BHP stalker Elliott thwarted, for now
Activist shareholder Elliott’s campaign for changes at BHP will struggle even more for traction this year, but it’s patient.
When Elliott first approached BHP with its radical plan for restructuring the group in about October 2016, the iron ore price was below $US60 a tonne but about to start a run that saw it climb to almost $US90 a tonne in February last year, before tumbling back below $US60 a tonne in June. It subsequently recovered and is currently just under $US78 a tonne.
The oil price was below $US60 a barrel at the start of October 2016, was about $US56 a barrel when Elliott first publicly disclosed its proposals for BHP in April last year and is now trading at just under $US62 a barrel.
The original Elliott proposal involved collapsing BHP’s dual-listed entity structure, shifting its incorporation and primary listing to the UK, spinning off or selling its petroleum business and committing to a $US33 billion or so five-year program of share buybacks. The proposed changes to BHP’s incorporation and listing were abandoned after it became clear that the Australian government was never going to allow that to occur.
When it emerged publicly Elliott disclosed that it had an economic interest in BHP’s UK entity of just over four per cent. Subsequently it has said it now holds a five per cent interest.
It’s not clear how Elliott accumulated its initial interest — its physical holdings on the BHP register have never reflected the holdings it has claimed — but the public limited company (plc) share price has risen about 47.5 per cent from about the time the group approached BHP in 2016 to today.
Had it done nothing but passively hold the exposure to BHP’s UK vehicle it would be the best part of $1 billion in front.
It doesn’t appear, however, that Elliott has done nothing.
As Elliott engaged with BHP and built its interest in the London listing short positions in Rio Tinto, in particular, but also in BHP’s Australian-listed entity and Fortescue Metals rose.
The market has concluded that Elliott, in what would have appeared a sensible piece of risk-management, hedged its “long’’ position in BHP’s plc entity with short positions against BHP’s Australian entity, Rio and Fortescue.
The underlying objective of the Elliott campaign was to close the discount at which the plc shares traded relative to BHP’s Ltd shares, so it would make sense to hedge the exposure to the UK entity so as to make the exercise a pure arbitrage play focused on the gap between the plc and Ltd shares.
The somewhat unexpected strength of the iron ore price has been particularly beneficial to BHP and Rio Tinto, given the quality of the ore they produce meant they have been among the biggest winners from the Chinese government’s restructuring of its steel industry to focus on more efficient and cleaner output, which requires higher quality inputs. BHP’s status as the largest producer of seaborne metallurgical coal has generated an additional and very substantial bonus from China’s policies.
The extension and effectiveness of OPEC’s production limits has been the major factor in the recovery in oil prices, which benefits BHP uniquely among the major mining groups.
If it has, as the market suspects, largely hedged out its exposure to the movements in BHP shares other than the relationship between the two legs of the dual listed entity structure, the resurgence of the iron ore and oil prices represent a very large missed opportunity.
While the discount at which the plc shares have historically traded relative to the Ltd version has fluctuated, and there were moments last year where they briefly outperformed the Ltd scrip, there has been no structural change to the relationship. On a straight currency conversion the plc units are still trading on a low double-digit discount to their Australian counterpart.
It is worth noting that since the time Elliott first approached BHP, the Australian-listed shares have risen nearly 40 per cent. Rio’s shares have performed even more strongly, rising about 47 per cent. Fortescue shares are up only about seven per cent — it lower-grade ore means it has suffered a larger than historically usual discount on the prices it receives relative to its larger Pilbara rivals.
The strength in Rio’s share price over much of the period since Elliott began its play would tend to suggest that the hedge, if indeed there is one, would need to be actively managed to protect the US group from loss.
It isn’t necessarily the case, of course, that the plc exposure would be completed offset by short positions elsewhere, in which case Elliott would be in front on the exposure given the solid performance of the plc price.
For the most part, the rebound in commodity prices — and the success of BHP’s own efforts to generate cost reductions, productivity gains and disciplined capital allocation — has undermined Elliott’s efforts to generate any momentum for its campaign for changes to BHP’s structure and policies.
The exception is BHP’s ill-timed and overly expensive foray into the US shale oil sector. While BHP has refused to contemplate a complete withdrawal/demerger of all its oil and gas interests — it remains committed to its conventional oil and gas business — it has accepted that it should exit the US onshore oil and gas sector.
It is running a three-option program of establishing the optimum approach to cashing out its US interests, with trade sales to parties with contiguous interests the most complicated but potentially most rewarding option. A simple trade sale to one buyer or the demerger favoured by Elliott are the other possibilities for dealing with the US assets.
While BHP has taken some very heavy writedowns on its US onshore business, the potential to release more than $US10 billion of cash means there is no particular urgency to the process. The focus is on maximising the amount of value recovered for shareholders.
With a new chairman, Ken MacKenzie, committed to ensuring BHP is more disciplined in its capital allocation decisions in future than it has been in the past — and a chief executive, in Andrew Mackenzie, who has delivered that discipline since being appointed CEO four and a half years ago — if the iron ore and oil prices hold up BHP shareholders will be showered with cash returns, either through special dividends or share buybacks, or perhaps both.
That would suggest that, unless there is a significant crash in commodity prices again, an Elliott campaign that failed to gain any real traction last year is going to find it even harder to generate any meaningful interest among BHP shareholders in 2018.
Its history, however, says it is a very patient stalker, prepared to wait years for its pay-off. In a sector with big cycles at some point in future, if BHP were seen to stumble, there’s probably going to be an opportunity to relaunch the campaign if Elliott is prepared for what could be several, perhaps many, years of waiting for it.
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