LONDON A major investor in miner Xstrata Plc is wary of a potential merger with European commodity trader Glencore International due to the difficulty in valuing the privately-held firm.
"Glencore are keen to do a deal, but Xstrata shareholders aren't and I would back the board on having enough independence to back the shareholders," said a fund manager with an institutional shareholder, one of the 10 biggest in Xstrata.
Swiss-based Glencore, which holds nearly 35 percent of Xstrata, is studying a merger to create a huge mining and trading group, a source close to the situation told Reuters on May 2.
"(A deal) would only happen if Glencore gave themselves very cheaply to Xstrata ... but given the management of Glencore are very price conscious, I don't think that would happen and therefore I don't think the deal is going to happen," the fund manager said.
The shareholder came away from talks with Glencore Chief Executive Ivan Glasenberg unconvinced, he added.
"I chatted with Glasenberg about the logic of the deal and why it would be a good thing if we did it. But it's very difficult to value Glencore because you just don't know enough about it. That's why most investors would prefer an IPO -- which will give you more visibility, allowing you to put a value to it."
Both Glencore and Xstrata declined to comment.
The fund manager worried that talk of a potential merger was hitting Xstrata shares, which have underperformed the UK mining index by 5 percent since the start of April.
"The market obviously thinks the deal is better for Glencore than Xstrata which is why Xstrata is being held back. If the deal didn't happen, shares would go up."
Xstrata shares rose 1.8 percent to 1077 pence by 1344, in line with the UK mining index.
WEALTH OF ISSUES
Speculation about a possible merger with Xstrata first surfaced in December when Glencore issued $2.2 billion in convertible bonds, one step toward a possible listing that could value it at more than $35 billion.
Xstrata's CEO Mick Davis told Reuters in February such a merger had positive potential, but no talks were underway at that time.
"Clearly, when one puts together a great trading house and a great mining house, you have the potential for value creation," Davis said. "But there is a wealth of other issues that one would have to think about in looking at that sort of combination."
One issue would be the potential for a brain drain from Glencore if a listed entity made it easier for partners to cash out, said analyst Paul Galloway at Bernstein Research in a note.
This was especially a concern since a trading company's key asset was its employees, he added.
"Our opinion would be to let Glencore (carry out an) IPO ... and at some future date, when Xstrata shareholders can gain some comfort of the true market value of Glencore, then listen to the merger proposal," Galloway said.
Another analyst, who asked not be named, said Glencore's mining assets were of lower quality than Xstrata's and he questioned how Glencore's agricultural trading would fit with Xstrata.
"I just don't know what Xstrata gets out of it ... Glencore has some fairly average, 3rd and 4th division assets and I'm not sure that does much from the quality point of view for Xstrata," he said.
"The key point is how do you value a trading organization. It is difficult because you have a huge turnover figure and a low profit margin." Glencore last year posted net profit of $2.7 billion on revenue of $106.4 billion.
December's convertible bond valued Glencore at about $35 billion, but nearly half of that consisted of the value of the Xstrata stake, leaving $19 billion for the core Glencore, Liberum Capital said in a note.
Another analyst who asked not to be named confirmed that Xstrata shareholders were skeptical of a tie-up with Glencore.
"We've been canvassing investors for some time to gauge the reaction and I haven't found anybody that's keen on a Glencore merger," the analyst said.
Liberum Capital said another solution would be for Glencore to sell its Xstrata stake to a strategic partner such as the Chinese. "That way it can reorganize its capital structure, a buy-back, and Xstrata doesn't have to merge with a trading company."
(Editing by Elaine Hardcastle and David Cowell)