Glencore International, the Swiss producer and trader of commodities, will kick off the Hong Kong retail portion of its initial public offering today, as the immediate concerns about last week’s slump in commodity prices appears to be easing off. Indeed, bankers say the volume of institutional orders has been growing steadily since the bookbuilding opened on May 4 and this portion of the offering is already more than five times covered.
Speaking to Hong Kong media by video link yesterday, Glencore CEO Ivan Glasenberg said he wasn’t worried about the recent decline in commodities prices as he views it as a short-term correction — a view that is shared by a number of analysts as well.
“The fall in commodity prices is removing the froth in the market and is caused by speculators. We look at the underlying fundamental demand and supply — the physical movement — and we still see strong demand in Asia as both India and China continue to increase their consumption of various commodities. We also continue to see mining companies struggling to produce and increase their production to meet this demand,” he said.
As reported earlier, Glencore is aiming to raise between $9 billion and $11 billion from the IPO ahead of a dual listing in London and Hong Kong — the largest IPO in the world this year and the largest European IPO since 1999. If it is priced at the mid-point, Glencore will have a market capitalisation of $61 billion at the time of listing.
Glasenberg explained that Glencore rarely takes outright price views on an underlying commodity, which makes it less affected by a decline in commodities prices than the producers and mining companies — although revenues are correlated to commodity prices to some extent. However, Glencore makes money primarily from the logistics part of its business and by looking for arbitrage opportunities between different parts of the world. Because it buys most of its commodities from third parties it also has the opportunity to blend products in order to provide its customers with the exact grade of the product they need, while at the same time reducing its average acquisition cost.
It is also making use of its extensive storage facilities to take advantage of the fact that futures prices are often higher than spot prices (known as contango). Instead of delivering the commodity straight away, it may store it for future delivery at a higher price, while hedging the forward price and making money on the margin.
The company, which generated $145 billion of revenues last year, or close to $400 million per day, is dividing its business into three key divisions: metals and minerals, energy products and agricultural products. But on top of that it also has three other parts of the business: the marketing activities, unlisted industrial assets, and listed industrial assets, including a 35% stake in Swiss mining company Xstrata and an 8.8% stake in Russian aluminium producer UC Rusal.
Glasenberg added that 2011 has started on a strong note, in line with the management’s expectations, as market conditions have improved. The industrial assets have performed well on the back of the pickup in commodities prices and production increases, while on the marketing side, the oil division in particular has shown substantially improved results due to increased arbitrage opportunities stemming from greater market volatility and tighter supply.
And in spite of the slump in commodity prices last week, he said he expect the demand for commodities and trading volumes to remain strong during the rest of the year. This will support the planned payout of $350 million of dividends for the first half, as noted in the prospectus. Glasenberg added that the intention is for the interim dividend to account for one-third of the total dividend each year, which means that the full-year dividend for 2011 should be above $1 billion. The company also intends to pursue a progressive dividend policy that will see it maintain or increase the total distributions every year.
The company is also very focused on return-on-equity and prefers to buy tier-two or tier-three assets that are cheaper but can become highly profitable as part of the group’s wider marketing operations. “We won’t do deals for the sake of growing the business or for the sake of being a bigger company. They have to be accretive,” Glasenberg said.
The strategy has paid off. In the past 10 years, the company has delivered an average ROE of 38% (it has ranged from 15% to 61% per year) and it has also been consistently profitable every year since it was bought out by the management in 1994.
The Hong Kong retail offering will initially comprise 31.25 million shares, or 2.5% of the maximum number of shares that will be sold, which at the mid-point of the price range will value it at about $250 million.
The company has also secured $3.1 billion from a high-profile group of cornerstone investors, including an $850 million commitment from the Abu Dhabi sovereign wealth fund (Aabar Investments PJSC), $400 million from the Government of Singapore Investment Corp, and $360 million from Blackrock. Another nine investors will put up smaller amounts ranging from $100 million to $225 million. Their support for Glencore and the proposed valuation cannot be underestimated, but aside from that, the fact that they are buying up to one third of the offering, means the portion of the deal targeted at other institutional investors will be a more manageable $5.6 billion to $7.7 billion.
There is the potential for the retail offering to be increased to as much as 10% of the total offering, although that will take a subscription ratio of more than 100 times. Even for it to increase to 3.75%, the subscription ratio will have to be more than 15 times, which suggests a total retail order amount of about $4.8 billion. Some observers say this could stretch the capacity of the margin lending available for this deal, and argue that an increase of the retail tranche beyond this first clawback trigger is unlikely.
The price will be set between GBP4.80 and GBP5.80 apiece, while the number of shares will depend on the final price. The maximum number of shares that can be sold is 1.25 billion, with the base deal comprising 1.13 billion. The rest is part of the 10% greenshoe. Some 79% of the shares in the base deal are new, while the remaining 21% are secondary shares sold by the existing management shareholders.
The price of the Hong Kong retail offering will be between HK$61.24 and HK$79.18 per share, which corresponds to the UK price range plus a buffer of about 7% at the top end to allow for potential exchange rate fluctuations before the final pricing on May 19. The shares will be trading in board lots of 100 shares, which means retail investors will have to pay HK$7,997.82 per board lot, including brokerage and other fees, when they subscribe. If the price is set below the top end, or the exchange rate movements means a direct conversion of the final UK price results in a lower Hong Kong price, the excess will be refunded.
According to a source, the majority of the institutional demand so far has come from long-only accounts in London that benchmark themselves against the FTSE 100 index, which has to buy since Glencore will be fast-tracked into this key index after its first day of trading. It is only the third company ever to achieve this and the first since British Gas 25 years ago. One syndicate research report estimates that Glencore will be the third largest stock in the FTSE 100 after Shell and BP, which does imply quite a lot of buying from these types of portfolio managers. The company is also expected to become part of the MSCI index series shortly after the London trading debut on May 24.
By comparison, benchmark portfolio managers in Asia have been lukewarm to the offering so far, as Glencore won’t be included in any of their indexes.
The two other major sources of institutional demand are global hedge funds, which supposedly see value in the stock, and private banks, which, according to the source, views Glencore as “a smart way to play the commodities market.”
On a direct question of whether the reason for Glencore having decided to list at this point is that the owners want to take some money off the table before the end of the current commodities cycle, Glasenberg stressed that the partners are not selling in connection with the IPO, except to cover expected individual tax liabilities that will result from the IPO. As reported earlier, there will also be a lockup of five years for the executive directors, and of two to four years for the senior management. All other employees will be prevented from selling any shares for the first year.
However, in order to continue to grow the company, the partners felt they needed to change the capital structure and create permanent equity that can be used partly as a currency when buying fixed assets, and also make it easier for partners leaving the firm to take money off the table. In the past, the latter situation has sometimes forced the company to sell fixed assets simply to release the cash to pay these former employees, he said.
Citi, Credit Suisse and Morgan Stanley are joint global coordinators and bookrunners. Bank of America Merrill Lynch and BNP Paribas join them as bookrunners.
