BHP Needs Rebound Not Spinoffs During Commodity Slump: Real M&A

Apr 17, 2014 10:39 am ET

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April 17 (Bloomberg) -- A spinoff of BHP Billiton Ltd.’s least-loved assets may do little for shareholders of the world’s largest mining company.

BHP, which is wringing out costs after a decade-long mining boom ended, said this month it’s studying “structural options” to help narrow its focus to four commodities including iron ore. With mines aging and new oil and gas fields becoming harder to find, BHP’s return on invested capital has sunk to the lowest since 2003, according to data compiled by Bloomberg.

Separating the nickel, manganese and aluminum assets from BHP probably wouldn’t boost profit at either the new or old entity, said Sanford C. Bernstein Ltd. Profit margins for the unfavored business have evaporated at the bottom of the commodity cycle and CLSA Asia-Pacific Markets said a spun-off company may be valued at $7.5 billion, just 4 percent of Melbourne-based BHP’s market value.

“There’s a long history of the larger companies succumbing to the cyclical pressures,” John Robertson, director at EIM Capital Managers Pty in Melbourne, said by phone. “If you’re going to float off a large chunk of assets that currently have a low return on capital, unless somebody’s got a magic wand, it’s really not going to do much.”

In 2011, as China devoured everything from iron ore to copper to feed economic expansion, BHP’s return on invested capital was 35 percent, Bloomberg data show. The figure slumped to 10 percent two years later because of slower Chinese growth and costs that were still aligned with a resources boom.

Four Assets

BHP Chief Executive Officer Andrew Mackenzie has said he wants to run a smaller collection of assets with long lifespans. He has picked iron ore, copper, coal and petroleum projects that stretch from Australia to the Americas and generated about 85 percent of BHP’s sales last year. Focusing on those commodities will boost returns and free cash flow growth, BHP said in an April 1 statement.

That same day, the Australian Financial Review reported that BHP and Goldman Sachs Group Inc. bankers were working on options that included a spinoff.

“The negative is that they mistime the cycle and they sell these things at a really low price and things change quickly,” Peter Esho, chief market analyst at Invast Securities Co. in Sydney, said by phone. “I’d rather they just do nothing than try to do too much.”

Bad Timing

Eleanor Nichols, a spokeswoman for BHP, declined to comment beyond the company’s April 1 statement.

BHP got its timing wrong in 2011 when it spent $20 billion on shale gas deposits in the U.S., including its biggest acquisition, Petrohawk Energy Corp., Esho said. The following year, then-CEO Marius Kloppers wrote down the value of the assets by $2.8 billion because of falling prices.

Any spinoff would probably include the nickel, manganese and aluminum operations, which span Australia, South Africa and Colombia, David Radclyffe, a Sydney-based analyst at CLSA, said in an April 7 report. Nickel prices will drop about 14 percent by the end of this year, while aluminum will be unchanged, according to commodity analyst forecasts compiled by Bloomberg.

Along with a South African coal unit and an Australian lead and silver mine, that metals group would be valued at A$8 billion ($7.5 billion) to A$11 billion when listed, he said.

“One of the risks that we see is that this is potentially at the bottom of the cycle,” Radclyffe said by phone. BHP might be better selling those assets for cash, he said.

Lower Margins

BHP’s profit margin from aluminum, manganese and nickel was 1.8 percent in the 12 months ended June 2013, down from 41 percent in 2007, according to company filings. That’s based on earnings before net finance costs, taxes and one-time items, a gauge that BHP calls its key measure of performance.

Profits from aluminum faded after Chinese smelters failed to crimp output even as many lost money. At the same time, Chinese nickel firms added to supplies of the steel-making product by making a lower-grade alternative. Prices of manganese, used to harden steel, also have declined.

Including debt, BHP now trades at about 6.6 times analysts’ forecasts for earnings before interest, taxes, depreciation and amortization in the year ending in June. The spun-off entity would have to command a multiple of more than 9 to generate value for shareholders, Lyndon Fagan, an analyst in Sydney at JPMorgan Chase & Co., said in an April 8 report.

“This looks a bit too ambitious,” he said.

Seeking Buyers

BHP may be aiming to flush out buyers by raising the prospect of a spinoff, said Sean Fenton, who helps manage A$1.6 billion at Tribeca Investment Partners Pty in Sydney.

Glencore Xstrata Plc, the global commodities trading and mining group, said last month it was assessing a bid for BHP’s Nickel West assets in Western Australia. Glencore, based in Baar, Switzerland, this week agreed to buy Caracal Energy Inc. for about $1.35 billion to take control of oil and gas operations in the African nation of Chad.

A representative for Glencore declined to comment.

Shares of Glencore declined 0.1 percent to 313.60 pence 2:59 p.m. London time today. BHP climbed 0.4 percent to A$38.10 in Sydney.

BHP has sold $3.3 billion of assets including uranium and diamond mines in the past two years, according to data compiled by Bloomberg. It got $650 million for its Pinto Valley copper project in the U.S., almost double JPMorgan’s estimate of its value.

Cutting BHP free from the less lucrative business would boost profit margins to 42 percent next year, compared with 37 percent without a split, Glyn Lawcock, an analyst at UBS AG in Sydney, said in an April 2 report.

Riskier BHP

Although there are benefits from a spinoff, it also would make BHP a riskier investment because it would be more reliant on fewer products, Robertson at EIM Capital said. Iron ore accounted for more than half of BHP’s underlying earnings in the year ended June, filings show.

A spinoff “raises a number of questions,” including why BHP couldn’t find other buyers for the assets, Paul Gait, a London-based analyst at Bernstein, wrote in an April 10 report.

“Whether or not this process actually creates value for shareholders is debatable,” he said.

--With assistance from Jesse Riseborough in London.