The terrible two that damned BHP

While the focus has been on BHP Billiton's US gas 'mistake', the two major errors that have held it back were its share repurchase and Olympic Dam naivety.

Hidden deep in BHP Billiton's accounts are two significant errors which have played a remarkable part in the miner's current position. One of the mistakes goes to the heart of why BHP cannot lift its dividend substantially.

All the short-term crazed institutions believe that the key BHP mistake was that it had to writedown its US gas assets so soon after purchase. They blame Marius Kloppers. It is true it was a timing mistake but it makes BHP a long-term player in the US gas revolution and may yet prove to be a great long-term buy.

No, BHP’s first hidden mistake was much bigger. Towards the end of 2010-11, BHP spent almost $10 billion buying back its stock at prices inflated by the boom. It was a bad mistake by the BHP board and against the advice of a number of the wiser Australian long-term institutions who told BHP in no uncertain terms to lift the dividend instead of buying back shares.

Instead Marius Kloppers and his board paid $40.85 a BHP share for most of the stock (the shares were higher at the time) and since then they have seen BHP shares slashed in price. BHP shares are currently around $33 which means that BHP shareholders lost a massive $1.8 billion on the deal. When BHP shares were around $31 a few weeks ago the loss was approaching the US writedowns.

BHP's actual cash dividend payment in 2011-12 totalled only $5.8 billion (last year it was $5.1 billion) so the buyback was twice the level of dividends.

Moreover, in 2011-12 the company was forced to increase its borrowings by $11 billion – about what was used in the buyback.

Australian shareholders are sick of buybacks that are designed to benefit overseas shareholders and help deliver personal bonuses to institutional mangers. BHP should have saved shareholders nearly $2 billion in losses and paid most of the $10 billion to shareholders via a dividend.

The second mistake was that BHP saw Olympic Dam as a massive earth-moving operation. It is much more than that. As I wrote last month (BHP Billiton's desperate Olympic race, July 30), in 2005 the complex mineralogy of the Olympic Dam copper sulphides caused the giant Anglo American group to walk away from bidding seriously for WMC (which then owned Olympic Dam). Anglo engineers argued that while a flotation process should be straightforward, uranium would remain in the copper concentrates. And even after an acid leach of those concentrates, the level of uranium in the concentrates would present technical and political problems if the concentrate material had be transported.

Seven years later and it seems that there is still no widely accepted hydro metallurgical route for the recovery of uranium from an acid leach in relatively saline water.

Others say that BHP needs to erect another smelter, as WMC concluded.

BHP needed to have invested much more in the Olympic Dam technology and should be much further towards a solution than it is.

The goods news is that in announcing the cancellation of Olympic Dam BHP emphasised that a new technology approach is required.

And the second item of good news is that BHP is actually well placed to get through the harder times that the mining industry is now encountering.