Mature bull and the horns of a dilemma

Commodities trading
By Angus McCrone

11 April 2017

Financial engineers are coiled, ready to strike – that’s the lesson from the recent Glencore and Kraft sagas, finds Angus McCrone.

Deals involving smaller players buying into larger ones seem to be symptomatic of mature bull markets, and the fact that recent months have produced two such moves - Glencore and Kraft - may be a signal that the long stock market upswing since 2009 is well into its pipe-and-slippers phase.

Lessons from Glencore

Glencore, which saw its share price plunge in 2015 amid the oil price slump but has since seen an improvement in investor confidence amid measures to reduce its mountain of debts, said on 10 December that it had formed a partnership with Qatar Investment Authority in order to buy 19.5% of Rosneft.

At first sight the cost to Glencore would be half of $12bn (the other half taken by QIA) – a huge mouthful for a company just emerging from a programme to reduce debt and recover investor confidence. However, that is where the snakelike cunning came in. The deal was constructed so that UK-listed Glencore would have to stump up equity of just €300m, and QIA equity of €2.5bn, to be put into a new vehicle that would in turn buy the Rosneft stake.

Photo of a mine

The balance of funds needed to purchase that holding would come from loans from an Italian bank, Intesa Sanpaolo. So Glencore and its Qatari partner appeared to be making a highly leveraged punt on the Rosneft share price – a bit like a financial spread bet, in that their profits would be magnified as Rosneft shares went up, and losses could amount to far more than €300m or €2.5bn if the stock price slumped.

Even that perception would not be right, however. Under the terms of the loan, Glencore’s additional exposure to the Rosneft share price (on top of the €300m in equity it had committed) would be limited to “margin guarantees” of up to €1.4bn, “for which Glencore has obtained full indemnification from appropriate Russian banks”.

What that would mean in practice if Rosneft shares soared, or collapsed, remained unclear but it appeared that Glencore had found a clever way to assume near-20% ownership of Rosneft, with QIA, while taking on only a small fraction of that financial risk.

These big-bites-bigger moves show us two things. 

First, that currency shifts have created apparent relative value in international businesses (in these cases the weakness against the dollar of the Russian rouble and the UK pound); and second, that financial engineers are out searching for audacious ways to generate returns at a time in the cycle when many of the more straightforward growth and consolidation opportunities have been taken.

Read more from the April 2017 edition of CA magazine

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