BHP looks to trim the fat and focus on its core
Mining giant BHP Billiton has signalled a possible demerger of mining assets worth an estimated £11bn as the company sharpens its focus on its core businesses. According to an April statement, the company now feels a portfolio focused on iron ore, copper, coal and energy assets would generate stronger growth in free cash flow and a superior return on investment. But what would such a massive divestment mean for the industry?
Anglo-Australian mining multinational BHP Billiton has responded to ongoing media speculation about a large-scale divestment from non-core markets by confirming that a review of its aluminium and nickel operations is underway. The disclosure came after a series of reports suggested that the company was weighing up the possibility of disposing up to $20bn worth of assets.
In response to the reports, BHP issued a statement to clarify its position. It said: "As we have said previously, the simplification of our portfolio is a priority and is something we have pursued for several years. We believe that a portfolio focused on our major iron-ore, copper, coal and petroleum assets would retain the benefits of diversification, generate stronger growth in free cash flow and a superior return on investment. By increasing our focus on these four pillars, with potash as a potential fifth, we will be able to more quickly improve the productivity and performance of our largest businesses."
As Brian Soh, associate analyst at StocksInValue, explained, dispersing the non-core assets would not have a huge impact on BHP profitability. He said: "A demerger of these non-core assets would markedly reduce revenue, however there would only be a small reduction in earnings given the assets to be demerged have a very low margin relative to the core assets."
Assets earmarked for disposal
While the London listed firm has so far commented only on its nickel and aluminium offerings, it is also believed to be eying up the offloading of its manganese and thermal coal assets. The motivation behind the divestment is to enable it to free up capital expenditure on areas that offer either unfavourable returns or where it doesn't have a large enough footprint and focus on its core markets.
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In the case of both aluminium and nickel, the company has cited 'structural oversupply' as the reason behind looking to offload. Aluminium prices have suffered over recent years as a result of a significant increase in output from China, which has been powered by subsidised electricity, while the long term prospects of nickel are currently clouded by an Indonesian export ban on unprocessed ore.
Manganese has been touted as another potential candidate for divestment as it is seen as not holding a large enough return for a company the size of BHP, while the low long-term growth prospects of thermal coal appear to put it in the shop window. Offloading the assets would leave the company focused on its main market of iron ore alongside significant assets in the copper, coal and energy markets, with potash also touted as an area of continuing interest for the firm.
Spin-off or sell-off
According to Albert Minassian, an analyst at Investec, the company is likely to be considering a number of ways to offload the assets: "It is not a time for big valuations; otherwise they might have done these deals already. They've got to get a situation where the buyer can do something with the divested assets. That's why one of the considerations is that they might just spin it out and let the market decide what it is worth, without really selling it. Just package it in another company and spin that one out. It's an option, I don't think it's the most likely, as they will definitely try and find buyers for a clean break."
Offloading the assets in this way would see the firm set up a new company to take ownership of all the unwanted operations and then offering it up to the stock market in an initial public offering. This prospect is strengthened by the indication that other major players may also be willing to offload unwanted assets, opening up further scope for growth for the new firm. Rio Tinto has long been in the market to sell its aluminium assets but has yet to receive a satisfactory offer, while Anglo-American has also admitted that it would sell at the right price.
Hedge fund Macquarie Private Wealth believes the 'spin-off' to be the preferred choice of BHP, stating: "For a company that chooses its language carefully, this strengthening terminology appears to support the idea of growing momentum and growing determination behind a potential spin-off."
However, the company believes that the mixed bag nature of the non-core assets would complicate matters: "Given the largely unrelated nature of many of BHP's divestment candidates - the only common thread is that none are in the four pillars - we believe it is unlikely that BHP would be able to package up all of these into a single entity to be spun off."
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An alternative is for the firm to break up the assets into smaller packages and sell them off to existing players. Glencore Xstrata, which operates in a diverse number of markets, has already confirmed that it is assessing whether or not to bid for the Nickel West operation. The commodity trading and mining multinational has existing operations close to the asset, so may find it an attractive proposition. The company may also be a candidate for manganese and thermal coal assets, though it is yet to state its position.
Another potential buyer is the former Xstrata boss Trevor Reid. Reid, who stepped aside after Xstrata merged with Glencore, has already raised $3.75 billion in investment for X2 Resources and has confirmed that the company is in talks with BHP over acquiring its thermal coal assets.
The top ten iron ore producers account for over 90% of the world’s total iron ore output.
Should the spin-off prove too difficult to complete, the problem asset to offload is most likely to be aluminium. With BHP, Anglo-American and Rio Tinto all admitting either offering out assets in the area, or at the very least open to offers, there is no shortage of supply on the market. But the lack of deals done so far suggests a distinct lack of demand.
Minassian though, believes that there is still scope for the bleak prospects to brighten: "Every commodity has its day so you might find that in three or five years from now that Chinese electricity costs have gone up a lot because the fuel has gone up a lot, or they need it to sustain the economy or for any other reason. So you might find that in five years, it's not so cheap for the Chinese to make aluminium."
Should that happen, the picture will look very different: "All of a sudden, the world becomes a more balanced place for that commodity and anyone buying this now will look good in five years' time."