The battle for BHP – what an investor needs to know

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Hedge fund manager Elliott Management’s ‘value unlock’ plan for BHP is starting to gain momentum, with a growing number of securities analysts and asset managers calling for the resources giant to make a more open and considered response to Elliott’s proposals.

Elliott, whose exposure to BHP is equivalent to a shareholding of a little over four per cent, says BHP should demerge its US petroleum business and unify the structure of the remaining business (it is currently split between an Australian registered company and a British registered company).

It argues that these measures would help address the company’s “chronic underperformance”.

With Elliott likely to put some resolutions at the company’s annual general meeting this year, all investors may be given the opportunity to express their view on the future of the company.

One thing analysts agree on is the underperformance. A May 15 article in The Mining Journal quotes a Citi analyst who thinks a spin-off of the US petroleum business would be just the start.

Citi is forecasting a period of declining earnings and dividends for BHP. It says: “On our forecasts, BHP is expected to deliver a return on invested capital of less than 10 per cent for the next few years, which is around the cost of capital but back to the substandard levels seen from the company in the 1980s and 1990s.”

Macquarie Securities issued a note on the Elliott proposals, saying the plan raised some interesting questions worthy of consideration.

And The Australian reported last week that AMP Capital wrote to institutional clients calling for an independent review of Elliott’s plan. “AMP Capital has emphasised the role of honest and transparent communications in the debate,” its letter says.

Elliott argues that its plan would add US$46 billion of value for shareholders.

Macquarie says: “Unlocking franking credits remains a long-term goal for BHP [which has an estimated $12 billion of credits in its franking account], however management has indicated that the costs of this restructure outweigh the benefits.

“On the surface, collapsing the dual-listed company structure makes some sense to us and has been speculated in the past. BHP notes it already has the structure under review and it has yet to identify sufficient benefits to outweigh the costs.”

Elliott claims it has exposed flaws and misleading claims from BHP management on the supposed costs of proposed unification measures.

BHP says unification would cost more than US$1 billion, while Elliott says it would cost US$200 million.

Under Elliott’s plan BHP would stay incorporated in Australia, Australian headquartered and Australian tax resident, retaining full ASX and LSE listings, with ordinary shares listed on the ASX.

A big concern for Australian investors is that over the past two years BHP’s UK listing has traded at an average 15 per cent discount to the ASX listing.

“The question if whether the UK listing is trading at a discount or the Australian listing trading at a premium,” Macquarie says.

“We are concerned that there could be significant leakage of the premium currently enjoyed by ASX listing.”

Elliott says it has sought feedback from shareholders and found strong support for capital returns. It says dismantling the DLC structure is the “gateway to optimal franking credit ultilisation.”

It says: “Post-unification discounted off-market buybacks are the clear gateway to greater franking credit usage and increased shareholder value.”

BHP spent around US$20 billion on US petroleum assets earlier this decade and has written off about half that value since then. BHP has sold some of its petroleum assets, an approach that Elliott describes as “piecemeal”.

“The intrinsic value of BHP’s US petroleum business is obscured by bundling it with BHP’s other assets within an overly complex group structure, while managed from a great distance with insufficient focus,”

Elliott says: “We believe that a more nimble and focused independent petroleum business, with a more disciplined approach to capital allocation, would have avoided significantly overpaying for BHP’s US onshore portfolio.”

BHP chair Jac Nasser is stepping down later this year and BHP is due to announce its new chair this week. Elliott believes the company needs board and management renewal and would like to see an outsider with resources industry experience take the chair.

The announcement of the new chair will mark the beginning of the next round of the fight between BHP and its hedge fund antagonist.


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