a $2.3bn convertible bond, exercisable in the event of an IPO or merger. With Morgan Stanley and Citigroup as advisers, it was the start of drawn-out preparations for what would be London’s largest-ever IPO.

The firm was structured as a partnership and, had it stuck to its original business of simply trading, storing and transporting commodities, it might have stayed that way. But it has pursued a lengthy programme of upstream vertical integration, acquiring producers of the commodities in which it trades, principally coal and base metal mining operations. It hived off some of these in 2002 to mining group Xstrata, in which it retains a 34% stake.

Funding challenges

Finding the cash to maintain that holding without dilution through successive Xstrata rights issues was only one of the funding challenges faced by Glencore. The partnership structure meant that every time a partner retired, his share of retained earnings became debt to be repaid over a number of years, so the firm’s capital was never permanent.

At the same time, Glencore wanted to be flexible enough to move quickly on opportunities to acquire mining assets as they arose, perhaps including Xstrata itself. An IPO would arm it with a convenient acquisition currency in the shape of its shares.

The team at Morgan Stanley began to have a strategic dialogue with Glencore several years ago, developing into thoughts on how the firm’s structure might evolve. “The intention to stage an IPO was already concrete when Glencore issued its convertible bond in 2009,” says Michel Antakly, a managing director in the Morgan Stanley mergers and acquisitions group.

The five-year bond had a strike price that valued the company at $35bn, and the investors included First Reserve, Singaporean sovereign wealth fund GIC, BlackRock and Zijin Mining. It put down an early marker, giving notice that an IPO was on the cards and effectively inviting potential equity investors to become more familiar with Glencore. “The next step was to start building a following among a broader group of reputable investors,” says Mr Antakly.

Tapping demand

Morgan Stanley and Citi would be sponsors for a primary listing in London and a secondary listing in Hong Kong. “The business is very much China-driven, and we thought there would be sources of demand in Hong Kong that we would not be able to tap if we weren’t there,” says Emmanuel Gueroult, Morgan Stanley’s co-head of Europe, Middle East and Africa equity capital markets.

The two banks began preparations in earnest in mid-2010 and were joined as joint global coordinators by Credit Suisse towards the end of the year. The IPO was targeted for a window between April and June 2011. “That gave us a comfortable period of time for a company of this size and complexity,” says Mr Antakly.

Size and complexity were the dominant issues. The size issue was straightforward enough. At about $10bn in absolute terms this would be the biggest IPO London had ever handled and the third largest in Europe. Only Deutsche Telekom and Enel had been bigger and they were both privatisations. The complexity issues were more marked.

Intelligent arbitrage

Glencore is both a trader and a miner. But even its trading business revolves around more than simply buying and selling commodities. Dealing in metals and minerals, energy and agricultural products, it has dominant shares in the ‘addressable’ – ie. open to third parties – markets of many of them, including 60% of zinc metal, 50% of copper metal and 45% of lead.

In what are often opaque markets, its intelligence-driven arbitraging activities mean not only diverting supplies geographically to where prices are highest, but also blending products such as coal into whatever grades are most in demand.

While mining stock prices rise and fall in line with the commodities they produce, the company argues that its sophisticated trading businesses act to smooth its profits profile. “Glencore believes the financial performance of its marketing activities is less correlated to commodity prices than its industrial activities,” it said when announcing its intention to float. “This lower correlation makes Glencore’s earnings less volatile than those of equivalent pure commodity producers that do not enjoy the full benefits of complete supply chain and third-party marketing.”

It may be some time before the market, unfamiliar with commodity traders, fully takes that on board. Glencore’s trading peers are giants, such as Cargill, Trafigura and Vitol, although each is more specialised and all are privately owned. The closest quoted comparable is Singapore-listed Noble Group, which is considerably smaller.

Difficult questions

The partnership-to-plc element of the IPO also raised questions that had to be addressed. Would Glencore’s key people be less motivated as employees than they had been as partners? Given that their business is to stay ahead of commodity trends, were they not cunningly cashing in at the top of the market? Commentators recalled Goldman Sachs, whose partners incorporated just before the dot-com bubble burst in 1999, and Blackstone, which went public in June 2007.

Mr Gueroult points out that Glencore’s decision to go public was taken in the middle of a downturn and that its executives retain more than 80% of the company. “The key executives are locked in for four to five years,” he says, “so their interests are aligned with public shareholders. CEO Ivan Glasenberg has said he will never sell a share while working at the company.”

Seeking to convince by example, Glencore brought in 12 cornerstone shareholders, the first time this had been done in a European IPO. In return for their names on the prospectus and a six-month lockup, they were guaranteed a total of more than 30% of the issue ($3.1bn) at the same price as everyone else. They included sovereign wealth funds, such as Abu Dhabi’s Aabar; long-only investors, such as BlackRock and Fidelity; and (not famous fans of lock-ups) hedge funds, such as Eton Park and Och Ziff.

“The list is extremely impressive," maintains Mr Gueroult. “It was very important because it derisked the transaction and showed the quality of people who had taken time to understand the company.” Another boost was the fact that Glencore would go immediately into the FTSE 100 Index – the first company to do so since British Gas in 1986 – and the MSCI World Index, thereby obliging trackers to buy the stock.

Huge interest

A two-week roadshow across four continents was launched on May 4 this year, with a price range of 480p ($7.73) to 580p, pitching Glencore’s prospective earnings multiple of 9.2 on the day somewhere between miners (with a mean of 7.7) and traders (12 to 15). The interest was huge, and the issue was covered four times on the first day alone. The following day tested the nerves, with silver plunging by 25% and oil by 10%, but a fortnight later the deal could still be priced at the mid-point of 530p, valuing Glencore at $59bn.

Since then the shares have traded below 500p, which voided the exercise of a greenshoe option. Critics say too many investors received allocations that were too small to bother holding on to. Mr Gueroult counters that the stock simply followed the market down. “Of 850 accounts, 350 got nothing and the top 50 got 67% to 68% of the overall book,” he says. “We took extra care that those who got $5m or less represented less than 5% of the offering.” He adds that Glencore should have a lower beta than the mining sector, but that this will take several quarters to establish.

Now that Glencore has emerged into the light, its public life is unlikely to be dull. Since flotation, it has released first-quarter 2011 figures which disappointed, despite a 47% rise in net profit over the first quarter of 2010. The European Investment Bank has frozen lending to the company over alleged tax irregularities – strongly refuted – at a Glencore-controlled Zambian copper smelter. As the company does business in some of the most lawless places on earth, there is unlikely to be a shortage of racy stories.

Nonetheless, as the IPO demonstrates, Glencore has its champions. “The success of a transaction this size in such a turbulent environment reflects the quality of the company and its management, and the structure of the deal,” says Mr Antakly. “You couldn’t have done it with a company that was merely average. It confirms that commodities are now an established asset class for investors around the world.”