By Paul Rickard
In the next few days, BHP is expected to announce the appointment of a new chairman to take over from Jac Nasser. For many investors, this transition can’t come soon enough because Nasser has presided over some of the most value-destructive acquisitions in BHP history. He also championed the hopelessly flawed progressive dividend policy - now since abandoned.
Ken MacKenzie, the former Amcor CEO (and no relation to BHP CEO, Andrew Mackenzie) is emerging as the favourite. Other candidates are said to include ex-KPMG head and chairman of Westpac and Transurban, Lindsay Maxsted and the former CEO and now chairman of Orica, Malcolm Broomhead.
MacKenzie is the cleanskin on the Board, having joined it last September. Broomhead has been on the Board since March 2010, while Maxsted joined in March 2011. Both are somewhat tainted with BHP’s disastrous US shale oil acquisitions (which occurred in February and August 2011), and the progressive dividend policy that misled so many shareholders.
Shareholder activist Elliott Associates will also welcome the announcement of a new chairman, as this may open up the lines of communication between the Board and a growing band of aggrieved shareholders. Interestingly, Elliott issued another press release yesterday, calling on the new chairman to “address the company’s poor capital allocation and underperformance, nominate diverse and qualified directors, and review the executive management team”.
Elliott cited the support their campaign has achieved from shareholders, including AMP Capital (one of BHP’s largest shareholders), which in a note to investors called on BHP to conduct an “independent assessment” of Elliott’s proposal and “to prove the worth of its US onshore (oil) business and why it is compatible in the BHP portfolio”.
Other investors cited by Elliott include Schroders Investment Management, Tribeca Global Natural Resources, Aberdeen Asset Management and BT Investment Management.
The Elliott proposal
Elliott’s open letter to the BHP Board on 16 May and the accompanying presentation is available here. It starts by outlining BHP’s chronic share price underperformance, which is detailed in the table below. This shows that compared to a broad range of comparators (Rio Tinto, comparable portfolio, comparable pure-play mining portfolio, ASX 200, etc.), it has underperformed over pretty well every time period. For example, over the last eight years, BHP’s total shareholder return is only 46% of Rio’s.
BHP total shareholder return relative to comparable peers
Graphically, this is represented by the following chart which shows total shareholder return since 2008 using a common base, with BHP in brown, Rio in black and the comparable portfolio in grey.
BHP total shareholder return vs Rio vs comparable portfolio, 2008 to 2017
In regard to BHP’s Achilles heel, its onshore US petroleum, Elliott says that BHP has “destroyed” US$22.7bn or 78% of its value. A total investment of US$29.1bn through US$19.9bn of acquisition costs and US$9.4bn of negative cashflow is now worth around US$6.5bn on consensus broker estimates.
US onshore petroleum - value destruction
According to Elliott, BHP is not the right custodian of the US onshore assets, petroleum offers no real operational synergies or risk diversification, BHP does not operate the vast majority of its petroleum assets and the value of these assets is obscured. Elliott concludes that “the intrinsic value of BHP’s US petroleum business is obscured by bundling it with BHP’s other assets within an overly complex group structure while managed from a great distance, with insufficient focus”.
Elliott proposes that the value of the US petroleum business should be unlocked via a full or partial demerger. They cite the demerger of South32 as clear precedent for success, noting that South32 has outperformed BHP by 47% since the demerger. They say that “a more nimble and focused independent petroleum business, with a more disciplined approach to capital management, would have avoided significantly overpaying for BHP’s US onshore portfolio.”
In regards to capital returns, Elliott says that there is strong shareholder support for BHP to return excess capital to shareholders. This won’t disrupt the balance sheet or put future growth at risk, will help ensure disciplined and optimal capital allocation, and will stop excess capital being wasted on value-destructive acquisitions and other pet projects. They say that there is a very strong case for regular buybacks, arguing that BHP needs to lift its game on buybacks as its track record has been “abysmal” (it has done these infrequently, and paid way too much relative to book value when it has).
They continue to push for a single unified entity (rather than two separate companies listed on different exchanges), and accept that this new entity would be headquartered in Australia, be an Australian tax resident, and have its primary listing on the ASX. A secondary listing would be in the UK.
They refute BHP’s counter claim that this would cost US$1.3bn to implement, saying that the costs should only be around US$200m. The benefits of unification are less clear, however. Elliott contends (though doesn’t substantiate) that it will enhance BHP’s market value by US$5bn. They say that BHP will be able to monetise franking credits more quickly and more efficiently (current reserve US$9.8bn), and that having a single unified structure and share capital will give BHP an “acquisition currency” (other than cash) that could be used in future acquisitions.
Elliott and the BHP Board may not be ready yet to sit down and smoke the peace pipe, but because BHP has such a lousy record and Elliott shows no signs of going away, BHP will inevitably cede major ground on this proposal. A new chairman will make this easier. The US petroleum assets will either be put up for sale or demerged, and expect BHP to be far more focused on returning excess capital through off market buybacks.
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