Last Wednesday, just minutes after we reported that the best way to trade the “beginning of the end” for Glencore (which just days earlier Bank of America calculated would need a $12 billion capital injection to reduce its net leverage to a viable 2.0x, a number which is “only” $3 billion for 3.0x leverage), was still through GLEN’s CDS, S&P finally woke up and made it clear that the next step for Glencore would indeed be a collateral waterfall-inducing downgrade, one which would have sent the credit default swaps into quadruple digit “junk” territory as the company’s investment grade rating was suddenly in jeopardy (just as we had previewed weeks ago), unless something drastically changed:
- S&P: GLENCORE TO BBB/NEGATIVE FROM BBB/STABLE
As a reminder, Glencore is the company which we said in March 2014 is the best, least risky, and most levered way to “Play The Chinese Credit-Commodity Crunch?“, by way of its CDS which we said at 150 bps is a no brainer buy as it had only one way to go: wider.
It did: on Friday afternoon, GLEN CDS blew out to 450bps, about 200% wider than where it was when we first highlighted it.
But while Glencore’s operational problems were well known, perhaps the main reason why the CDS entered a blow off top phase is because last Wednesday, the company announced it would actually engage in a liquidity-reducing event, when it decided to repay $350 million in perpetual bonds with cash on hand, thereby limiting its operating leeway even further and bringing even more attention to its cash burn.
This was also the tipping point for S&P, which made it quite clear (in case the stock – which plunged to an all time low last week – hadn’t) that Glencore CEO Ivan Glasenberg should take the surge in default risk seriously, or very soon it would shift away from risk and become reality.
It all culminated early this morning, when Glencore finally capitulated and admitted defeat not only on its expansionary phase (it was just last year Glencore had approached Rio Tinto to engage in a merger), but on its shareholder “friendliness”, with a stunning annoucement that it would proceed in a $10 billion debt reduction, issuing $2.5 billion in equity in the form of a rights offering, sell $2 billion worth of assets (such as “proposed precious metals streaming transaction(s) and the minority participation of 3rd party strategic investors in certain of Glencore’s agriculture assets, including infrastructure”), cut working capital by $1.5 billion, cut capex and its loan book by a further $1-$1.8 billion… oh, and it would also scrap its final $1.6 billion dividend as well as next year’s interim payout, saving a further $2.4 billion.
All this because our “best way to trade China’s blow up” was finally picking up steam.
This is what Glasenberg said in today’s capitulatory press release:
“Notwithstanding our strong liquidity, positive operational free cashflow generation, lack of debt covenants, modest near-term maturities and the recent affirmation of our credit ratings, recent stakeholder engagement in response to market speculation around the sustainability of our leverage, highlights the desire to strengthen and protect our balance sheet amid the current market uncertainty.“
Sorry Ivan, but your actions were quite clearly “withstanding” a reality you had ignored far too long, one which we long before anyone else warned would catch up with the company.
Some more details on the company’s dramatic capital-raise from the WSJ:
The Switzerland-based company also said it would suspend operations at two massive African mines and sell stakes in some precious metals and agricultural assets in a bid to slash its net debt by up to $10 billion—three times more than it had previously said it would cut.
Company officials said they were trying to reassure investors who have been rattled by a downgrade in Glencore’s credit outlook amid a swooning market for nearly everything the company produces, from copper to oil, coal to zinc.
Glencore’s massive trading arm, fueled by billions in debt, could be brought to a standstill if its debt lost investment-grade status, since the lower rating would make the debt far more expensive to service.
The company was supposed to be insulated from commodity price cycles because of its trading arm, which buys and sells goods and moves them from place to place. Instead, the price rout has affected nearly every part of Glencore’s business and made shareholders fear the worst.
“[B]ankruptcy risk was clearly investors’ main concern, and today’s announcement significantly reduces that risk,” Sanford C. Bernstein analyst Paul Gait wrote in a note.
Where Glencore’s decision gets interesting, is the company’s decision to halt production at its Katanga and Mopani copper mines for 18 months “in light of the challenging environment for commodities”, up until the completion of the expansionary and upgrade projects. According to Glencore, “this includes the whole ore leach at Katanga and the new shafts and concentrator at Mopani. A suspension of operations will remove approximately 400,000 tonnes of copper cathode from the market.“
Or, as Ivan Glasenberg said on a conference call, “we once again, like we did with coal previously, have introduced supply discipline.” Which is great news… for Glencore’s competitors.
Recall that Glencore is the one company in the world most geared toward copper pricing…
… and it is Glencore who has decided it would be the first to defect from the “prisoners’ dilemma”, and fully eliminate copper production. Which is great news for its competitors who will all benefit from the resulting higher equilibrium prices (assuming demands stays the same), even as Glencore’s mining cash flows tumble.
So what does all of this mean for Glencore, and its balance sheet?
Considering that following the copper mining halt, GLEN’s cash flow will tumble for the foreseeable future (or at least until the company decides the plan was flawed in a world in which all its competitors will now flood the market with even more production, eating away at Glencore’s market share), what Glencore has really done is buy itself about 6 months in EBITDA in the form of outside funding between the $2.5 billion capital raise and the $2 billion in (assumed) asset sales.
In other words, Glencore’s plan is simply a bet that the Chinese demand slump – which recall is the primary culprit behind all of Glencore’s troubles – will be resolved in 6-9 months. It has done so at the expense of liquidating its most marketable assets, diluting shareholders, and ending shareholder-friendly activities.
To be sure, GLEN CDS has improved substantially on the news, tighter by some 106 bps to 339bps, as an imminent default has just been pushed back by 6-9 months; this however merely reinforces our thesis and allows all those who missed the initial blow out in GLEN credit default swaps to put the trade on… at levels not seen since about a month ago.
Because as a result of today’s asset-stripping and equity-raising activity, Glencore is now a that much better levered bet on China’s economy in a broad sense, and copper pricing in a narrow one. In fact, with every passing week that neither China’s economy rebound nor copper reverses recent losses, expect GLEN CDS to accelerate its widening once again, and overtake its recent multi-year high level of 445 bps in very short notice.
