Xstrata, the Swiss mining giant whose shares are listed on the London Exchange, wants to raise $5.9bn (£4.1bn) in order to pay off debt and buy a coal mine from its major shareholder.
Xstrata plans to issue almost 2 billion shares at a price of £2.10, some 66 per cent lower than Wednesday's 623p closing price, the company revealed yesterday.
Xstrata has $16.3bn of debt, the majority of which accrued from the $19bn purchase of Canada's Falconbridge mining group in 2006. Although the pile does not require re-financing until 2011, and Xstrata maintains it is well within its covenants, the company has been hammered by the collapse of commodity prices. It has lost around 85 per cent of its value since May, and the market shows no sign of recovery. Results for 2008, published yesterday, show pre-tax profits down 36 per cent to $5.17bn, on revenues down 2 per cent to $27.9bn.
In such economic conditions, 40 per cent gearing is no longer acceptable, Mick Davies, the chief executive, said. "It is clear that, while appropriate for market conditions experienced in the first three quarters of 2008, in the aftermath of an unprecedented financial crisis, Xstrata's absolute level of debt is now perceived as a potential constraint," he said. "Our rights issue will provide a significant injection of capital, mitigate the risks presented by the current uncertainty and remove this potential constraint."
The City responded positively, and although the share price fell off by some 15 per cent in early trading, it bounced back to close up 3.6 per cent at 645.5p.
Of the $5.9bn to be raised selling the new equity, just under $4bn will be spent bringing the group's debt down to $12.6bn, or less than 30 per cent of its earnings. The remaining $2bn will pay for the Prodeco coal mine, in Columbia, which is being acquired from Glencore, Xstrata's 35 per cent shareholder. The Prodeco deal is a mechanism whereby Glencore is able to exercise its right to take up the new share issue, although it is not able to find the requisite cash.
It is not the first time Xstrata and Glencore have come to such an arrangement. The Swiss commodities trading group also paid for its share of the Falconbridge purchase with a coal mine. In the case of Prodeco, the two groups could not agree a price, so Glencore retains the option of buying the mine back for $2.25bn within the first 12 months of the deal.
The arrangements have raised eyebrows because Xstrata's chairman, Willy Strothotte, is also the chairman of Glencore. And although the miner's relationship agreement stipulates that any discussions relating to Glencore will take place without Mr Strothotte, analysts remain sceptical. "There is no doubt that the perception will be Xstrata has overpaid to facilitate the deal going through," one said. "If they have paid too much, it is not the end of the world, but it does remind you that Xstrata is a different kind of company where these kinds of things happen."
The announcement from Xstrata comes just one day after Rio Tinto, another highly geared mining group, was forced to admit it is considering a rights issue to help meet its target of paying down $10bn of its $40bn debt this year.
As falling economic growth and restricted credit cut a swath through miners of all sizes, companies at the top end can be divided into those that are saddled with debts, and those that are not, according to Tim Williams, the global director of metals and mining at Ernst & Young.
"Historically, the mining business hated taking on debt, and financed new projects by raising new equity or from cash flow," Dr Williams said. "Those that are now highly geared will be regretting that they listened to the bankers that told them they needed more efficient balance sheets and buying assets with debt was a good idea."