23 Mar 2015
What happened?
BHP Billiton has announced details of the proposed demerger of their non-core assets. The proposal will split the company into two separately listed companies, BHP Billiton and South32, via an in-specie distribution of South32 shares.
If approved by shareholders on 6 May 2015, BHP will be focused on its upstream tier 1/core assets consisting of a portfolio of 19 assets with a smaller geographical spread and a higher proportion of common characteristics.
South32 will be a new diversified metals and mining company with a complementary portfolio of quality assets with the freedom to adopt a tailored strategy and no longer have to compete with BHP’s core assets. South32 will become the 20th largest listed company in Australia.
Eligible BHP Billiton shareholders will receive one South32 share for each BHP Billiton share they own.
What does it mean?
BHP’s current operations consist of 41 assets spanning 13 countries and 6 continents. The demerged BHP’s assets will include coal, petroleum, copper, iron ore and potash. These assets will be located in Australia, North America and South America. BHP will shift $1.5bn of closure and rehabilitation provisions off their balance sheet with only a modest reduction in net debt.
South32’s assets will include nickel, metallurgical coal, silver, lead and zinc, manganese ore and alloy, energy coal and alumina/aluminium. These assets are located in South Africa, Australia and South America. These assets are all in very good condition being in the first or second quartiles of their industry cost/margin curves.
Given information at hand, the demerger will create a small estimated cost saving of US$100m per annum. However, following the demerger, BHP will be able to increase standardisation across its assets to better leverage technical expertise and be better placed to drive substantial productivity benefits in the longer term. South32 will have a dedicated board and management team to pursue an investment strategy specifically tailored for its portfolio of assets. Management will be better placed to cut costs and extract greater productivity, whilst the underlying assets will find it easier to compete for additional capital.
South32 will have an experienced board and management team and will be a cash generator with high quality assets competitively positioned within their respective cost curves. Concerns have been appeased that South32 won’t carry a high debt burden with net debt of only US$700m. The company will also distribute a minimum of 40% of underlying earnings as dividends.
Importantly, BHP has reiterated their commitment to steadily increase or at least maintain current dividend levels with no plan to rebase the dividend post the demerger.
Is any action required?
We believe that BHP’s current share price is depressed due to investors' unwillingness to own BHP’s non-core assets. The demerged companies will appeal to different investor preferences. It will also make South32 a more appealing and easier acquisition target for competitors who may wish to acquire the whole company or selectively purchase assets which are complementary to them.
The demerger will simplify BHP in a single step, whilst providing the opportunity for South32 to maximise the value of its assets. BHP will earn higher margins with no material change in earnings/margin volatility.
Overall, we think the demerger is positive outcome. However, we don’t think it will be as successful as the Westfield local and overseas assets demerger (into Westfield Corp and Scentre Group), unless South32 is acquired (in sum or in parts) or can prudently pursue complementary acquisitions.
At this point, no action is required. Stay tuned for more information as we get closer to the shareholder vote.
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