Publicado 10/04/2017 8:06:27CET
Absent a clearly defined optimal path to monetizing those franking credits, they are not being appropriately valued by the market.
Over the last 16 years since the completion of the DLC merger, PLC's shares have traded at an average discount of 12.7% to Limited's shares. In our view, that sort of price dislocation stems from the economic asymmetry described above, as between PLC and Limited, which in turn undermines the fundamental principles and objectives of the DLC structure, being the achievement of equivalent economic returns on their shares as between PLC and Limited shareholders.
-- create a single Australian-headquartered and Australian tax resident unified BHP company which would continue to be managed from Australia. That company could retain BHP's current stock market listings and continue to be included within key FTSE and ASX stock indices;
-- put BHP's Limited and PLC shareholders on the same footing, eliminating the current trading value mismatch between the two lines of shares;
-- allow BHP to access the value represented by its existing massive US$9.7bn franking credit balance, plus future franking credits generated by the business, for the benefit of all BHP shareholders;
-- significantly enhance the scope for, and optimize the value impact of, BHP share buybacks - unified BHP's management could return the substantial upcoming excess cashflow to shareholders by way of 14% discounted off-market share buybacks. That would be a highly value-accretive way of management deploying a large amount of
capital without any additional operational risk - effectively buying BHP's own first- class core assets at a meaningful discount to their market price;
-- remove any need to use the Dividend Share Mechanism, thereby avoiding wastage of valuable franking credits;
-- help management to avoid making badly timed acquisitions paid for in cash, given the opportunity to deploy significant cash resources in value-enhancing post-unification share buybacks;
-- increase the scope for management to pursue appropriate acquisition opportunities using unified BHP's own shares as consideration; and
-- remove certain other material tax, operational and strategic inefficiencies caused by the DLC structure.
We estimate that the BHP group's tax and other deal costs for implementing our unification plan would be both reasonable and far outweighed by the significant shareholder value unlock opportunity to which it is key. In addition, we do not see any material regulatory obstacles to BHP implementing our unification plan - for example, a unified BHP would be tax resident and headquartered in Australia, so there should be no reason for concern on the part of FIRB.
Step 2: Demerging and separately listing BHP's US petroleum business
Based on commonly utilized valuation metrics for comparable businesses, the indicated value for BHP's US petroleum business is c. US$22bn, which is well in excess of the current analyst consensus valuation for that business.
Our analysis indicates that the US petroleum business has not been able to successfully contribute to shareholder value at BHP since (i) it provides no meaningful diversification benefits to BHP as a whole; (ii) there is a lack of synergies between BHP's US petroleum business and its mining assets; and (iii) its intrinsic value is being obscured by bundling it with BHP's other assets.
We believe that within the confines of the existing group, BHP's US onshore acreage opportunities are extremely limited. BHP has competing capital allocation alternatives - including its world- beating mining assets such as those within its iron ore division, and highly value-accretive post- unification off-market BHP share buybacks at a 14% discount to market price. In the circumstances, BHP's management simply cannot justify allocating the capital which the US onshore assets would need for the US petroleum business to realize its growth potential or meaningful corporate expansion activities.
A demerger and separate listing of BHP's US petroleum assets on the NYSE would:
-- unlock the intrinsic value of the US petroleum business and provide shareholders with access to what we believe would be a much higher market value for that business;
-- allow the demerged US petroleum business to be properly capitalized and pursue value- accretive strategic opportunities;
-- allow BHP's management to fully focus on deriving value from BHP's unrivalled portfolio of first-tier mineral assets; and
-- allow BHP's investors to tailor their own desired exposure to US energy and petroleum equities rather than being constrained by the fixed acreage composition and petroleum vs. minerals mix currently being offered by BHP.
We see the demerger of BHP's Gulf of Mexico assets in combination with the US onshore petroleum assets as providing a standalone US petroleum business with consistent cash flow to fund its own further expansion, allowing BHP to increase its focus on its core competencies and also helping the value of BHP's remaining core portfolio to positively re-rate.
Step 3: Adopting a policy of consistent and optimized capital returns to shareholders
BHP is expected to generate c. US$31bn of excess cashflow in the next 5 years, assuming the current 50% payout ratio of net income.
Unfortunately, BHP has previously used excess cash to make value-destructive acquisitions when it acquired certain Fayetteville assets and Petrohawk. Management should avoid making badly timed acquisitions for cash and instead return its substantial upcoming excess cashflow to shareholders by way of highly value-accretive post-unification 14% discounted off-market share buybacks.
A clearly defined and communicated ongoing 14% discounted off-market buyback program undertaken by a unified Australian tax resident BHP which has demerged its US petroleum business would:
-- enable BHP to purchase its own shares at a substantial discount, achieving an overall cost which is c. 5.6% lower than the price at which BHP can currently buy back its shares;
-- release up to c. 66% more franking credits to shareholders; and
-- facilitate an initial off-market buyback of at least US$6bn.
We estimate that within the five year period ending June 2022, in addition to the continuation of the current 50% dividend payout ratio, adopting this capital return policy as part of the Value Unlock Plan could result in:
-- a total of c. US$33bn being returned to shareholders via share buybacks;
-- c. 29% of core BHP's share capital being repurchased;
-- total EPS accretion from buybacks of c. 33% in respect of the shares remaining in issue after the 14% discounted buyback program; and
-- an increase in BHP's NPV of c. US$20bn (c.21% of BHP's current market capitalization).
Moreover, BHP could deliver these sorts of significantly enhanced returns for shareholders whilst still retaining an "A" grade credit rating.
The potential to unlock a significant amount of shareholder value at BHP
Our analysis indicates that implementation of the Value Unlock Plan could provide BHP shareholders with an increase in the value attributable to their shareholdings of up to c. 48.6% (Limited shareholders) / c. 51.0% (PLC shareholders).
(Photo: http://mma.prnewswire.com/media/488297/Value_Unlock_Plan.jpg )
Source: Company filings and Elliott's estimates.
Independent analysts' views
Independent research analysts have commented on many of the issues which underpin the Value Unlock Plan and a selection of those comments is set out in the Appendix to this letter.
Conclusion and next steps