Demerger brings deal between BHP and Billiton full circle
BHP Billiton’s plan to demerge its unwanted aluminium, nickel and manganese assets underscores just what a fantastic deal shareholders in the old Billiton got when the two joined in 2001.
When Australia-based BHP joined forces with the London-listed, but largely South African, Billiton, a diversified natural resources giant was created.
At the time it was largely viewed as a deal that favoured Billiton shareholders. BHP shareholders got about 58% of the merged entity, while Billiton’s got 42%, meaning BHP paid about a 20% premium to Billiton shareholders, said a March 19 2001 report in the Wall Street Journal.
With the August 15 news that BHP Billiton’s board favours a demerger, the 2001 deal comes full circle. While it is unlikely to be an exact match, the bulk of assets proposed for the new spin-off firm will be those that Billiton brought into the 2001 merger. Billiton’s main assets in the 2001 merger were the Hillside and Bayside aluminium smelters in Richards Bay, the Mozal smelter in Mozambique and energy coal mines in SA.
Other assets of the merged BHP Billiton that may be spun off include a manganese mine in the north of Australia, the ore for which is smelted at a plant in Tasmania, a manganese mine in SA, a ferronickel mine in Colombia, an integrated nickel mine and smelter in Western Australia, and a bauxite mine and alumina plant, also in Western Australia.
It is also possible that Billiton’s energy coal assets in SA, as well as the old BHP energy coal mines in Australia’s New South Wales, will be included in the demerged entity, which reports have suggested will have a value of about $14bn.
This will leave BHP Billiton with its four core pillars, namely iron ore, coking coal, copper and petroleum, with a potential fifth in Canadian potash assets.
Iron ore, copper and coking coal are heavily exposed to the China growth story, and to some extent so is the oil and gas business, given that much of the growth in demand is expected to come from China and the rest of Asia.
The four core businesses generate margins of more than 10% above the group’s overall margins, meaning, as The Australian newspaper’s columnist Stephen Bartholomeusz noted, the others generate “significantly more than 10 percentage points below the average”.
The demerger will allow BHP to focus on its most profitable businesses, which is what it already has been doing, given the efforts to expand iron-ore output, while controlling costs at the other major divisions. There may be some questioning the wisdom of selling the noncore assets just as better times appear to be coming after years of poor returns.
The outlook for aluminium, excluding China, has been improving given the closure of loss-making plants and rising demand as developed world economies recover and more vehicle makers switch from steel to the lighter metal.
Nickel has also enjoyed a bull run this year, largely as a result of Indonesia’s ban on exports of raw ore, meaning it is likely that this market will move into structural deficit next year, once Chinese stockpiles are likely run down.
Energy coal is still problematic as the global supply overhang remains and any rally in prices will merely result in idled supply coming back onto seaborne markets. However, the point is that the demerged company will not necessarily be a basket case, although it will require capital injections, particularly in the nickel business, to fully realise its potential.
Thus BHP Billiton shareholders stand to reap the benefits of having a high-margin resource company with top-quality assets that should be able to deliver stronger profits when compared with its competitors.
They will also get a spun-off company with some still-solid assets that may benefit from a turn in the market for the main products. If you go back to the 2001 BHP merger with Billiton, it is especially good for any Billiton shareholders still invested in BHP Billiton. They keep 42% of BHP Billiton and get 42% of most of the assets they contributed to the initial merger back in the form of the demerged entity.
Since its formation in June 2001, BHP Billiton’s share price has risen sixfold in US dollar terms, outpacing the threefold increase in the S&P GSCI index of commodities over the same time period.
Billiton’s shareholders got access to the incredible growth assets of BHP’s iron ore, copper, coking coal and oil a few years before prices soared on the back of surging Chinese demand.
The bulk of assets proposed for the new spin-off firm will be those that Billiton brought into the 2001 merger
The touted benefit of diversification for BHP shareholders in gaining Billiton’s aluminium and energy coal assets, turned out to be far less than expected.
It could be argued that the main benefit for BHP, which had struggled to make profits in the years prior to the 2001 merger, was that it gained access to an aggressive and skilled management team, but this is considerably harder to quantify.
What can be quantified is how much Billiton shareholders benefited. The market cap of BHP Billiton was $189bn on August 15, and splitting that using the 58% for BHP and 42% for Billiton gives a value of $109.62bn for the old BHP shareholders and $79.38bn for Billiton’s.
It is easy to say in retrospect that BHP’s management was hoodwinked by Billiton’s, but its more likely that neither saw the huge demand coming from China that made the old BHP assets considerably more valuable.
Disclosure: At the time of publication Clyde Russell owned shares in BHP Billiton as an investor in a fund.