As a slide in BHP Billiton’s share price that began in London on Tuesday night spilled into the local market on Wednesday morning, BHP and advisers began asking the obvious question: were BHP shareholders giving the group’s demerger plan the thumbs down?
Their tentative answer after sifting through the evidence was that the selldown was less about what BHP announced on Tuesday, and more about what it did not announce.
BHP’s Australian shares rose by 5.1 per cent to $39.68 between August 19 and the close of trade on Tuesday afternoon, just before BHP's big announcement.
The market as a whole was strong during that time, with the S&P/ASX 200 index rising by 3.5 per cent and the resources sector of the index rising by 3.4 per cent. BHP outperformed, however, and speculation that it would use Tuesday evening’s June year profit report to launch a share buyback was a key reason.
A reduction in net debt to $US25 billion was BHP’s stated buyback trigger, and analysts knew it was close to the mark. Investors also appeared to believe that BHP could simultaneously handle both a buyback of up to US5 billion and its demerger project.
After the close of Australian trading on Tuesday BHP announced a 10 per cent higher $US13.4 billion US dollar profit for the year to June, and confirmed plans to demerge a portfolio of mid-size resource assets and pare itself back to four big divisions - iron ore, coking coal, copper and petroleum.
It did not announce a buyback, however, and the market response was savage. The shares fell by 4.9 per cent in London, opened sharply down on Tuesday's close in Australia on Wednesday morning, and ground their way to a 3.9 per cent loss for the day.
The missing buyback is the prime suspect, even though it is unclear why investors were so unhappy when it was not announced.
Nobody is arguing that a buyback won't happen. It is only the timing that is being debated, and BHP’s net debt actually finished the year at $US25.8 billion, slightly above the $US25 billion trigger.
BHP's decision to demerge the new company with virtually no debt was another clue. It could have created room for a buyback by shipping more of its debt out to the new company. Instead, it decided to make its offspring more attractive, by giving it a balance sheet that has capacity for investment and acquisitions in the medium term.
There were other factors at work, including the fact that dual Australia and London-listed BHP will not be listing the demerged company in London. It will be headquartered in Perth, with its primary listing on the Australian Securities Exchange, and a secondary listing on the Johannesburg Stock Exchange.
That decision reflects business and market reality, however.
The new company will be worth about $20 billion when it lists, but will still only be a middleweight in the resources industry, and too small to replicate BHP’s dual listing structure.
In a normal year, almost 50 per cent of its revenue and more than 60 per cent of its earnings before interest, tax, depreciation and amortisation will also come from Australian operations, including the Cannington silver, lead and zinc mine in Queensland, the Worsley bauxite mine and alumina refinery in Western Australia and the Illawarra coal mines in New South Wales.
There is operational logic of Australian residency, in other words, and shifting ownership of Australian assets to the UK would also probably involve the creation of taxable capital gains: the same problem makes it difficult to undo BHP’s dual-listing.
Once those points are conceded Australia becomes the obvious sharemarket and operational base for the new company, and considering a listing in the UK becomes a waste of time. The new company’s relatively small share base, Australian headquarters and heavy Australian asset weighting would almost certainly prevent it from being included in the London Stock Exchange’s FTSE index.
Some UK shareholders would no doubt have preferred to be paid out for their entitlements to the new company. The sensitivity of London investors to listing location issues was also heightened just before BHP’s announcement when AngloGold Ashanti announced that it was taking its infrequently-traded shares off the London Stock Exchange.
It is hard to criticise BHP for deciding to treat all its shareholders equally by issuing shares in the new company to them all, however, and sellers and buyers should find each other when the new company lists.
Overseas shareholders will initially own about 40 per cent of the new company, and the largest overseas holders have global horizons, and will assess the new investment on its merits.
Others will sell, but as Goldman analyst Craig Sainsbury notes, Australian institutions that track the ASX indices should be buying at the same time. The Australians will inherit about 60 per cent of the new company's shares - but 100 per cent of its shares are going to be included in the ASX .
