Glencore is desperate to sell its assets and vowed to reduce net debt by $10bn. However, who will and at what price? A look into Glencore's Xstrata acquisition gives us some glimpse of what Glencore's assets are actually worth.

1. Why Glencore’s assets will fail to realize its true value
Prologue
The company made headlines on Monday (28/09/15)when its shares
fell by 30%.
Management made assurances to investors they are raising cash and
selling assets to reduce its gross debt of $50bn, which is more than the
company’s market capitalisation.
More:If you want to read my analysis on Glencore,the company, click
on the link HERE. But today, we will be discussing Glencore biggest
acquisition: Xstrata.
Before we begin, here is some background on Glencore.
Who is Glencore?
A business that trade hard and softcommodities, it also mined natural
resources and in 2013 merged with Xstrata at a costof $30bnfor the
66% stake Glencore doesn’t own.
So on a 100% equity basis, Glencore values Xstrata’s stake at $44.6bn.
Today, the market value of Glencore and Xstrata is valued at $26bn.
Why have investors diluted the value of Glencore?
At the time of acquisition, Ivan Glasenberg says operational cost-saving
would be $2bn.
But Glencore impaired $7.5bnof its assets and made a loss of $7.4bnin
2013.Also, the company paid out an extra $600m in interest costs from
the previous year.
Gross debt in 2013 jumped to $55bnfrom $35bn.

2. It means that Glencore’s debtto equity is exceeding 100%,which adds
financial risk if company’s profits can’t covertheir capex, dividends and
debt repayments.
Glencore’s Xstrata problem
However, Glencore’s management is no better than (previous)
management at BHP Billiton and Rio Tinto. Both of which did
acquisitions and share buyback at the wrong business cycle.
For example, Rio bought Alcan for $38.1bnin 2008 but was forced to
write off $25bnof its Alcan’s assets!
At the time of the purchase, Alcan had revenue of $30bnin revenue and
$2bn of earnings.
BHP Billiton made the same mistake in 2011 when it bought Petrohawk
(a gas company) for $12bn(debt + cash offer).In the end, they had to
write-off $5.8bnof Petrohawk’s assets. At the time, BHP was paying 18
times Petrohawk’s EBITDA.
Both Rio and BHP has written down between 66% and 48% of its
investments respectively. Meanwhile, Glencore has written off 17% of
Xstrata’s assets.
But, will there be further writedowns from Xstrata?
Xstrata – the business
Xstrata’s four main commodities:Coal, copper,nickel and zinc accounts
for 75% of its revenue.
Let see the performance ofthese commodities.

3. Source:Xstrata annual report
Coal has played a major role in contributing to Xstrata’s revenue while
nickel and zinc stayed on the back foot.Copper stays on as the biggest
contributor.
By analysing Xstrata’s commodities EBIT marginvs. the commodity
market price, we get the sense of direction of where the EBIT margin is
heading.
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
2006 2007 2008 2009 2010 2011 2012
($m) Xstrata's revenue breakdown
Coal
Copper
Nickel
Zinc

4. Source:Xstrata annual report
Copper’s margins were falling even though the average selling price is
high, meaning fixed operational costs have increased substantially since
2006.From 2012 onwards, the copperprice has dropped by27.3%.
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
0
5
10
15
20
25
30
35
40
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
($/TONNE)
(%) Xstrata's copper EBIT margin
Copper (%)
Copper ($/tonne)
0
20
40
60
80
100
120
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
40.0
45.0
50.0
($/TON)
(%)
Xstrata's coal EBIT margin
Coal (%)
S.A. thermal coal price ($/ton)
Australian thermal coal price
($/ton)

5. Source:Xstrata annual report
The EBIT margin for coal is even worse when prices touched their all-
time high!
This kind of situation happens because capacity utilisation has not
reached its optimal level, especiallywhen the company is adding to
capacity.
Meaning that coal’s EBIT margin has to compensate forthe spare
‘unused’ capacity. Now, that coal prices have dropped onaverage by
40%, the EBIT margin will be significantly reduced.
Source:Xstrata annual report
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
-5
0
5
10
15
20
25
30
35
40
45
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
($/TONNE)
(%)
Xstrata's nickel EBIT margin
Nickel (%)
Nickel ($/ton)

6. Source:Xstrata annual report
Both Nickel and Zinc plays a supporting role; nickel margin is likely to fall
further, after the Glencore’s acquisition. But the margin on zinc is likely
to be maintained, given its price resilience.
Investors need to rememberthat heavily capital intensive industry needs
to make a decentmargin if they are going to rely on internal funds to
repay debtand pay a ‘sustainable’ level of dividends.
More importantly, to maintain productionlevel, these types of
businesses needto reinvest their ‘surplus’ capital. To know how much
capital is required, one should look at their depreciationand amortisation
(D + A) expenses peryear.
If the company invest the equivalent of its (D + A), then they have
maintained its production levels.
For Xstrata, if we ignore net interest costs and corporate taxes, the
amount of EBIT (earnings before tax and interest) it makes each year
barely cover their Capital expenditure (see below):
0
500
1,000
1,500
2,000
2,500
3,000
3,500
0
5
10
15
20
25
30
35
40
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
($/TON)
(%) Xstrata's zinc EBIT
Zinc (%)
Zinc ($/ton)

7. Source:Xstrata annual report
People would bash me for not including depreciationand amortisation
charges. However, the above illustration should make retail investors
that a highly capitalised business needs to make a decent margin to
cover their CAPEX!
Secondly,investors should be careful if businesses (especiallyhighly
capitalized ones) talk about expansion.
-2000
-1000
0
1000
2000
3000
4000
5000
2006 2007 2008 2009 2010 2011 2012
($m)
Xstatra's EBIT minus CAPEX breakdown
Coal
Copper
Nickel
Zinc

8. Source:Xstrata annual report
In the case of Xstrata, it manages to double revenue in the last six
years; however operating cash flow and net profit did not double!
Lesson:If businesses rely on market prices for their fortune, it doesn’t
possess any competitive advantages, apart from being labelled the
‘lowest costs producers’.
Therefore,when management decides to expand the size of its
operations, make sure that cash profit grows at the same pace as
revenue.
If we look at the free cash flow of Xstrata and compare this alongside its
net operating cash flow and total debt we get this:
0
5
10
15
20
25
30
35
40
2006 2007 2008 2009 2010 2011 2012
($bn) Revenue vs. net profit vs. cash profit
Revenue
Operating cash flow
Net profit

9. Source:Xstrata annual report
The chart tells us two things about Xstrata:
1. ‘Net operating cash flow’ from 2006 to 2012 ranges from $4bn-$9bn
per annum equivalent to 20% to 35% of its revenue.
And free cash flow after capex, acquisitions and disposalis negative!
2. Total debt increases when free cash flow is negative, exceptfor
2008/09 becausethey raised $5.7bnfrom shareholders.Otherwise, total
debt would be $22bn, instead of $17bn.
Will there be a further write down in Xstrata’s assets?
Furthermore, Glencore will need to write down it’s Xstrata stake because
margins would have deteriorated further as commoditiesprices dropped
a further 30-40% (exceptzinc), since 2012.
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
-20,000
-15,000
-10,000
-5,000
0
5,000
10,000
15,000
2006 2007 2008 2009 2010 2011 2012
($m)
($m) Xstrata's FCF vs. OCF
Free cash flow ($m)
Net operating cash flow ($m)
Total debt ($m, RHS)

10. Glencore values its Xstrata stake at 13 times net earnings (Xstrata’s
average net earnings is $3.53bnfrom 2006-2012),or 32 times 2012’s
earnings.
Giving the prolonged and persistentweakness in commodities prices,a
write down of 50% of Xstrata's assets is appropriate.
Because Glencore is desperate to raise cash from selling its assets to
reduce its ‘mammoth’ $50bnof debt.
Also, with weak persistentcommoditiesprices,assets held by miners will
be less valuable.
My conclusion on Glencore’s Xstrata stake would be a further write
down of between$7bn and $15bn.
However, the company has indicated they will be selling assets to raise
cash, and it will be interesting how much they will get for their asset vs.
how much they have valued it in their books!!
Disclosure:I do not own any Glencore shares, but this could change if
certain events occurred!