Elliott Management letter to BHP Billiton
We are writing to you on behalf of Elliott Associates, L.P. and Elliott International, L.P. (together, the "Elliott Funds"), which together with certain of their affiliates hold a long economic interest in respect of approximately 4.1% of the issued share capital of PLC.
Despite being a leading global resources company with a portfolio of best-in-class large-scale diversified mining assets, in recent years BHP as an investment has underperformed a portfolio of comparable mineral and petroleum companies.
Unfortunately, despite the progressive and successful demerger of South32 in May 2015, BHP's management still cannot deliver optimal shareholder value without (i) resolving the shareholder value inefficiencies caused by its dual-listed company ("DLC") structure; (ii) monetizing the intrinsic value of BHP's US petroleum business , the value of which is being obscured by its continued inclusion within the group; and (iii) enhancing capital management to an optimal level.
The BHP Shareholder Value Unlock Plan, which we outline in this letter and the enclosed presentation (the "Value Unlock Plan"), is designed to directly address these issues with three key steps:
- Step 1: Unifying BHP's DLC structure into a single Australian-headquartered and
Australian tax resident listed company
- Step 2: Demerging and separately listing BHP's US petroleum business on the NYSE
- Step 3: Adopting a policy of consistent and value-optimized capital returns to shareholders - which would also help BHP's management to avoid any repetition of prior tendencies to make value-destructive large-scale acquisitions paid for in cash
Our analysis shows that implementation of the Value Unlock Plan could enable management to provide BHP shareholders with anincrease in value attributable to their shareholdings of up to c. 48.6% (Limited shareholders) / c. 51.0% (PLC shareholders).
We are making this letter publicly available as a follow-up to our discussions with certain senior members of BHP's management, in order to provide access to the details of the Value Unlock Plan for all of BHP's shareholders, and so that you can work openly with all shareholders with regard to our plan for significantly enhancing shareholder value.
BHP in context
BHP's DLC structure dates back to 2001 and was originally put in place in order to economically combine PLC and Limited without either company actually acquiring or merging with the other in the legal sense.
Today, out of approximately fourteen major corporate groups which adopted a DLC structure over time, BHP is one of only five significantly-sized DLCs in the world which remain, of which the largest by market value is already under review with the objective of creating greater simplification and strategic flexibility. We, along with many other market participants, believe that BHP's DLC structure has far outlived its original utility.
One key aspect of management's inability to deliver optimal value for BHP's shareholders is that the DLC structure has led to a massive build-up of franking credits at Limited. Australian tax resident companies like Limited should be able to pass on all of those tax credits to shareholders, but BHP cannot do that in an economically efficient way whilst it retains its legacy DLC structure. The Value Unlock Plan would rectify that.
A first-class portfolio of assets which are failing to deliver optimal value for shareholders
Despite the first-class quality of most of BHP's assets, BHP as an investment has underperformed a portfolio of comparable mineral and petroleum companies in recent years across a number of metrics, including total shareholder returns - this is clear from the charts on slides 8 to 10 of the enclosed presentation.
BHP's management took an important first step towards streamlining BHP's portfolio in order to release value for BHP's shareholders by demerging South32 in May 2015. However, in isolation, we believe that the South32 demerger has actually magnified the inefficiencies of BHP's DLC structure by further decreasing the proportion of BHP's EBITDA which is generated by PLC.
In our view, most of BHP's underperformance in terms of total shareholder returns has been driven by the incomplete status of management's streamlining and value-optimization of BHP's group structure and asset portfolio. The Value Unlock Plan is designed to directly address this and would be the logical next step.
The Value Unlock Plan for BHP - addressing key shareholder value issues
The Value Unlock Plan is intended to directly address BHP's key shareholder value issues for BHP's owners, with three key steps. Each step is designed to individually contribute to unlocking significant shareholder value and we present them in the order in which they should be undertaken:
Step 1: Unifying BHP into a single Australian-headquartered and Australian tax resident listed company
Following the South32 demerger, we estimate that PLC now generates only c. 8.9% of BHP's EBITDA, but PLC's shares account for 39.7% of BHP's aggregate number of issued shares. The long-term misalignment of profits vs. shareholder base in the DLC structure has led to a massive and continuing build-up of franking credits - totaling US$9.7bn  or c. 10% of BHP's market capitalization.
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 equivalenteconomic 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).
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
BHP's management has a remarkable opportunity to significantly enhance shareholder value. We urge each of you, consistent with your duties as directors of BHP, to review the Value Unlock Plan in light of the very real and measurable benefits which we believe they can have for BHP's shareholders.
Given that our analysis shows that implementation of the Value Unlock Plan could provide BHP's shareholders with an increase in the value attributable to their shareholdings of up to c. 48.6% (Limited shareholders) / c. 51.0% (PLC shareholders), we expect that a full and open review of our plan by management in the near term would be welcomed by an overwhelming majority of BHP's owners.
We look forward to you as BHP's directors announcing on a timely basis the start of your work in formally reviewing the Value Unlock Plan, along with a commitment to publishing within a reasonable timeframe the details of the scope and results of that review.