Xstrata shareholders should say no

June 19, 2012

By Chris Hughes

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Xstrata shareholders should vote down the $45 million three-year retention package awarded to Chief Executive Mick Davis to seal the miner’s tie-up with commodity trader Glencore. Sure, the merger would collapse, but that’s a price worth paying.

In 2011, Xstrata paid Davis $14.3 million in salary and bonuses plus a long-term incentive plan (LTIP) that delivers an estimated $9.8 million if the miner meets performance targets. If Xstrata merges with Glencore, the Xstrata board thinks an extra $15 million a year is required to keep Davis loyal, taking his total annual package to around $40 million during the integration phase.

This would put Davis’s pay well above his peers. Marius Kloppers at BHP Billiton was paid $7.7 million in 2011, plus a $3.3 million LTIP. Cynthia Carroll at Anglo American got about the same, although more tilted to the LTIP. Rio Tinto’s Tom Albanese got $3.9 million plus a $3 million LTIP. Sure, these figures reflect individual performance, and Albanese waived his annual bonus. But their maximum potential pay was still well below that of their Xstrata counterpart.

Davis’s retention is effectively insurance against the damage the merged “Glenstrata” would suffer if he quit. He might well leave. M&A often gives executives itchy feet. And Davis’s job will have some big challenges, like managing Glencore’s powerful CEO, Ivan Glasenberg. Davis has form too – he quit BHP Billiton shortly after its founding merger. And he’ll have made millions on vesting options.

It’s also true that the company could suffer without Davis at the top. Squabbles between Glencore and Xstrata staff about the allocation of capital to “their” sides of the business could become toxic, other Xstrata people may leave, and the potential synergy of melding Glencore’s trading nous with Xstrata’s mining assets may be lost.

Take the probability-weighted hit to the group’s $78 billion market capitalisation if Davis left and the highest bid in the market for his talents (say, from a Central Asian miner) and somewhere in the middle is where to price this retention “insurance”.

But if the claims for the combination are true, the job of running Glenstrata should be at least as attractive as running Xstrata, which was itself clearly more attractive than emerging market miners. Davis has celebrated the “unique opportunity” of the deal. There won’t be many jobs that offer the combination of interest, prestige and Davis’s current pay.

What’s more, the company’s loss might not actually be so bad if Davis departed. His talents as an operator are less lauded than his ability to negotiate and execute deals. Those skills are becoming less relevant at Xstrata, which is now quite large, and would be in even less prized if Glencore’s assets were added in.

The merger stands or falls with Davis’s package. Losing the deal itself would certainly be a shock. Xstrata shares outperformed the sector after the deal leaked; the gains are now unwinding amid doubts about completion. But with Glencore holding a 34 percent blocking stake in Xstrata, their union would probably only be delayed, not scuppered permanently. And Glencore could still offer good enough terms to satisfy Xstrata’s investors and independent directors.

There is also an important gain to consider. Investors would have added to the value of all their holdings by showing they won’t let bosses hold them to ransom.

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