BHP’s expensive date with the Anglo directors

It may be an expensive date, but BHP has finally forced the Anglo American board to sit down and engage with it.

At close to $10 billion – or about 25 per cent – more than BHP initially offered, the extra cost of that engagement is steep, but after weeks of being cold-shouldered by its target, the world’s largest miner will now be able to put a detailed case for what’s now a $74 billion takeover bid to Anglo directors.

Having been cold-shouldered by Anglo American for weeks, BHP has finally got its board to engage with its offer.Credit: Bloomberg

The revised offer, equivalent to about £31.11 ($59.77) a share, has been rejected, just like BHP’s two previous offers of £25.08 a share and then £27.53. However, in extending the deadline for a formal offer by a week to May 29 and agreeing to engage, it was notable that Anglo’s board said little about the offer’s value and instead based its rejection on the deal’s structure.

The BHP proposal has retained its original structure, with a demerger of Anglo’s separately listed Kumba Iron Ore and Amplats platinum metals subsidiaries ahead of a successful acquisition.

For BHP, the two demergers are a non-negotiable element of the bid. It’s not going to pay a big premium for unattractive assets that it doesn’t want, and in a subsequent demerger would probably have to sell at a discount to their sharemarket value.

Anglo’s board said it continued to believe there were serious concerns with that plan, given that it was likely to result in material completion risk and value impact that it says would fall disproportionately on Anglo shareholders.

The shift in focus from value to execution is a significant one for BHP’s prospects of success.

Over the next week – the duration of the extension to the period which, under London takeover rules, BHP is obliged to either proceed with an offer or walk away – BHP will have an opportunity, which it had previously been denied, to directly respond to Anglo’s concerns.

Anglo wouldn’t have agreed to the extension, or the engagement, if (a) the value of the revised offer wasn’t in the ballpark of something the board could accept or (b) it wasn’t at least prepared to contemplate recommending an offer.

BHP, obviously, believes it can assuage Anglo’s concerns. It has done a lot of work on how it would execute the twin demergers central to its proposal and what they might cost.

It doesn’t believe the planned transactions are as complex, risky or costly as Anglo has depicted them and appears confident that it can convince the target company’s directors its plan is actually less risky than the alternative that Anglo’s management unveiled last week.

Anglo’s response to the bid also involves a demerger – of its Amplats business – along with a number of major asset sales and the effective mothballing of its cash- and capital-devouring $US9 billion ($13.6 billion) Woodsmith crop nutrient project in the UK.

Both BHP’s planned demergers and Anglo’s single demerger would require regulatory approvals in South Africa and elsewhere, and both would trigger very substantial capital gains tax windfalls for the South African government.

The capital gains tax liability in BHP’s plan has been estimated at close to $US2 billion, so Anglo’s single demerger would also involve a very large tax bill.

The shift in focus from value to execution is a significant one for BHP’s prospects of success.

BHP isn’t fazed by the regulatory requirements or the execution risks and costs, having managed through the larger and far more complex (in terms of structure, products and geographies) demergers of BH South and BHP Petroleum. Both Kumba and Amplats are already separately listed, making the spin-off process far more straightforward than the BHP transactions.

BHP is also said to have worked up detailed costings, including the cost of regulatory concessions, of its planned demergers, which might help allay some of the Anglo board’s fears.

Moreover, under the structure BHP has proposed, with Anglo shareholders now ending up with 17.8 per cent of an enlarged BHP via the all-scrip offer, BHP existing shareholders would wear more than 80 per cent of the costs and risks associated with the demergers and any other asset sales post-completion.

Under Anglo’s plan, its shareholders would be exposed to the costs and risks of its restructuring, with the cashflow-constrained company having to sell a prized asset, its Queensland metallurgical coal mines, to fund what it says will be an 18 to 24-month process of shedding not just Amplats, but also its De Beers diamond and nickel operations. It’s proposing to sell five major sets of assets in five different jurisdictions.

It also plans to put the Woodsmith project – a unique and uniquely attractive “unicorn” project, according to Anglo – on care and maintenance because Anglo can’t fund it by itself.

It’s not as though there aren’t costs and execution risks in the Anglo alternative. There’s no certainty that Anglo can see through its proposed restructure and sell the assets it has targeted at acceptable prices within the timeframe it has set itself.

If the BHP bid were to succeed, not only would Anglo shareholders gain a large takeover premium – BHP calculates it at 47 per cent over the price at which Anglo shares traded before it made its original offer – but they would also gain an exposure of almost 18 per cent to the considerable synergies BHP ought to be able to extract from bringing Anglo’s South American copper and iron ore operations and Queensland coal mines next to its own, while shedding the costs of Anglo’s head office and its South African businesses.

Within BHP’s announcement of its latest bid, the mining giant said it was its “final” offer and would not be increased … unless a third-party bid for Anglo, or Anglo’s board announced it was minded to recommend an offer on better terms.

That sparked immediate interest: Did it mean BHP was prepared to contemplate another, even higher, offer?

Apparently not. The language in the statement is London Takeover Code boilerplate.

Mike Henry and his chairman Ken MacKenzie know that a fourth bid – bidding against themselves for a third time – would jeopardise their hard-won reputation for disciplined capital allocation and risk a revolt by their shareholders. When Henry said the bid was final, it appears he meant it.

The Anglo board and some Anglo shareholders might consider BHP’s intense interest in Anglo – an interest driven primarily by its high-quality copper assets – a put option that would protect them if Anglo were to bungle its own deconstruction.

If Anglo executes perfectly and emerges as a less-leveraged group with only its South African and Brazilian iron ore businesses and the copper unit, its shareholders might even get a higher offer in an environment where the offloading of most of the poison pills Anglo has in its current portfolio might attract a wider range of potential bidders.

There are a lot of “ifs” in those scenarios, not the least of which is that time moves on.

Who knows what BHP might do over the next two years or so? Its strategies might have evolved, or the external settings for the volatile resources sector might have changed significantly.

BHP might even have a different chairman, with less of an appetite for acquisition risk than MacKenzie who, in his former role as chief executive of Amcor, gained a stellar reputation for his successful execution and integration of a multitude of takeovers.

Will Anglo, with its weak balance sheet and constrained free cash flows, be prepared to expose its shareholders to all the risks and costs of its complex strategy, or would it be better to take BHP’s premium and allow BHP shareholders to wear the bulk of the costs and risks of its plan?

In a week’s time BHP, and the rest of us, should be closer to an answer.

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