Updated with management comments and added sector detail. NEW YORK ( TheStreet) - Glencore stock deal to buy Xstrata is unique, but not for its $41 billion size. The mega-merger represent's a rare all-stock deal at a time when companies are sitting on record cash piles and have open access to low interest rates to finance bids. The result is that some Xstrata's largest shareholders are fighting back against the deal. Two of Xstrata's largest shareholders -- Standard Life Investments and Schroeder's -- both object to the deal and want more money, according to Reuters reports.
Glencore, which holds 34% of Xstrata shares, will pay a 15% premium to Xstrata's closing share price on Feb. 1 in an all-stock deal to reunite the two mining giants, creating a combined company with revenue of $209 billion and pretax profit of $16 billion, according to 2011 earnings. In a sector filled with behemoths like BHP Billiton ( BHP), Rio Tinto ( RIO) and Vale ( VALE - Get Report), the combined company, called Glencore Xstrata, would be the fourth largest in the sector. The deal would also mark the biggest merger in the sector since a $38.1 billion cash deal by Rio Tinto to buy Alcan in 2007. Since then, blockbuster minig deals have been hard to cut. In Feb. 2008, Xstrata walked away from a $76 billion cash and share offer from Brazilian mining giant Vale. Later that year, BHP walked away from a hostile $100 billion-plus all stock offer for Rio Tinto after regulatory threats and an escalating financial crisis harmed the deal. "We are not expecting significant anti-trust issues except maybe for Coal in Australia," wrote Societe General analysts of Tuesday's merger announcement. "I'm in complete agreement with Standard Life and we intend to do exactly the same. This is a fabulous deal for Glencore, it's probably a great deal for the Xstrata management, but it's a poor deal for Xstrata's majority shareholders," Schroders' head of equities Richard Buxton told Reuters. Combined, Standard Life and Schroeder's own 3.6% of all Xstrata shares and 5.6% of the shares needed for approval, according to Thomson Reuters data. To be completed, the deal needs to be approved by 75% of voting shareholders, To finance the stock merger, Glencore will issue 2.8 new shares for each Xstrata share in what it calls a "merger of equals." The move will combine Xstrata's coal mining dominance, particularly in Australia with Glencore's commodity trading operations, wrenching out $500 million in immediate synergies and a 11% plus annual compound growth rate through 2015, according to the two companies. "Xstrata shareholders continue to benefit not only from the Xstrata growth story, but also from the value proposition that Glencore brings to their growth and diversification, their projects and their marketing and trading business," said Xstrata Chief Executive Mick Davis in an analyst call. Beause the share merger may improve the financial condition on the merged company and possibly their bond ratings as credit default swaps imply, Davis said that the tie-up could help "bolt-on" transactions. U.S. coal giant Cliffs Natural Resources ( CLF) rose on news of the deal, even as competitor shares were falling. Still, one issue is whether a stock deal represents the best value for Xstrata shareholders. For instance, if Glencore shares were to slide from now until the deal closing, it would lower the overall value. The other concern is whether shareholders would rather wait out for a stronger cyclical recovery that will boost commodity prices. "The single digit premium seems low to us, even for an all share merger of equals. While we think there is little chance of Glencore topping up the offer with cash, it would seem that there is increasing support against the merger," writes RBC Capital Markets analyst Timothy Huff in a note reacting to the deal. In our view, if management perceives a problem with getting past the 75% threshold, there should be an increasing chance of a higher ratio being offered should the two management teams want to complete this transaction," adds Huff.
On a valuation basis, Glencore's purchase price represents "only a slight premium to the diversified mining group," according to FBR Capital Markets, which values the deal at 6 times Xstrata's 2012 earnings before interest taxes depreciation and amortization, a slight premium to the sectors 4.5 times EBITDA average. Recent share offers in the cyclical mining and construction sectors like Martin Marietta's ( MLM) hostile bid for Vulcan Materials ( VMC) have faced stiff resistance from company management. Meanwhile, Commercial Metals ( CMC) and Oshkosh ( OSK) shareholders have sided with management in hostile bids by activist investor Carl Icahn. Stock deals are generally cut for a few reasons. First, companies without the cash and financial health may need to use their shares to pay for a merger and the structure helps bridge the pricing gap between what can be paid and what sellers expect. Secondly, companies may also like to use an overvalued stock. Even with a recent run up in stock prices, Xstrata and Glencore shares have both fallen over 14% in the last twelve months, so it would be hard to argue that management thinks their stock prices are overvalued. CEO Davis of Xstrata said on an analyst call that the share deal allows investors in both companies to benefit from the ongoing success of the merger, instead of a one-off cash payment. But at a $62 billion size, the stock deal is more of a signal that Glencore doesn't have the financial strength to raise bonds to pay for Xstrata in cash. Currently, the company has a Baa2 rating from Moody's and a BBB long-term debt rating from Standard & Poor's, both low investment grade bond ratings subject to a turn in financial and economic conditions. With risks like a slowdown in Chinese growth and a worsening of the European debt crisis, commodity sensitive companies are especially exposed. However, investors should follow Tuesday's mega-mining merger to see what disgruntled shareholders say about the offer. If they have an aversion to the timing of the all-stock deal, it might speak volumes about shareholder expectations of a stronger cyclical recovery in coming years -- that will continue to shelve stock deals. In the U.S., all-stock deals represented under 5% of total M&A activity in the past twelve months, according to Bloomberg data. That contrasts to a pre-crisis average of above 10%, when companies paid higher premiums to EBITDA and book value in mergers, the data shows. -- Written by Antoine Gara in New York