LONDON (Reuters) - Mining group Xstrata and commodities trader Glencore are in talks over an all-share merger 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 Swiss-based companies -- in 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.
Investors, analysts and sources familiar with the matter say one key concern, after years of informal talks, will be the issue of a premium, with shareholders already signaling a deal will require a sweetener.
But any agreement will hinge on the relationship between the ambitious South African bosses of both companies -- Glencore's Ivan Glasenberg and Mick Davis at Xstrata.
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.
But so far its activities have been limited to buying out minorities in Australian nickel producer Minara and seeking control of South African coal miner Optimum.
"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.
NEEDED THE CAPITAL
News that Xstrata, the world's fourth-largest diversified miner, had received a concrete approach boosted shares in both companies, sending Xstrata up 13 percent and Glencore over 5 percent in early London trade. Glencore's Hong Kong shares rose as much as 6 percent before trade was suspended.
"It confirms why Glencore went public. They needed the capital to buy other companies," said Ion-Marc Valahu, a fund manager at Geneva-based ClairInvest.
Both sides said there was no certainty an offer would be made and the deal was described as an all-share "merger of equals," which would imply a friendly deal without a control premium. 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 a giant presence in copper and coal, among other commodities.
Xstrata is for example already the world's largest exporter of thermal coal, with interests in over 30 operating coal mines globally, while Glencore is the world's largest trader of seaborne export thermal coal.
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, or offer substantial upside for investors.
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 Anglo American in 2009, but that failed after Davis refused to offer a premium.
Glencore is not expected to offer a control premium, but it could offer an "equalization" premium to the share price, to better reflect the value of the two companies and their growth options. Xstrata, founded a decade ago, has seen spectacular growth through deals, though it is now focused on organic growth to boost production by 50 percent to 2014.
Glencore's Glasenberg has said he sees value in a deal with Xstrata, while Davis has told analysts the prospect of having both as independently listed firms was "unsustainable."
Another question is who would run the combined entity, with Glasenberg and Davis both in the running for the chief executive's role. Both are expected to remain in some capacity, though Davis is already the industry's longest-serving boss.
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)
(Additional reporting by Sinead Cruise, Kate Holton, Sarah Young and Sudip Kar-Gupta in London, with Elzio Barreto in Hong Kong and Sakhti Prasad in Bangalore; Editing by Chris Wickham and David Holmes)