Elliott vs. BHP

By Charles Asubonten, CPA, CFA (a/)

Elliott has launched a value creation effort (The BHP Shareholder Value Unlock Plan) to get BHP management to increase the firm’s value by undertaking the following:

1)   Stop its dual-listing and maintain only one listing in Australia

2)   Carve out its US petroleum business and list it on the NYSE

3)   Return more money to shareholders

BHP has responded by stating that the actions Elliot has put forward are only financial engineering, and hence will not create value in the long-term.

It is fair to provide an assessment to ascertain the validity of the proffered claims:

A)  Dual Listing

While there are costs associated with dual-listing, the resource industry has reaped substantial benefits from dual listing as it is able to keep its core investors in jurisdictions where natural resource investing is de rigueur, and also benefit from “outside” investors who add natural resources to their portfolios for diversification and momentum benefits. Dual listing provides better chances in the event of capital raisings (it offers BHP a diverse investor base). Having already spent on such listings awhile back, BHP only stands to benefit in the future, should the need for equity infusion were to arise. It is fair to point out that the exercise to deregister the Plc and infuse it into Ltd would be very time consuming for management (to say the least about internal Australian approvals that BHP would have to go through), which will detract management from value creation, exactly what Elliott is clamoring for in the first place. Elliott’s assertion that Plc has traded at an average 12.7% discount to Ltd since inception of the dual listing in 2001 shows that there are no arbitrage opportunities (beneficial trading opportunities) between those 2 entities as the discount is explained by the franking credits on Ltd, any economic asymmetry as proffered appears to have been factored into the valuations of the two entities (in other words, any disadvantage accruing from economic incongruity is made up for by fiscal regimes, existing in the different jurisdictions). Elliott’s proposal for management to create a unified BHP to be incorporated in England & Wales and become tax resident in Australia would do less to minimize the so-called inefficiencies that Elliott alludes to in BHP’s current arrangement. BHP’s assertion that the costs of that exercise (following Elliott’s DLC structure) would outweigh the benefits has merits.

B)  Demerging the US Petroleum business and listing it on NYSE

Mining and Oil & Gas (Oil) have been known to have diversification benefits to each other as they used to be negatively correlated. More importantly, it is worth stating that these diversification benefits no longer exist as minerals, especially, iron ore, appear to behave in tandem with oil (the global economy is no longer what it used to be! QEs, minerals as speculative financial instruments, etc. have decoupled the market structure of commodities where market clearing price was just an interplay between physical demand and supply); hence evaporating any diversification benefits. Given that both resources -- mining and oil appear to be inversely correlated with the US dollar (a proxy for the economy), separating oil from BHP mining business may have some benefits to shareholders as the “natural” diversification benefits seem to be waning in current market conditions, which will support Elliott’s position for carving out the oil business (it is worth noting that the correlation between the dollar and commodities is even questionable in current market conditions). However, as both resources are struggling at this time in the global economy, carving out the US petroleum business as a stand-alone entity may not be a value accretive move. Given Dr. Andrew Mackenzie’s deep experience in these sectors, having spent several years at BP (including a stint in Investor Relations) and Rio Tinto prior to his BHP assignment, if he cannot deliver value from both businesses in the portfolio (through synergies), perhaps such benefits may not exist even on a separated basis – supporting the thesis that value from oil to BHP hinges more on market conditions than lack of management focus. Can shareholders risk a stand-alone US petroleum business with abysmal returns?

C)   Returning cash to shareholders

While Elliot has a point in minimizing what Peter Lynch calls “diworseification” – management’s penchant to deploy idle cash in acquiring less than stellar assets and destroying shareholder value (instead of buying back shares and raising dividends) in the process, it is worth analyzing BHP’s current liquid position vis-à-vis its volatility, liquidity requirements, and current management’s track record to assess whether BHP’s current cash position would augur for better capital management.

BHP’s unimpressive M&A forays, including failed Rio Tinto and Potash Corp bids, have been well documented. It should be pointed out that they occurred under previous regimes.  It is worth recalling also Rio Tinto’s attempt for cash infusion during the GFC through a “fire sale” with Chinalco for $19.5 billion, as in a crunch management had to resort to such deals (ultimately shareholders revolted but if enough cash was at hand, perhaps the move would not have been contemplated in the first place). Meanwhile BHP has pledged to a minimum 50% dividend payout of underlying attributable profit at every reportable period. At a payout of $3.6 billion in 2016, Rio Tinto’s payout ratio was around 42% -- putting BHP ahead of return to shareholders.

Recent events have lighted the volatility in the natural resource sectors, hence the need for prudent cash management. While the industry continues to be in the bottom of the cycle, having enough cash on hand is the optimal cash management posture, rather than pay out and be distressed later, especially to the detriment of long-term shareholders.

Conclusion

The possibility for value improvement may exist at BHP but Elliott’s course of action to unlock that value, if followed, will not be a panacea.

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a/ -- Full disclosure: The author is a global value creation expert who served on the Rio Tinto Southern Africa Management Service Board with Andrew Mackenzie when both worked at Rio Tinto. The author also worked at Ford Product Strategy Office, which ultimately reported to Jac Nasser, when Nasser was Ford’s Head of Product Development.