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Crispin Murray: ‘Why should Australian shareholders pay for BHP’s proposal to collapse its DLC structure?’

Pendal’s head of equities Crispin Murray today challenged BHP’s proposal to collapse its dual-listed company (DLC) structure.

“As BHP Ltd (Australia) shareholders, we are not in favour of BHP’s proposal for the collapse of its DLC structure,” Mr Murray said.

On December 8, BHP announced a final board decision to end the DLC structure and unify its corporate structure under the existing Australian parent company, BHP Group Limited. 

BHP Group Limited and BHP Group Plc shareholder meetings are expected to take place on January 20 with unification due to be complete by January 31. 

“This proposal is transferring value from Australian Limited shareholders to offshore PLC shareholders. This value transfer has been evidenced by the material decline in the Australian multiple of earnings that BHP Ltd trades on,” said Mr Murray, who leads one of the Australia’s biggest Australian equities teams for independent asset manager Pendal Group.  

“We appreciate that the main reason for the proposal is the greater flexibility it provides to do large M&A deals in the future. However, there are two questions we have around this. Firstly, BHP has had a poor track record in this regard historically. There is a risk that Australian shareholders pay the price for the unified corporate structure and then see more value destruction overtime. Secondly, while a unified corporate structure will make doing scrip-based M&A easier, the decline in multiple potentially negates this.” 

Pendal expects that should the proposal not go through the long-term premium of the Australian listed company to PLC would return. 

Below, Mr Murray outlines Pendal’s main issues with the proposal: 

What has been the value destruction borne by Australian shareholders to date?

The BHP Ltd share price fell 14% in the two days (17th-18th August 2021) following the announcement of the DLC collapse.

The premium of BHP Ltd’s (ASX) share price to BHP PLC’s (LSE) share price — which had existed almost since the inception of the DLC — fell from more than 20% to around 5% after the announcement.  

Even with the more recent recovery in resources, the stock has underperformed the market by about 15%, in line with the reduction in the Ltd premium to PLC. 

This premium is likely to erode further if the vote goes through.  

In our view, this represents a substantial, permanent and unnecessary value transfer from Australian to PLC shareholders.  

BHP management expected the UK share price to re-rate to a multiple in line with the Australian listing.

In fact, the opposite has occurred. 

The charts below show the absolute PE of BHP Ltd vs the ASX200 is at a 10-year low, despite the overall rise in market rating.

Relative to industrials, the stock is almost half the rating it was 10 years ago.  

If a key motivation is to enable scrip-based M&A, the reduction in multiple makes any potential acquisition less appealing.

Source: Bloomberg as at 7 January 2021.
Has the dual listed structure impacted BHP’s ability to do M&A?

In our view, none of the reasons BHP is proposing as rationale for the collapse of the DLC structure would stand in the way of BHP executing its strategy.  

The DLC structure was consciously put in place by BHP, at its discretion, at the time of the Billiton merger. It has now been in place for 20 years and through this time BHP has had no issue implementing its strategy or accessing capital.

BHP has a strong balance sheet and access to debt and equity capital markets across multiple geographies and listings.

In the preamble to the US Onshore petroleum stake in 2017 — and under activist shareholder pressure — BHP vigorously defended the DLC structure and concluded it was too expensive to unwind.

Most of the costs associated with the DLC collapse have increased in the interim and are expected to be $350mln to $450mln. 

But M&A is not always a good thing…

We respect the BHP Board and management. However, we do note how difficult it is to execute effective, large-scale deals in the resources sector.

To highlight this, there are a number of examples of unsuccessful transactions under former BHP management. These include:

  • The merger with Billiton. After 15 years, BHP chose to demerge most of the Billiton assets into South 32 (S32), since they did not meet BHP’s standards of being low cost and long life. The demerger resulted in de-rating of the S32 earnings of about 33%, which persists today. 
  • The 2011 acquisition of PetroHawk and Fayetteville for U$15.1bn and US$4.8bn respectively. An additional US$18.9bn was spent on the assets during ownership. Ultimately these assets were sold for US$10.8bn in FY18 after an attributable EBIT loss of US$5bn during ownership. 
  • The 2005 acquisition of WMC Resources. This includes Olympic Dam and Nickel West. Neither asset has fulfilled the original expectation of returns.
  • There was also the failed attempted acquisition of Potash of Saskatchewan (Canada) in 2011 at a price that subsequently fell away materially. 

BHP has had cumulative write-downs of $22.9bn since 2001. Much of this relates to assets bought at too high a price. 

M&A in the resource sector is difficult. The likelihood is that value accrues to the acquired company’s shareholders.  

That Australian shareholders wear the current value destruction from the collapse of the DLC just to simplify M&A in the future is challenging to accept. 

Isn’t this really about the de-merger of the petroleum business?

In our view, reassessment of the DLC structure is tied to the decision to de-merge the petroleum business. 

While BHP has stated it would go ahead with the demerger even if the DLC was not collapsed, the company has highlighted that it would make the process simpler. 

We believe these two strategic decisions need to be evaluated separately.

And, again, we are not sure it is in the interests of Australian shareholders to accept the value destruction of the DLC collapse for a simpler demerger that may or may not go ahead. 

Are there broader implications for the market?

The consolidation of BHP on the ASX will see its ASX 200 index weight rising from about 5.8% to about 9.6%. 

While this is not the concern of BHP management, taking a macro view highlights that such a concentration of index weighting is not ideal for Australian broad market investors. It reduces diversification and impacts expected risk-adjusted returns.

It certainly will, however, lead to an increase in ‘non-discretionary holdings’ from index funds and those managing benchmark risk. This could reduce active shareholder pressure on management. We would strongly argue that this is not in the long-term interest of BHP shareholders.

Conclusion 

We appreciate the company’s motivation for seeking to collapse the DLC structure in terms of simplifying management of the organisation.

BHP PLC shareholders will also benefit from this one-off gain, though many of those with current PLC stock may not ultimately be long-term holders. This is why there is very little push-back on the proposal.  

But in our view, as detailed above, this proposal is clearly not in the interests of Australian BHP Ltd shareholders.

Given the clear value destruction and the questionable benefits accruing from the change, Pendal will be voting shares under its management against the proposal.


This document has been prepared by Pendal Institutional Limited (PIL) ABN 17 126 390 627, AFSL No 316 455 and the information contained within is current as at 10 January 2022. It is not to be published, or otherwise made available to any person other than the party to whom it is provided. This document is for general information purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their or their clients’ individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information in this document may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information in this report is complete and correct, to the maximum extent permitted by law neither PIL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information.

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