"The Glencore IPO - End of the Commodity Boom?"

Sydney M. Williams

Thought of the Day

“The Glencore IPO – End of the Commodity Boom?”

April 25, 2011

A friend recently suggested that the Glencore IPO may mark the end of the commodity cycle. Tops of markets are often marked by watershed events. With oil, silver and gold trading at or near record levels could the ten year run in commodities be coming to a close just as investment bankers – those trustworthy souls! – are about to take public one of the world’s largest commodity traders?

Over the past eleven years we have seen two stock market peaks – March 2000 and October 2007. In 1999, 289 internet IPOs raised $24.66 billion, versus 42 in 1998, which raised $1.96 billion. During that period there were a number of deals that, alone, symbolized that the inmates had taken over the asylum. One of the best examples was VA Linux Systems. The company went public on December 9, 1999, almost three months to the day before the peak in the NASDAQ. The stock was priced at $30.00; it opened at $299.00, traded as high as $320.00 before closing at $239.25, a 698% gain on the first day of trading – a record that still stands. A year later, on December 8, 2000 the stock closed at $8.49, and on July 24, 2002 (near the trough in the market), the stock traded at $.54. Today, the value of a share of VA Linux Systems (now incorporated into GeekNet) is worth about $2.50.

Despite distant rumblings of impending doom in mid 2007, complacency ruled most markets. Private equity was in its heyday. Blackstone held assets approaching $80 billion, quadruple what they had been in 2001, so management chose to take advantage of market conditions and go public. With investment bankers placing a $40 billion valuation on the company, it would be offered at 17X the previous year’s income of $2.3 billion. Steven Schwarzman, CEO, was expected to earn $677 million and own a stake valued at $7.5 billion. Co-founder Peter Peterson sold stock valued at $1.88 billion. (Insiders sold $2.33 billion worth of stock on the offering.) Big numbers even for an industry used to big numbers! In a somewhat less than prescient comment at the time, Anton Schutz, manager of the Burnham Financial Services Fund, said, “It’s going to be highly sought after.” It was – for a few minutes. The stock was priced at 29 and traded as high as 35. By December it was trading in the low 20s and by February 2009, the stock traded under $4.00. On Friday it closed at $19.31 – 33% below where it was priced almost four years ago.

Both those situations lend credence to the old Wall Street adage that says: “When the smart money dries up, it’s time to chase the dumb money.” The question for investors is: in Glencore, will dumb money be replacing smart money?

Glencore is a Swiss-based commodity trader whose roots go back to Marc Rich, an American who has been credited with building the global spot market for crude oil in the 1970s. Because of countries with which he dealt – Iran, Cuba, and Libya – his activities sparked interest on the part of U.S. authorities. In the early 1980s Mr. Rich was indicted in the U.S. for tax evasion, but was never extradited and chose to stay in Switzerland. (President Clinton pardoned him in 2001.) Mr. Rich sold his share of the firm (Marc Rich & Co.) to current management in the mid 1990s; they renamed the company Glencore, short for “global energy commodity resources.” This offering, of approximately $10 billion in shares – about $8 billion in new stock and around $2 billion for existing shareholders (for “tax purposes”) – would value the business at $60 billion – about 15X last year’s net income. The shares would be listed in London and Zurich. The stated purpose for the offering is to enable the company to use its shares for acquisition – in particular, the purchase of mining companies. Joseph Schuster, founder of Chicago-based IPOX Capital Management was quoted last week in Bloomberg.com as saying, “The market gurus always know things better…that [they believe] the valuation will be worse down the road.” However, he also points out that, unlike the Blackstone situation, the company’s board members and executive directors (management) are subject to a five-year lock up, in terms of future stock sales.

So, does this offering suggest that commodity prices are topping? Like most things in life, I don’t know, but I suspect not yet. Other than the price of silver (up 173% in the past year and 19% in the past two weeks), there seems to be no mania. Commodity prices have been strong. Global demand, a weak dollar and low interest rates have created an environment friendly to commodities. In my opinion, today’s commodity markets bear little resemblance to equities in the late 1990s, and I suspect that it is unlikely we will repeat the credit crisis of three years ago. Today’s hard commodity prices, adjusted for inflation, are lower than they were thirty years ago.

But, we also know that ten years into a commodity Bull Market, we are not at the beginning of this cycle. Could there be a consequential correction? Of course. A change in any of the above conditions – a global economic slowdown, a strengthening dollar, or a rise in interest rates could precipitate a decline in commodity prices. Caveat emptor, was a saying associated with real estate when I bought my first house forty five years ago. It applies to any deal of this size and of this significance.