It’s presumably not a coincidence that BHP Billiton announced today that its preferred option for its much-touted portfolio simplification is a demerger. That suggests we’re going to see the unveiling of a new and sizable resources company when BHP releases its results next week.
For much of this year, BHP’s Andrew Mackenzie has been arguing the benefits of streamlining the group’s portfolio to focus on its core 'basin' assets (or the 'four pillars' he often refers to).
Those assets -- iron ore, petroleum, copper and metallurgical coal -- generate margins about 10 percentage points higher than the group’s overall margin. This means just about everything else generates significantly more than 10 percentage points below the average.
"Everything else" includes BHP’s Nickel West business in Western Australia, its aluminium businesses, its manganese operation, base metal mines and its South African (and perhaps Australian) energy coal mines. It doesn’t include BHP’s Jansen potash prospect in Canada, which Mackenzie sees as a potential 'fifth pillar'.
If BHP could shed those assets it would be able to focus its investment on its highest-returning assets -- as, to some degree, it already is doing -- and would obviously be left with only very high-margin and high-returning operations with very strong and stable cash flows.
Mackenzie has consistently referred to 'structural' options. They could have included either divestments or a de-merger of the mostly former Billiton assets but it has been increasingly likely that it would be the demerger option that was chosen.
That’s partly out of necessity. BHP has had a protracted sale process for the Nickel West business, which has attracted meaningful interest from potential buyers like Glencore and Mick Davis’ X2 Resources. Unhappily, perhaps put off by a substantial capital expenditure requirement, it appears no-one was prepared to pay BHP’s asking price, forcing it to revert to the demerger option.
Given that the group will report its full-year results next Tuesday, it would seem probable that some details of BHP demerger plans will be released with the result.
While the assets likely to be included are those that BHP itself doesn’t want, analysts have speculated they could still have a value of up to $US15bn. Any new entity, if it included all the non-core assets, would be a sizable second-tier resources group.
If it proceeds, it will be interesting to see how BHP manages the execution of the demerger.
If all the non-core assets were bundled together, they would come from both sides of the 2001 BHP dual-listed entity merger with Billiton, comprising mainly Australian and South African assets. This would therefore create some tax complexities that wouldn’t be as significant if they were housed today within one of the legal entities that have been stapled together by the dual-listed entity structure.
Perhaps, with commodity prices where they are, that might be less of an issue than at the heights of the commodity boom when resource asset prices were far more inflated. The nature of the likely asset base does suggest the headquarters for the new vehicle would probably be in Australia.
The dual-listed structure of the group also means that there may have to be some compensation to one set of shareholders (whether BHP Ltd or Billiton Plc shareholders) if there is a disproportionate contribution, in terms of the value of the assets, from one entity relative to the other. In the past the group has used share-buybacks to balance shareholder value but it could also use cash to balance out the interests of shareholders in the two discrete legal entities.