UK fraud probe may be “cathartic” for Glencore’s DRC exposure

SHARES in Glencore dropped 4.4% on Friday which was equivalent to an implied equity value loss of $3.6bn compared with the group’s market capitalisation of $77bn on May 17, according to JP Morgan Cazenove.

The plunge followed publication of a Bloomberg report on May 18 that the UK Serious Fraud Office (SFO) is at a preliminary stage of investigating Glencore’s links in the Democratic Republic of Congo to Israeli businessman Dan Gertler – a US sanctioned individual.

Gertler and Glencore are currently in a legal dispute over two of Glencore’s DRC subsidiaries – Mutanda Mining and Kamoto Copper – with Gertler claiming a total of $2.9bn from Glencore which disputes Gertlter’s claims and is opposing them.

According to a research note published late on Friday by JP Morgan Cazenove, the drop in Glencore’s market cap that has already occurred “… may exceed any potential liability, if one arises. Furthermore, if any SFO investigation ultimately concludes that Glencore is not in breach of law, we believe this may be cathartic for Glencore’s investment case and could remove a long standing overhang relating to Glencore’s DRC risks. We re-iterate our overweight recommendation,” said JP Morgan analyst Dominic O’Kane.

According to the Bloomberg report, the SFO intended to seek formal approval for a full probe into Glencore’s dealings in the DRC

“The reputational and financial outcome of any investigation, if one materialises, is uncertain. However, we look to recent precedent investigations by the SFO for insight on procedure and the scale of potential liabilities, most prominently Rolls Royce’s £497m deferred prosecution agreement (DPA) with the SFO.

“Based on precedent DPAs we understand the SFO has the authority to fine a company up to 400% of profits linked to the assets or contracts in question. Our analysis suggests Glencore’s DRC assets may have incurred cumulative net losses under Glencore’s ownership – TSX-listed Katanga Mining has reported cumulative gross losses of $424m over 2008 – 2017 and $3bn of cumulative net losses.”

O’Kane said that profitability for Glencore’s DRC operations is expected to improve materially from 2018 onwards with Katanga ramping back towards copper output of 300,000t/year after an 18-month shutdown for a plant re-design.

Investec Securites also believed the DRC risks had been “entirely discounted” given Glencore’s 15% share price underperformance versus its peers since late January. The bank had a net present value for the company’s DRC assets at 9% of its total NPV. “If an investigation does take place, it could take a while,” said Investec.

“Rio Tinto had been under investigation for over a year over self-reported irregularities involving Simandou-related payments in Guinea,” it said. “In addition, the SFO is itself under pressure, given the number of cases being investigated and the recent change in leadership,” said Investec.

Commented O’Kane: “Supplemented by higher copper and cobalt prices, we forecast materially lower costs and improved profitability at Glencore’s DRC operations from 2018 onwards. At current prices, we estimate Katanga and Mutanda could contribute combined net income of more than $900m in 2018 and more than $2bn in 2019.”

JP Morgan currently has a price target on Glencore shares of 550p compared with the level of 380.35p at which Glencore closed in London on Friday.