A merger between Rio Tinto and Glencore appears to make strategic sense

News from un-named sources that Rio Tinto and Glencore had discussed a potential merger late last year came as little surprise to investors who have knowledge of both companies. On first take the merger makes strategic sense for both entities.

Rio Tinto has divested its coal mining assets as it seeks to move away from fossil fuels and has indicated its copper and lithium businesses are its future focus. However new copper mines are difficult to find and expensive to develop, while existing copper mines are getting depleted and becoming lower grade. The strategic solution for Rio Tinto is to acquire companies that own existing, long-life, large-scale copper mines.

Glencore is the standout candidate to fulfil Rio Tinto’s strategic objective. Glencore jointly owns 44 percent of one of the richest copper deposits in the world, the Collahuasi copper mine, situated in northern Chile. The mine is jointly owned with Anglo American (44 percent) and Japan Collahuasi Resources (12 percent). According to the most recent Collahuasi Life of Mine Plan, the mining site has a remaining life of 45 years to 2070.

Anglo American’s 44 percent stake in the Collahuasi copper mine was believed to be the primary driver behind BHP’s failed takeover attempt of Anglo American last year. This followed RIO’s previous offer to both Glencore and Anglo American for their stakes in the Collahuasi mine during the 2015 commodity price slump.

A merger of Rio Tinto and Glencore would create the world’s largest copper miner and provide Rio shareholders with significant exposure to copper which is key to the world’s clean energy transition. The merger would also provide RIO with exposure to other clean energy metals that it doesn’t currently mine, such as nickel and zinc.

Glencore shareholders also stand to gain strategic benefit from a merger with Rio Tinto. The strategic rationale for a merger with Rio Tinto appears two-fold.

Firstly, coal is not a renewable resource and emits a high level of carbon dioxide into the atmosphere, contributing to global warming. A long-term reliance on income from coal production is simply not sustainable as the world transitions to clen energy.

Secondly, Glencore has large cornerstone shareholders including its former CEO Ivan Glasenberg, who initiated an earlier merger proposal with Rio in 2014. Glasenberg still owns almost 10 percent of Glencore. The other major Glencore shareholder is the Qatar Investment Authority (QIA), Qatar’s state-owned sovereign wealth fund. QWA owns a 9 percent stake in Glencore. A merger of Glencore and Rio Tinto would enhance stock liquidity and market capitalisation for Glencore shareholders, which would benefit existing shareholders by enabling a smooth and less market price disruptive exit for the two existing cornerstone shareholders.

Rio Tinto has a market value of about A$163 billion, while Glencore is valued at about A$92 billion. The combined market capitalisation of the merged entity at about $250 billion would comfortably absorb an orderly sale of stock valued at around A$18 billion, representing 7 percent of the combined entity’s market capitalisation post-merger.

What’s next?

Glencore’s significant exposure to coal mining would be a stumbling block to any merger proposal between it and Rio Tinto. This would mean that Glencore’s coal mining assets would have to be divested as part of any future merger proposal.

When news of the most recent merger discussions became publicly known, Glencore’s American Depositary Receipts jumped as much as 8.7 percent in trading. RIO shares declined about 1.8 percent. This outcome is unsurprising because the smaller ‘Target’ company owns the ‘jewels’ and Rio Tinto, being the acquirer, must pay a premium that reflects the benefit of owning an asset that has strategic value as well as economic value. The market’s response implies that any merger proposal between these two large mining houses should ultimately gain market buy-in.

Rio Tinto has been buying stakes in companies with copper assets in recent years. In December 2022 RIO paid A$3.1 billion for a 66 percent direct interest in the Oyu Tolgoi copper mine in Mongolia. The remaining 34 percent equity is owned by the Government of Mongolia.

It is no coincidence that Rio Tinto’s expanding focus on copper mining comes at a time when RIO remains heavily dependent on iron ore to drive future profits. This dependence carries increasing earnings risk because China’s long-dated construction boom appears to be ending, as evidenced by iron ore prices having halved over the past three and a half years. Throughout this period of extended iron ore price weakness, Rio Tinto has turned its attention to future-facing commodities like copper and lithium.

Both Glencore and RIO own some of the best copper mines in the world and so combining these two businesses to form the world’s largest mining house with a material exposure to copper makes economic and strategic sense. Ultimately the commercial imperative usually wins out and so Rio Tinto shareholders should maintain a watchful eye on stratagems that may lead to Rio Tinto and Glencore combining to become the world’s largest mining business.