BHP UNIFICATION – GOOD OR BAD?

BHP Unification. If it was that clear we wouldn't be writing about it. So, let's explain. First of all - WHY IS IT HAPPENING There is a lot of fluff about changing the structure to provide a simpler and more agile company but that’s the marketing.  

The real reasons include:

• Because as a common courtesy, as often happens on a merger, when BHP merged with the UK listed Billiton PLC in 2001 the management egos and shareholder base of Billiton required their own UK listing to enable some continuity of investment structure and index relevance in the UK (and Johannesburg).
• At that time the Billiton entity accounted for 40% of total earnings. But since the demerger of the South32 assets into a separate structure and with the growth in the relevance of the Australian iron ore business the ‘Billiton’ earnings (UK earnings) only account for about 5% of BHP Billiton’s earnings now.
• BHP PLC shareholders have complained about the structure because the PLC shares have traded at a significant discount to the ASX listed shares (partly to do with the lack of franking for UK shareholders). They want the structure gone which should in theory see their UK shares re- valued in line with the Australian shares.
• And it has worked – here is the chart of BHPPLC (listed in the UK) relative to BHP Group Ltd (listed on the ASX) showing a sharp short term improvement in the performance of the PLC listed shares compared to the ASX listed shares.

• The main advocate for change has been the US hedge fund shareholder Elliott Management who are now a vocal advocate for the change in dual-listing structure. Elliott is an ‘activist’ shareholder that bought 4% of BHP PLC in 2017 and started to attack BHP for its structure, lack of handouts and strategy. Elliott have attacked many companies in the past looking to extract value (Alcoa). The founder has turned a seed of $1.3m borrowed from friends and family in 1977 into funds under management of  US$73bn with just 14 clients. Biggest holding is Dell.
• Another reason to get rid of the PLC listing is that the stock market exists to raise capital. If BHP needed to raise capital (its making so much cash it doesn’t) it is almost certainly going to need it for the Australian end of the business not the UK end so the UK listing becomes less useful.

 

SO WHAT HAPPENS NOW

• After voting it through last week the BHP Unification takes effect on Monday 31^st January.
• BHP Billiton PLC ceases to exist.
• All London and Johannesburg shareholders get ASX listed (BHP Group Ltd) shares as of Monday on a 1:1 basis.
• BHP Group Ltd (the ASX listed company) is the only listed entity from Monday but it will still have listings in the UK and US and other exchanges, but they will represent the ASX domiciled company not the UK domiciled company.
• Nothing changes at a company level – same management, same economic outcomes just a different legal structure.
• BHP Group Ltd moves from about 6.6% of the ASX 200 (and other indices accordingly) to about 10.9% (everyone’s quoting 10%) of the ASX 200.
• BHP Group Ltd becomes the biggest stock in the Australian indices.
• Passive, indexed, benchmark conscious fund managers and Exchange Traded Funds will have to buy more BHP Group Ltd shares to increase their weightings in line with their benchmarks/indices - around $4bn worth in Australia. This includes domestic and international institutions benchmarked to the MSCI indices that include Australia and by implication, BHP.
• BHP Group PLC drops out of the LSE and JSE indices (FTSE 100 benchmark most obviously) and as such the UK passive, indexed, benchmark conscious fund managers and Exchange Traded Funds will have to sell BHP Group Ltd shares to decrease their weightings in line with their benchmarks/indices which now don’t include BHP.
• This is why the short position in BHP Group Ltd shares has spiked as the mostly UK institutions anticipated getting handed BHP Group Ltd stock (ASX listed) and anticipated the need to sell BHP Group Ltd (the ASX stock) when it dropped out of the LSE indices. So they started shorting BHP in Australia to avoid the ‘stampede’ out of the BHP Group Ltd stock when they were handed them in place of BHP Group PLC shares.
• BHP is (amazingly – but this will explain it) the 4th most shorted stock in Australia with 10.07% shorted up from 4% prior to the announcement that the dual listed structure would end. This is a chart of the short position in BHP in Australia over the last three years. This is because some PLC shareholders (and general arbitrageurs) have effectively chosen to sell ASX listed shares early hoping to benefit from the value change of PLC (up) relative to ASX listed (down). PLC shareholders will replace the short positions by selling their ASX stock when they get it.

 

WHAT DOES THIS MEAN FOR THE ASX LISTED STOCK

The adjustment (PLC up, ASX listed down) has already happened and, amazingly, because the iron ore price has gone up at the same time, the ASX listed stock has done very well during the preamble to the unification event. The chances are that from here (large short position in BHP’s ASX listing) the short position will be closed (which involves the buying of BHP on the ASX), the indexed, benchmarked and index conscious funds and ETFs will be buying the ASX listed stock as the weighting of BHP significantly rises in Australian indices. This will be offset by any selling of the ASX listed stock by the PLC shareholders that get ASX listed shares that are no longer relevant to their index benchmarks. As such the chances are good that post unification (on Monday) the ASX listed stock will be pushing higher as passive funds buy and as short positions close. On top of that the ASX listed shareholders (new and old) will get a Woodside share (like a dividend) when the de-merger of the BHP oil and gas assets into WPL goes through on July 1^st 2022. As Elliott Management recently said “The unification plan would eventually provide a technical trading tailwind for the Australian stock too, given BHP will occupy a bigger place in Australian market indices once unification is complete; something that could compel some mandated investors to increase their exposure to the company.” We have certainly upped our ASX holdings in anticipation. The relative recovery in BHP’s ASX listed shares is already happening. This is the chart of BHP relative to the ASX 200 showing the dip in relative performance as unification was announced and as short positions rose. More recently that has been followed by a recovery in anticipation of a higher index inclusion (on Monday) and short positions being closed (from now on). And of course, the iron ore price has helped. You will also read in the AFR that some brokers think the next move for BHP post de-merger, and with just one share listing to worry about, will be to do a buyback (Morgan Stanley note that half the companies that have been through a reunification had buybacks soon afterwards), or raised capital for an M&A deal (70% did). Morgan Stanley reckons BHP could raise $23.8bn in net debt without any change in investment-grade and could do it without shareholder approval. That would allow them to make any number of global acquisitions. They say "The combined potential, in our opinion, opens a significant opportunity set for BHP to potentially undertake transformational M&A as and when the right opportunities arise (we note management has not explicitly commented on this). The hypothetical extra capital would put IGO Limited, Nickel Mines Limited, Oz Minerals and Chalice Mining within BHP’s M&A budget. Morgan Stanley also suggest that BHP could use its entire franking which includes a US$16 billion franking balance, to offer a special dividend worth $US3.36 per share or an off-market buyback worth US$40bn which would be 11% earnings accretive.