Glencore, Xstrata Merger on the Rocks (GLCNF, XSRAY, BHP, VALE, RIO)

The announcement last February that Glencore International AG (OTC: GLCNF) would acquire mining giant Xstrata plc (OTC: XSRAY) has always faced one very big problem: just 17% of Xstrata shareholders voting against the deal can kill it. Glencore, which already owns 34% of Xstrata, cannot vote in the deal that has recently been pegged at a value of $58 billion. Some earlier estimates of the deal’s value ran as high as $90 billion.

Whatever. The latest threat to the merger is a demand from Qatar Holdings — the sovereign wealth fund that owns 11% of Xstrata — that Glencore boost its offer by 16%, from 2.8 shares to 3.25 shares of Glencore stock for every share of Xstrata.

Qatar Holdings’ demand follows a dispute over a retention package for Xstrata’s senior managers worth about $270 million. The total payout to Xstrata employees would be around $337 million. Originally to be paid in cash, the package is now mostly based on performance and will be paid in stock.

Now, though, Qatar Holdings thinks shareholders should be compensated for their generosity to Xstrata’s management. Glencore thinks the sovereign wealth fund’s demand overvalues Xstrata and Glencore is prepared to turn its back on the deal completely.

If the deal goes through, Glencore, already one of the world’s largest trading houses, would rival BHP Billiton plc (NYSE: BHP), Vale SA (NYSE: VALE), and Rio Tinto plc (NYSE: RIO) in size and influence. Xstrata will certainly survive on its own, but Glencore wants to play with the big boys and the only way to do that is to complete the deal for Xstrata.

Xstrata’s shares have completely priced-in the Glencore offer, and if the deal falls through, the shares could dive by as much as -30%. Under UK law Glencore could back with another offer after waiting a year, and its 34% stake in Xstrata effectively blocks any other attempts to acquire the mining firm.

Many observers expect Glencore to counter Qatar’s demand with an offer of 3 shares, but Glencore walked away from a deal to sell its stake in Xstrata to Vale in 2008. A lot of people think the trading house would do the same thing in this case, especially given the recent decline in commodity prices. Glencore can afford to wait because it essentially controls Xstrata’s destiny.

Paul Ausick