Commodities trader Glencore is in talks to buy mining group Xstrata in an all-share transaction that could create a combined group worth more than 50 billion pounds ($79 billion), shaking up the industry with its biggest deal to date.
Glencore, the world's largest diversified commodities trader, already owns 34 percent of Xstrata and a tie-up between the two -- a deal which would trump Rio Tinto's $38 billion acquisition of Alcan in 2007 -- has long been expected, as Glencore aims to add more mines to its trading clout.
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"We've always had the belief these two companies should be together," Glencore Chief Executive Ivan Glasenberg told a financial conference in Moscow.
Investors and analysts say the main potential stumbling block, after years of on-off talks, will be the price -- the premium, if any, offered to Xstrata shareholders, who are already signaling they want to see the growth profile of their company recognized in any offer, however friendly, and will require a sweetener to approve the move.
But any agreement will also hinge on the relationship between the ambitious South African bosses of both companies -- Glencore's Glasenberg and Mick Davis at Xstrata.
News that Xstrata, the world's fourth-largest diversified miner, had received an approach boosted shares in both companies, sending Xstrata up 10.8 percent and Glencore up 6.5 percent by 1554 GMT. Glencore's Hong Kong shares rose as much as 6 percent before trade was suspended.
Both sides said there was no certainty an offer would be made and the deal was described as an all-share "merger of equals." Under UK rules, Glencore now has 28 days to make an offer, though that could be extended at Xstrata's request.
The two sides have little overlap in mining, meaning a combined "Glen-strata" entity would get synergies from some areas of marketing but would otherwise combine industrial and operational assets to create the world's largest zinc and thermal coal producer and a heavyweight in copper and nickel.
Analysts at Credit Suisse estimate the synergies at around $468 million, roughly 5 percent of combined 2012 net income, thanks to a better use of Glencore's marketing capabilities.
Any deal is expected to be agreed, or friendly, meaning Glasenberg and Davis, along with Xstrata shareholders, have to settle on one thing that has so far kept the two apart -- valuation, and what premium Glencore will need to pay.
Davis and his Chairman John Bond, whose appointment last year was widely read as a signal to Glencore given the former HSBC boss's tough reputation, are expected to be resistant to any deal that does not recognize what they see as Xstrata's growth potential.
Glencore, though a shareholder, would not be able to vote on a deal, leaving the decision outside its hands.
"I don't see any scenario where a nil-premium merger will get shareholder approval," said one top-five shareholder, who declined to be named because of the sensitivity of the matter.
"We still haven't seen Glencore's Q4 figures either and there's a bit of concern about the marketing profitability on that number. I'm assuming there's nothing untoward ... but even with that, I would expect to see some degree of premium."
Another shareholder, a top-20 investor who also declined to be quoted, said: "We turned down Glencore at IPO on valuation grounds ... there is no way we will take lower-quality paper without a sizeable premium to reflect the difference in earnings quality."
Xstrata itself made a "merger of equals" bid for rival Anglo American in 2009, but that failed after Davis refused to offer a premium.
Glencore is not expected to offer a control premium for Xstrata, but it could offer an "equalization" premium, meaning an adjustment to the share ratio to better reflect the value of the two companies and their growth options, along with different valuations placed on marketing and mining businesses.
Xstrata has seen spectacular growth through deals, though it is now focused on organic or self-generated growth to boost production by 50 percent to 2014, with a project pipeline budget of $19.5 billion over the two years.
Analysts at Credit Suisse suggested a premium of 11 percent for Xstrata would put the two sides on similar valuations, while a source familiar with the deal said that level would be in line with other, similar deals. Under a nil-premium merger, Glencore would own almost 60 percent of the combined group.
Another question is who would run the combined entity, with Glasenberg and Davis, both driven dealmakers, in the running for the chief executive's role. Both are expected to remain in some capacity, and though Davis is already the industry's longest-serving boss, one source familiar with the issue said he did not expect Xstrata's boss to hand over the reins yet.
While their two groups have held on-off talks over years, speculation over a tie-up accelerated with Glencore's bumper $10 billion listing last May, which handed Glasenberg the currency for deals. The listing also allowed the market to put a value on Glencore -- a key demand among Xstrata shareholders.
Glencore, a trader of metals, minerals and oil and which also has assets from mines to farmland, said at the time the motivation behind going public after almost four decades as a private company was to seize acquisition opportunities.
"These two companies were expected to merge and this is obviously a little bit faster than we had anticipated, but it makes sense given how the companies have performed and the current market positions," said analyst Tim Dudley at brokerage Collins Stewart.
Glencore shares have fallen almost 17 percent since its listing, but have still outperformed the drop in Xstrata, listed in 2002 after the acquisition of Glencore's coal assets.
If Glencore were to buy all outstanding Xstrata shares at current market prices that would cost around 21 billion pounds.
Xstrata is taking advice from Nomura and Goldman Sachs alongside JP Morgan and Deutsche, the company's corporate brokers, people familiar with the matter said. Glencore has opted for advisers Citigroup and Morgan Stanley, which were also lead banks for Glencore's $10 billion listing last May.
($1 = 0.6306 British pounds)