How to short BHP

Shorting BHP, a primer. The Australian Competition & Consumer Commission (ACCC) should be announcing soon whether it will be giving its blessing to BHP Billiton’s proposed acquisition of Rio Tinto. It’s likely the ACCC will be focusing on the iron ore market, because that’s the area that BHP and Rio really dominate in Australia, and globally.

I expect the ACCC will approve the merger with certain caveats about use of things such as third-party infrastructure. We’ve already seen that the High Court is probably going to force BHP and Rio to allow other groups – Fortescue, for example – to use their rail lines in the Pilbara.

But the ACCC’s attitude will be of importance to the other regulators around the world that still have to approve this deal, specifically the European and South African regulators. It’s a step along the way.

I still think the deal will happen, but it’s looking more like June/July 2009 now; the regulatory timetable is just that slow. This is the reason Rio is now trading at a 17–18% discount to the value of the deal; the market is almost pricing the deal as though it’s not going to happen. If BHP had to walk away from Rio, Rio shares could fall another 5–10%.

But my feeling is they’re almost at a level now where they’d probably settle anyway; that is, if there was no deal on the table. So, some would say it’s a low-risk trade; that is buying Rio and, if you’re allowed to, shorting BHP.

It’s quite difficult playing scrip bids at the moment. What is interesting is that ASIC has kept changing the rules; it’s allowing some forms of shorting, and I’ve just had it confirmed that you can now take short positions in the derivatives market.

You can also short BHP in London, because they’ve only banned shorting on financial stocks. So one way around the ban is to short Billiton, which is what BHP is called on the UK exchange. Second, if you wanted to short BHP to hedge your long position in Rio, you can write a BHP call option, what they call an “in-the-money call”. Of course, that may well be a bit too esoteric for many readers.

But the odd thing is that you’re allowed to write an in-the-money call, which is a synthetic short on the derivatives market, but you’re not allowed to just short the stock, which to me seems ludicrous because when you write a call, you do it to a market maker who will then hedge their long position in the call option by short-selling BHP, which they’re allowed to do. So the end result is that BHP is still short-sold.

Babcock & Brown. Now, other deals that really may happen: Babcock & Brown almost tripled last week after it got hit to a low of 76¢ on Thursday, September 18, when the markets really crumbled. Now, Babcock would have been one of the most shorted stocks around, and presumably the ban on shorting did help it, although my reading of the situation is that it didn’t make much difference because you couldn’t short Babcock in the last few weeks because there was no one lending stock. You simply couldn’t borrow it.

What’s now taken over is the rumours on the other side. When something gets hit hard enough, that’s when takeovers come out of the woodwork. Now, if you believe that Babcock & Brown isn’t terminal as a firm, and there’s still some doubt about that, then it might be taken over. And if there’s going to be a bid, it’s most likely to be organised by Phil Green, the former chief executive.

Green stood down last month but stayed on the board, and then two weeks later he resigned from the board. Now once he’s off the board, he’s quite free to go and organise a bid, and if anybody knows the business well, it’s him.

So if a bid occurs, it will be organised by Phil Green. But if a bid doesn’t occur pretty quickly, you will see the stock start to slide down again. It’s a strong rumour, but it’s a rumour.

Suncorp-Metway/Commonwealth Bank of Australia. Commonwealth Bank might have a crack at Suncorp. Suncorp has a few issues in that it is heavily exposed to the property development and construction industry up in Queensland, and the property market up there, in certain sectors, is hitting a big oversupply. We’ve seen firms like MFS and City Pacific that finance the riskier end of property development run into trouble: MFS has pretty much gone under, and City Pacific is teetering on the edge. Suncorp has more exposure to those areas than perhaps is a good idea.

Would Commonwealth Bank take it over? Maybe. But my feeling with the Commonwealth, as with the other big banks, is that they don’t need to be taking others over to get market share at the moment. We’ve seen that non-bank lenders, Wizard Home Loans and GE Money and so forth, just don’t have access to money at the moment.

Also, Suncorp has to stay in Queensland, so why would you take it over knowing you’ve got to maintain what would then become an unnecessary head office? It’s also got an insurance operation and the banks’ experience of running insurance companies in the past has not been a good one.

Foster's. The rumours are swirling around the future of Foster's again. The company has a new chief executive, Ian Johnston, who has replaced Trevor O'Hoy. Press reports have named the usual suspects such as Diageo and Coca-Cola Amatil, along with Colony Capital.

Deutsche Bank has emerged as a 5% shareholder, but somebody else is probably behind that stake. There might be parallels here with how the same bank was initially a nominal shareholder in WMC when BHP was amassing a stake crucial to the eventual takeover of that company.

It might also be part of a wider play to get the company to split off the wine business, we'll have to wait and see on this one.

Mt Gibson Iron/Pallinghurst Resources. Pallinghurst Resources, which was the failed under-bidder for manganese group Consolidated Minerals last year, apparently might be interested in Mt Gibson Iron. Pallinghurst is an investment fund run by Brian Gilbertson, the former head of Billiton, who ran BHP for a couple of years before he had a falling out with the BHP board and decided to leave. He set up Pallinghurst to buy stakes in things and thus far he’s been a bit thwarted. He made some money out of the Consolidated Minerals bid, but hasn’t really achieved his goal.

Linc Energy/Sapex Limited. First, Linc Energy’s takeover of oil and gas explorer Sapex was approved by Sapex shareholders last week. So Sapex shareholders will get 72¢, the options will be bought for 50¢ and the stock will stop trading on Thursday, October 2.

Of course, Linc Energy has also done a deal with China’s Xinwen Mining Group, and it’s selling all its coal properties for $1.5 billion.

Linc is really now going to focus on its coal-to-liquids fuel technology; that is, making diesel and other things out of coal, which will be interesting, and it’s also doing a pilot plant for that in China with Xinwen Mining.

So Linc is effectively selling its resources and getting into more of the technology. Now, it’s only capitalised marginally above the value of that $1.5 billion cash. Of course, if the technology works it’s worth a lot, but if they spend all the money and it doesn’t work, then you’ve got a company that’s probably not worth much. But the high price of energy is making that sort of technology attractive.

Extract Resources/Rio Tinto. Rio Tinto has bought 14.4% of uranium explorer Extract Resources, and may eventually move to buy the whole thing. Rio might be thinking that gradually the uranium mining laws in Australia are going to be relaxed; certainly the new Premier of Western Australia, Colin Barnett, has said that he intends to try and change those, so we’ll see. And once he does it, others will do it. Queensland would be the next obvious one.

Felix Resources. Felix Resources is a coal company that has put itself on the block. The rumour is that Brazilian iron ore giant Vale (formerly CVRD) wants to buy it. But apparently the price Felix wants, which is something like $20 a share, is just too much.

Remember, Macarthur Coal was sold for $20 a share not long ago, but its share price has now slid back to less than $12. So if Felix doesn’t get the bid it wants, its share price will fall. And that’s always the risk about buying into possible bids when their shares have already shot up and they’re priced as though the bid is occurring: you always run the risk if the bid doesn’t occur, that they fall back.

Everest Babcock & Brown. Everest Babcock & Brown Alternative Inv Trust (EBI) is probably going to de-list, like Ellerston GEMS Fund (EGF), which is James Packer’s listed fund. EBI’s been trading at a 25–30% discount to its net tangible assets, and so it’s going to allow people to redeem their money out of it at a 7.5% discount, which again is very similar to Ellerston. So it’s not a takeover as such, but it allows people to get the value of their investment much closer to its true value. It’s funny: these investment companies list when times are good, and then they invariably de-list when times are bad. Probably a lot of people will pull their money out of that.

Southern Star/Fremantle Media. It looks like TV production and distribution business Southern Star, which is owned by Fairfax Media, is for sale. Fairfax bought Southern Star in November last year through its purchase of Southern Cross Broadcasting. Southern Cross is probably best-known for radio stations 3AW in Melbourne and 2UE in Sydney, but also had a television production arm that made shows including Rush. (Disclosure: I am a paid broadcaster at Fairfax's 3AW in Melbourne)

Anyway, Fremantle Media is apparently interested in buying Fairfax Media’s TV production. I’m pretty certain Fairfax would quite like to sell it. Southern Star did make Big Brother, and when it got axed that was big hole in its revenue, because that was probably its biggest show.

There is a need for these local production companies, simply because the TV stations themselves can’t be bothered producing shows any more, but they have to still meet their local content quotas. So if the TV stations don’t produce them, someone has to produce them.

(As a curious aside, thanks to our Free Trade Agreement with New Zealand, shows produced on the other side of the Tasman count as Australian shows. That’s why you get all those border protection shows, which are obviously set in Auckland and places like that, as well as those NZ cop shows. They count as Australian content under our media rules, thanks to the free trade agreement!)

Fremantle Media also took a 19.99% stake in TV program producer Beyond International (BYI) recently. What happened with Beyond was it was going to be taken over by Destra, and Destra was using Opes Prime to finance the takeover. When Opes Prime collapsed, Destra lost those shares, and in fact the former chief executive Domenic Carosa lost his own personal stake in Destra, which was also financed by Opes Prime. So that stake, which I think was almost 30% in Beyond, got thrown on to the market, and so clearly Fremantle picked up the maximum they could pick up, which was 20%, and now they’ll probably bid for the whole thing.

Looking across the media landscape, I don’t think James Packer would be interested in buying the Nine Network back now. I think he knows he did a smart thing by selling it. And of course Lachlan Murdoch tried to buy Consolidated Media, which owns the remaining 25% of Nine, but the financing fell through. So it’s an interesting time for TV networks, and it’s why you won’t be seeing any really good new programs on commercial television for a while.

Tom Elliott, a director of MM&E Capital, may have interests in any of the stocks mentioned.

nTakeover Action September 22-26, 2008
Date	Target	Code	Bidder	(%)		Notes
17/09/08	Anzon Australia	AZA	Roc Oil	68.89		Anzon Energy UK scheme approved by shareholders.
25/09/08	Ausdrill	ASL	Macmahon Holdings	13.06		Closing Sept 29. Incl 1.49% acceptances and 10.95% in insto facility.
04/09/08	Babcock & Brown Communities	BBC	Prime Retirement & Aged Care Property Trust	0.00		Seeks up to 40%.
24/09/08	Bellamel Mining	BMM	Norton Gold Fields	92.48		Compulsory acquisition
03/09/08	GoldLink IncomePlus	GLI	Emerald Capital	29.44		Seeks 45%. Ext to Oct 1.
17/09/08	Huntley Investment	HIC	Brickworks Investment	0.00
08/09/08	Incremental Petroleum	IPM	Cooper Energy	4.90
26/09/08	Medusa Mining	MML	Crosby Capital	5.14		Incl 4.6% held by Crosby Active.
22/09/08	Murchison Metals	MMX	Sinosteel	0.00		Cleared by FIRB to move to 49.9%
11/07/08	Olympia Resources	OLY	Territory Resources	73.53
11/09/08	Portman	PMM	Cleveland-Cliffs	85.20		Mop up offer.
03/07/08	Rio Tinto	RIO	BHP Billiton	0.00		Early termination of Hart-Scott-Rodino anti-trust waiting period.
11/09/08	Roma Petroleum	RPM	Queensland Gas	80.01		Closing Oct 17.
24/09/08	Sunshine Gas	SHG	Queensland Gas	22.82		Incl 15% pre-bid agreement.
nScheme of Arrangement
24/07/08	Australasian Resources	ARH	Resource Development International	66.37		Resource Devel associated with Clive Palmer who holds 66.37%.
22/08/08	Espreon	EON	Vectis Group	19.80		Vote mid-Nov.
05/09/08	Extract Resources	EXT	Kalahari Minerals	39.11		Vote Nov 6.
26/09/08	Sapex	SXP	Linc Energy	19.42		Shareholders approve scheme.
13/08/08	St George Bank	SGB	Westpac Banking Corp	0.00		Vote Nov 6. ACCC clearance.
nBackdoor Listing
25/09/08	Grange Resources	GRR	Australian Bulk Minerals shareholders	73.90		ABM shareholders will have 73.9% if reverse bid suceeeds.
09/09/08	Mark Sensing	MPI	TMA Group	82.00		Vote Oct 22. TMA would have 82% on completion.
nForeshadowed Offers
04/08/08	Asciano	AIO	TPG Capital consortium	0.00
28/08/08	Berklee	BER	Manumatic	0.00		Heads of agreement on $10.9m sale of business.
05/09/08	Bravura Solutions	BVA	Ironbridge Capital	0.00		Discussions continue.
28/07/08	Felix Resources	FLX	Several expressions of interest	0.00
28/08/08	Oaks Hotels & Resorts	OAK	Archer Capital	0.00		Non-binding indicative proposal.
19/06/08	Pelorus Property	PPI	Pelorus unlisted funds	0.00		Group merger planned.
16/06/08	Staging Connections	STG	Several parties	0.00		Non-binding proposals. Due diligence proceeding.
22/08/08	Warehouse Group	WHS	Woolworths	0.00		Seeks to appeal court refusal of takeover clearance.

Source: NewsBites