Breaking up BHP is hard to do

A demerger of BHP Billiton's non-core assets aligns with the company's desire to simplify its structure, but its status as a dual-listed entity would make for an unwieldy unwinding process.

This week’s intense speculation about the prospect of a demerger of BHP Billiton’s non-core assets has underplayed one of the central aspects of the group’s structure: the fact that it is a dual-listed entity.

While BHP did confirm that it was actively studying the “next phase of simplification including structural options”, actually demerging the grab-bag of assets considered non-central to Andrew Mackenzie’s ‘four pillars’ strategy is easier said than done.

It is known that BHP has actually looked at something far more structural than spinning out its less desirable assets. For instance, it has looked at unwinding the dual-listed entity structure it created in 2001 when BHP merged with Billiton.

It has long been a source of frustration for the group that trading in the shares of the locally listed and London-listed vehicles has been quite divergent. That structure has added complexity and cost to its affairs.

Unwinding a structure which involves two separate legal entities -- in two different legal and tax jurisdictions, with two relatively discrete sets of shareholders – would be a mind-bogglingly complex and difficult exercise, especially as the group’s asset base is variously owned by the two entities.

The costs and tax implications alone might prove an impossible obstacle. There would also be the negative of the loss of the combined shareholder base and major presence in two big capital markets.

A demerger of a part of the group’s asset base, as opposed to the breaking up of the dual-listed structure itself, would have echoes of those complexities.

The assets that don’t fit Mackenzie’s four pillars description are the group’s aluminium, alumina, nickel, bauxite, manganese, zinc and energy coal businesses.

Most of those assets came into the dual-listed structure via Billiton, although the core of the nickel business was acquired by BHP Billiton when the merged group successfully took over WMC resources in 2005. Presumably, these assets are housed, for legal and tax purposes, within the Australian arm of the group.

We know it is possible to spin-off assets from the group because soon after the merger, BHP Steel was spun-out. BHP Billiton Ltd shareholders received shares in what became BlueScope Steel, while BHP Billiton Plc shareholders received the equivalent value in bonus shares.

That’s because the arrangements under which the dual-listed entity operates require that there has to be equitable treatment of both sets of shareholders. Any distribution that benefits one set of shareholders has to be matched by an equivalent benefit for the other.

If the assets earmarked for a spin-off represent a mingling of assets held within the two corporate entities, presumably there could be some netting off of the values to creating matching benefits. However, this would add another layer of complication to a transaction that would already be extraordinarily convoluted because of the tax and legal implications and potentially large leakages of value.

A substantial spin-off of former Billiton assets would also gut the asset and cash-flow base of the UK legal entity. Whether that would be an obstacle to the functioning of the dual-listed entity or something that would make it easier to dissolve that structure is impossible to tell from the outside.

It is, of course, possible that BHP is simply doing what most companies would do in its circumstances. Perhaps it is exploring the spin-off option to see if, despite those complications, it is a practical option.

Canvassing that option seriously also provides a potential source of competitive tension for the somewhat more straight-forward and conventional alternative of selling the assets to third parties.

It is known that in an environment where there have been buyers for resource assets, the approaches that BHP and Rio Tinto have received have involved low-ball indicative offers.

There is a firming outlook for trade sales. Former Xstrata chief executive Mick Davis this week raised up to $US3.75 billion of equity for his new X2 Resources, which signalled that he’s in the market for acquisitions. Glencore’s Ivan Glasenberg also indicated that, with the merger with Xstrata now bedded down, he’s also looking for acquisitions.

The confirmation that BHP has a big fall-back position in the form of ‘structural options’ would give it a stronger position in any trade sale negotiations.

There’s no doubt that Mackenzie and his board are committed to shedding BHP of its less attractive and strategic assets. How they go about doing that is a fascinating, multi-billon dollar question.