Dealtalk: Glencore move on Xstrata lights fire under M&A hopes

A worker uses a mobile lift to clean the windows of the headquarters of Swiss commodities trader Glencore in Baar near Zurich April 13, 2011.

LONDON (Reuters) - Glencore's (GLEN.L) earlier-than-expected move on mining group Xstrata (XTA.L) could indicate that mining company valuations have reached a bottom, getting bankers excited about the prospect of a revival in merger activity.

Glencore is already Xstrata's biggest shareholder and a deal has been expected since the commodities trader went public in 2011.

But coming just a year after the bumper $10 billion listing, and after a dismal performance in Glencore's shares, it is being read as an indication that the time could now be right for more mining deals, with valuations low and cash piles high.

"It reinvigorates the sector," said Liberum analyst Dominic O'Kane.

A combined Glencore-Xstrata, is expected itself to retain the appetite for deals, particularly in areas it has earmarked for growth, like iron ore. And a sharp drop in Glencore's borrowing costs - the cost of insuring its debt has come off by almost a third this week - will certainly make it easier for the company to borrow.

Some are even speculating that the merged group could take another swing at mining group Anglo American (AAL.L), under pressure from its larger peers and embroiled in a potentially damaging legal battle in Chile.

"The consensual target is Anglo, and that is based on the fact that Xstrata tried to acquire Anglo in 2009," said Liberum's O'Kane. "A combined company would be around 65 percent larger than Anglo and there is expectation it could have a go again -- and their probability of success would be higher this time round."

Deal-hungry bankers say they see the potential for more all-share deals that take advantage of low valuations.

"If you are able to find opportunities to find share deals, mergers of equals, there is maybe more scope for them," one senior industry banker said. "What is difficult in an environment as volatile as this, is to go out and do very large cash deals with big premiums. As the CEO and board you would be taking a huge amount of risk -- you are taking a lot of cash out, and you are making a bet on the future."

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For a graph on gold miners' equity valuations by company, click on: link.reuters.com/bux36s

For a graph on the sector over the last decade, click on: link.reuters.com/xas36s

For a graph of the sector against the gold price, click on: link.reuters.com/sas36s

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MID-CAP FLURRY

Buying rather than digging new mines is also becoming more attractive. Mining companies continually seek to replace their reserves and typically weigh up building new mines versus buying production. Rising costs, increased labor troubles and tougher government relations, have made buying more appealing.

This, analysts and bankers say, means deals will be more likely among mid-cap companies, where gold, iron ore and coal are expected to be the hottest commodities, and where deals are possible without large amounts of cash.

Mid-cap deals were already the mainstay of the market last year -- 2011 saw the highest value since 2007, but the recovery has been marked by a higher number of lower value deals.

Glencore-Xstrata could also contribute with asset sales, like Xstrata's 25 percent stake in troubled platinum producer Lonmin (LMI.L), a left-over from its bid for the company in 2008, which was stymied by the financial crisis.

But the hotspot, industry experts say, is likely to be gold, where companies' cash flows are at record highs and equity valuations at their lowest in more than a decade.

"Gold remains much more fragmented than most of the other commodities," a second senior sector banker said. "There is still a significant tier of emerging companies with attractive assets and consolidation remains on the agenda."

Unlike the more volatile base metal space, gold has remained robust with prices still more than three times what they were less than a decade ago, and analysts, bankers and industry players point to the metal as a likely bright spot.

"The longer gold prices stay high, the higher the probability someone will make a move," said Tyler Broda, analyst at Nomura in London.

The sector, buoyed by cash flows that have far exceeded capital expenditure plans, has already seen deals in recent months, including a move by Qatar Holdings to provide funding to European Goldfields (ELD.TO) that handed it a almost 10 percent stake in the miner last year. This was the Gulf investor's first move into gold.

European Goldfields, which is developing mines in Greece, has subsequently agreed to be taken over in a separate $2.4 billion deal with Canada's Eldorado Gold (ELD.TO).

But industry sources point to other potential targets, particularly in exploration, including miners like Australia's Gryphon Minerals (GRY.AX), developing the Banfora gold project in Burkina Faso, or AIM-listed Goldstone Resources (GRL.L), which has projects in Ghana, Senegal and Gabon.

Miners digging for gold face even more pressure to keep stocks topped up, as the average life of a gold mine is under a decade, compared to roughly three times that for copper.

(Reporting by Clara Ferreira-Marques; Editing by Chris Wickham)