22 November 2019
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Think smart, not big

Paul Rickard
27 July 2017

By Paul Rickard

If you have been watching commercial television lately, you will probably have seen BHP’s commercials that are branded under the Think Big tag. I really like them as TV - but why a company that is a price taker and sells only to other companies and intermediaries is running a consumer-orientated brand campaign is absolutely beyond me. While it might make the staff at the Melbourne Head Office feel a little better about working for BHP, for shareholders, it is just another example of a lazy $10m being frittered away.

On the theme of “Think Big”, or not, shareholder activist Elliott Associates has launched their latest salvo at BHP. Under the heading “Instead of THINK BIG, BHP needs to THINK SMART”, they argue that change is needed at BHP.

You can read my thoughts on the Elliott proposal here, or visit the website they have created to see their arguments in full.

In brief, Elliott makes four key points.

Firstly, they say that BHP has underperformed. While they provide an apples and oranges comparison by citing the performance of BHP compared to the S&P/ASX 200 index (US$100 invested in the index five years ago would today be worth US$131 compared to just US$72 if it had been invested in BHP), they have previously demonstrated that BHP has underperformed compared to Rio and other comparable stocks.

They argue that BHP’s dual listed structure, which was established following the merger with Billiton in 2001 and sees two companies - BHP Ltd in Australia and BHP Plc in the UK - is obsolete and leads to the destruction of valuable franking credits. Elliott claims that US$853m of franking credits have been wasted on the shareholders of BHP Plc since 2015. Under their model, a unified BHP that was incorporated, headquartered and listed in Australia would be established.

The Elliott team says that US$11 billion of value could be created if the dual listed structure was unified, as this would unlock a significant balance of stranded franking credits. This could then be used to increase returns or conduct off market buybacks.

Elliott makes a particular point about BHP making the most of Australia’s unique and valuable franking credit system, and argues that the expected returns from allocating capital to new projects should be compared with those that can be achieved by buying its stock back at a discount. Previous off-market buybacks have been conducted at a discount of 14% to the then market price, and each time, massively oversubscribed. Elliott says that dedicating more free cash flow to discounted buybacks could lead to significant value accretion and create US$20 billion of value for shareholders.

The third suggestion is for BHP to maximise the value of its US petroleum assets by conducting a full review of alternatives such as a demerger of this business or the sale of the assets to local specialists. Elliott says BHP has destroyed more than US$22bn of value with its investment in shale oil, as that investment of US$29.2bn is now worth around US$6.5bn on consensus valuations.

Labelling the foray into shale oil as “disastrous” and “misguided”, Elliott says that the operation of these assets is so incongruous with a global, bureaucratic resource company that is used to projects with very long lead times and long paybacks. Typically, these wells are developed in months and only operate for relatively short periods, so the culture to develop and operate requires a very different mindset - nimble and entrepreneurial.

Demerging BHP’s existing US petroleum business, comprising US shale oil and offshore Gulf of Mexico assets, could unlock US$15bn in shareholder value.

Finally, Elliott argues that further changes to the BHP Board are required. It has welcomed the appointment of Ken MacKenzie, the former Amcor CEO (and no relation to BHP CEO Andrew Mackenzie) as Chairman to take over from the hapless Jac Nasser, but sees this as just the start of a process to renew the Board and remove some of the cluttered thinkers that signed off on BHP’s disastrous acquisitions.

What does this mean for shareholders? Elliott says that its “think smart” plan could add US$46bn of value - increasing the current value of BHP by approximately 51% from US$90bn to US$134bn!

Bottom line

If Elliott is only 10% correct, the “think smart” plan represents considerable value to BHP shareholders and should be considered. So far, BHP’s response to the plan is unconvincing and Elliott has won considerable support from institutional shareholders. One inevitability is that BHP exits the US oil shale business, another is that there are further changes to the BHP Board. The question is just how long this process takes to play out.

Elliott is maintaining pressure on the BHP Board and is encouraging retail shareholders to sign an on-line petition. You can find this here.

Disclosure: The author and his super fund are BHP shareholders.

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