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Could Glencore/Rio Tinto mega merger work?

Amy Coopes | AFP | Getty Images

The mooted takeover of mining giant Rio Tinto by upstart Glencore may, in the way of other mining mergers, never happen.

For starters, Rio, which is listed in London and Sydney, already rejected a merger approach from Glencore in August. Yet share price movement for both companies Tuesday, after reports of the approach emerged Monday night, suggests there are some in the market banking on a deal.

On Tuesday, Glencore confirmed that it had made "an informal inquiry by telephone call" in July this year to gauge whether Rio was interested in merging. Rio responded in the negative.

Glencore said it was no longer considering any possible merger with, or offer for the shares of, Rio, on Tuesday.

However, there are a number of obvious overlaps for the two mining companies, including in iron ore and coal production and logistics, which might mean cost savings for a merged entity.

Here we take a look at the key issues which might hobble a merger, which would create a $160 billion company, and the world's largest listed miner.

China

Chinese appetite for Australian resources has been one of the biggest trends of the past couple of decades, so any change in ownership at one of the country's key sources of iron ore and other commodities essential for the growth of Chinese industry will draw attention.

Aluminium Corp of China (Chinalco) is Rio's largest shareholder, with a 12.91 percent stake in the Australian business, and bought in to the company when the share price was close to twice its current level. Glencore has reportedly already consulted the aluminium specialist about its takeover plans.

MOFCOM, the Chinese antitrust regulator, will be very interested in how the merger might affect its copper and coal cost – and may find that the two companies' dominance of the market is ultimately anticompetitive.


Australia

Rio Tinto is one of Australia's largest and most successful companies, and as such there may be political pressure if it becomes foreign-owned. Australia's Foreign Investment Review Board (FIRB) could block a deal even if shareholders agree on price.

Iron ore

The commodity on which this deal hangs, which has just hit a five-year low amid worries of economic slowdown in China. If Rio shareholders believe it might stage a recovery, they may be less inclined to listen to Glencore.

"This is Glencore calling a bottom on iron ore," Jessica Ground, UK Equities Fund Manager, Schroders, told CNBC.


Shareholders

Given the relative size of the businesses, and Glencore's high gearing, the deal is likely to be in shares of the merged company rather than cash, according to analysts at Citi. Glencore will have to make a pretty convincing case that the merged company will deliver greater value to shareholders.

"Shareholders of Rio Tinto are going to need a lot of persuading," Tim Schroeders, portfolio manager at Pengana Capital, which owns shares in Rio Tinto, told CNBC.

"Glencore is more highly geared, has lesser margins and has a trading business viewed by some in the market as opaque."


Is diversification the right way forward?

The death of rival BHP Billiton's pursuit of Rio Tinto in 2008 has been followed by a spin-off of assets at BHP, rather than further consolidation. Some analysts are concerned that enlarging Glencore and Rio would create an unwieldy business.

"This (deal) would place GLEN/RIO on an opposing trajectory to BHP, which is trying to simplify the portfolio by spinning non-core assets," analysts at Citi pointed out in a research note.


- By CNBC's Catherine Boyle.