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The Beginning Of The End For Glencore, And How To Trade It

Tyler Durden's picture




 

Update: even the rating agencies finally noticed - S&P: GLENCORE TO BBB/NEGATIVE FROM BBB/STABLE

Next stop: junk, and 500bps+ CDS

* * *

Back in March of last year, when previewing the events that have rocked the world over the past month (because nobody, nobody could have possibly anticipated the Chinese economic crash and the concurrent commodity tumble which are just two sides of the same bursting credit bubble coin) we wrote "Is This The Cheapest (And Most Levered) Way To Play The Chinese Credit-Commodity Crunch?"

We were referring to Glencore credit default swaps (i.e., default risk), which trading at just over 150 bps, were, from an upside/downside and every other perspective, the cheapest, most levered and most attractive risk bet to trade the upcoming Chinese/commodity crash as a result of Glencore massive exposure to the price of copper, which in its own words stood to lose over $1 billion in EBIT for every 10% move in the price of copper ... 

 

... a sensitivity few had realized.

Fast forward to two weeks ago when the same day the Fed leaked its FOMC minutes and in the process unleashed the recent market correction, we wrote "The Next Leg Of The Commodity Carnage: Attention Shifts To Traders - Glencore Crashes, Noble Default Risk Soars" and finally, well over a year after we first introduced Glencore as the fulcrum anti-China trade, the investing public finally started to notice.

When we wrote our Glencore update on August 19 , GLEN CDS had soared from its baseline level of about 150 bps to north of 300bps, even as the stock kept sliding as show in the chart below.

 

In the past two weeks things for Glencore have gone from bad to worse, and as of today, the stock closed at an all time low of just 122.8p, dropping another 8%, following a 10% drop the previous day - the worst two-day drop in the stock price since going public - and taking its all time loss since its 2011 IPO to a whopping 75%!

 

Why the drop? Yesterday Bank of America released a report looking at global miners in attempting to answer the question whether "the miners are cheap enough yet", in which it posed the question how much new equity do miners needs. Its answer: $50 billion now (up to) $60 bn. It added that, "as in April, we believe early “recappers” could be rewarded with less dilution, premium market ratings and possibly a “license” to undertake M&A."

That's for the industry in total, what about just Glencore?  BofA looked at several scenario, most notably the "baby bear" (in which commodities and currencies dropped another 20%) and a "doom and gloom" (a 33% drop) and said that "Glencore has limited equity value in our “Doom and Gloom” scenario. We think this is consistent given 1) fairly high financial leverage and 2) some assets are not particularly low cost. For us, this confirms what most investors already know about GLEN, it is something of a “bull call” on commodity markets."

BofA adds that Glencore, which has $30 billion in net debt on $9 billion of EBITDA, has a $12 billion capital shortfall if the company were to hit a target 2.0x leverage, and just over $3 billion if the leverage was stretched to 3.0x.

Putting these numbers in context, BofA estimated that Glencore has 25% downside to the base case and 64% downside to the "Baby bear" scenario. Under the "doom and gloom" case Glencore would go bankrupt.

The end result of all these considerations is what equity investors, realizing that the overlevered company would have to issue a lot of stock just to preserve equity value - it is questionable whether and at what price it could pull this off - decided to sell first, and ask questions later, pushing the stock down by nearly 20% in the past 2 trading days.

And while an equity offering would be perfectly expected given the company's financial and cash flow plight, what is extremely confusing is that earlier today Glencore announced that instead of shoring up capital, it would part with some $350 million in much needed capital  announcing it would pay back $350 million of perpetual bonds next month, "showing the company has cash to pay debt as it battles a commodity price slump and a slowdown in China" according to Bloomberg.  "The commodity trader and miner headed by billionaire Ivan Glasenberg, will redeem the 7.5 percent securities on Oct. 6, the earliest date possible, it said in a statement to the Luxembourg stock exchange. The notes will then be canceled, it said."

“It’s a little signal from management that Glencore is comfortable with the cash profile it has despite everything that’s going on,” said Rick Mattila, head of strategy and research at Mitsubishi UFJ Securities International Plc in London. The company doesn’t “feel the need to leave this outstanding, and save themselves $350 million of liquidity.”

Management may be comfortable, but shareholders certainly weren't, the result being Glencore's stock hitting fresh all time lows. And, not unexpectedly, neither were bondholders, because as a result of the cash outflow there was net selling across the entire capital structure, with CDS pushed another 18 bps wider just why of 400 bps.

Which, incidentally, remains the best way to trade a company which still remains largely misunderstood, because at its hear, Glencore's problem is not a capital structure one, nor even a purely debt one (although debt is certainly a major concern), but one of  cash flow, or rather the collapse thereof, because should copper (and all other commodities) continue to trade at current subdued levels, the bigger question will be not whether GLEN can issue stock to keep itself viable, but how much the debt-to-equity exchange will have to be in the coming year, to cram down the stock and restructure the debt which is now longer feasible for the current contractionary global phase.

Which is why, while the stock may stage a violent rebound here purely on short selling, we remain convinced that GLEN CDS, which we loved at 150 bps, is still the way to trade not only the inevitable downfall of Glencore equity, but the Chinese and commodity crunch as well.

This can be seen especially when comparing just the recent violent move lower in the stock to the (still) relatively muted blow out in Glencore CDS.

Expect much more from not only this name, but from its peers Trafigura, Mercuria and of course, the company we are all keeping a very close eye on: Asia's biggest commodity trade, Noble Group, profiled here previously.

 

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Wed, 09/02/2015 - 14:20 | 6500674 DirkDiggler11
DirkDiggler11's picture

All miners seem to be getting crushed today, Gold and Silver included. WTF ???

Wed, 09/02/2015 - 14:23 | 6500689 Bunghole
Bunghole's picture

Miners yes, gold yes, silver no (up 0.5%)

 

Wed, 09/02/2015 - 14:45 | 6500832 DirkDiggler11
DirkDiggler11's picture

Normally when I've see this in the past, ( the equities of the miners getting hammered while the underlying commodity trades in the green) the underlying commodity then gets drunken monkey hammered the following day.  Is almost as if the TBTF Banks equity trading desks are front running the commodity smashdown by the same bank's commodity trading desks the following day.  I know that would never happen though, that would be illegal. 

Wed, 09/02/2015 - 15:20 | 6501051 Sudden Debt
Sudden Debt's picture

It's just insane! There's like none of them that isn't down 80%

But with a average debtload of 350 billion, I guess 4 out of 5 will go bankrupt.

Should as it's not their working costs that's killing them but their management fees that's burning their cash.

So let's just hope most of them grow a brain and stop rewarding themselves on income and not what they think they should earn.

Normally, with demand for gold as high and low oil prices, they all should be doing fine but bad management...

Wed, 09/02/2015 - 17:11 | 6501532 giovanni_f
giovanni_f's picture

Dollar up, Gold down. It's  the logic of a rigged casino that is designed to enrich the inner circle. There is no meaning in asking "why does the price of this underlying move in this direction today?" Problem is that the world gives importance to the casinos and the bastards who own them, in perfect wizard-of-oz-like fashion.

Wed, 09/02/2015 - 14:21 | 6500685 KnuckleDragger-X
KnuckleDragger-X's picture

Well, now that the crazy people are in charge of the asylum, I expect much bigger things soon.......

Wed, 09/02/2015 - 14:23 | 6500688 NoDebt
NoDebt's picture

The people who made money off the original IPO are already long gone.

Here- hold this bag for me for just a second.  Be right back.  Thanks.  See ya, sucker.

 

Wed, 09/02/2015 - 15:28 | 6501100 Loucleve
Loucleve's picture

just like Molycorp.  remember the Rare Earth metals frenzy a few years back?

stock is $0.  insiders took out almost $1bb.

Wed, 09/02/2015 - 14:22 | 6500691 Calculus99
Calculus99's picture

Almost a kiss of death becoming a rockstar CEO.

Glassenberg was being gushed all over the business media a few years back.

Same with the Brazilian oil and gas billionare who's now broke.

 

Wed, 09/02/2015 - 14:43 | 6500822 Omen IV
Omen IV's picture

would never have happened if Pinky Green & Marc Rich were running the show

Wed, 09/02/2015 - 14:55 | 6500892 PontifexMaximus
PontifexMaximus's picture

U seem to be an insider, Sir

Wed, 09/02/2015 - 14:26 | 6500706 Kolchak
Kolchak's picture

Cut to the chase and label the real deal.

 

The Beginning Of The End For The Cabal.
Wed, 09/02/2015 - 14:28 | 6500710 Dr. Engali
Dr. Engali's picture

Maybe they can survive until the Keynesians start building empty cities in Africa. Build it and the future pygmy stawk pushers will come.

Wed, 09/02/2015 - 14:36 | 6500763 venturen
venturen's picture

Hillary is already lining up a pardon for Marc Rich...Oh Wait he dead

Wed, 09/02/2015 - 16:55 | 6501560 GRDguy
GRDguy's picture

Bill pardoned Marc on his last day in presidential office.  Ms. Marc Rich made a huge donation to Ms Clinton's political ambitions.

Wed, 09/02/2015 - 14:39 | 6500797 Enceladus
Enceladus's picture

Well luckly they have coal in there to offset any downside

Wed, 09/02/2015 - 14:59 | 6500908 Treetop
Treetop's picture

Maybe management owned the bond...on sauve ce qu'on peut...

Wed, 09/02/2015 - 15:10 | 6500979 jiggerjuice
jiggerjuice's picture

So I'm in IB, how do I short Glencore CDS, exactly? 

Wed, 09/02/2015 - 15:27 | 6501086 Loucleve
Loucleve's picture

no, you go long the CDS, thinking they will go higher.  but there is no way for us pikers to do it.  only big money can access them.

Thu, 09/03/2015 - 02:01 | 6503194 Sorry_about_Dresden
Sorry_about_Dresden's picture

CDS is in units of $10 million dollars. You would pay the premium on blocks off bands of $10 million.

So if the  premium is 400 basis points then protection would cost $400,000 to insure $10 million in bonds, notional.

Wed, 09/02/2015 - 16:17 | 6501370 A is A
A is A's picture

I'm not sure if you are being serious but if you are CDSs are not publicly traded. You have to call a big bank to buy one and you'll be lucky if they will sell you one anyways, for a multitude of reasons.

Wed, 09/02/2015 - 16:22 | 6501401 RaceToTheBottom
RaceToTheBottom's picture

Trust no one.

Wed, 09/02/2015 - 17:45 | 6501750 OzFan
OzFan's picture

Couldnt happen to a nicer company. 

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