Plan to end BHP Billiton dual-list structure won’t get past treasurer

The treasurer, on advice from FIRB, would have to approve the transfer of BHP’s domicile and primary listing from Australia to the UK. Pic: AFP

It is apparent from the presentation that US activist Elliott Management made for its proposed radical restructuring of BHP Billiton that a core premise is that unifying the two entities within the current dual-listed company structure would create value. The evidence suggests that wouldn’t necessarily be the case.

In its presentation Elliott says that unification of the Ltd and Plc entities would eliminate the “trading mismatch’’ between the two lines of shares “which has undermined the fundamental objective of BHP’s DLC structure since inception.’’ It also said it would resolve the “lack of fungibility’’ between Plc and Ltd shares.

It is true that the Ltd shares have generally traded at varying levels of premium to Plc shares since the merger of BHP and Billiton in 2001. It is also true that the shares aren’t fungible, even though they entitle shareholders in the two entities to the same dividends and cash flows per share.

That has, however, been an observable fact since the DLC structure was pioneered by Royal Dutch Petroleum and Shell Trading in 1907.

BHP, like Rio Tinto when it absorbed CRA, used the structure to avoid a major tax liability at the point of the merger as well as to capture Billiton shareholders within the Plc structure rather than have them sell out of the merged group.

It retained a much larger shareholder base and two pools of shareholders in two different jurisdictions with two different capital markets to access rather than experiencing the “flow back’’ that occurs in conventional cross-border takeovers as target company shareholders sell out.

To comply with UK merger accounting rules and minimise the tax implications the structure as moderately generous to Billiton shareholders, who ended up with effectively 40 per cent of the DLC against Ltd’s 60 per cent.

That meant that the larger pool of shareholders and liquidity was structurally located in Australia rather than London.

There’s been a lot of academic analysis of DLCs and the way the shares in the two entities trade, including a 2002 study by our Reserve Bank. All have identified the general “mismatch’’ or discrepancies in value between shares with identical economic interests.

While there are no definitive explanations as to why that might be the case there are a number of strands that might explain a phenomenon that would conventionally be expected to be arbitraged away.

The obvious answer is that the shares aren’t identical. They are securities priced in different currencies and traded in different jurisdictions and markets and which can’t directly be exchanged. They have different weightings in each of the markets’ stock exchange indices and the liquidity in Ltd shares is much deeper than that in Plc shares.

In practice, the shares with the primary listing with the deeper liquidity trades at a premium to its sibling. For Rio, where UK shareholders ended up with 77 per cent of the DLC, that has meant the Plc shares trade at a premium to the Australian listing. For BHP, with the 60:40 split between Australia and the UK, the obverse has applied. The same has been generally true of all the DLCs.

The RBA analysis and other studies have found that the entities also tend to trade in line with their own markets. Ltd is a far bigger component of our market than Plc is of the UK’s but also the markets themselves can trade differently, depending on their different economic settings.

Thus it isn’t the structure that causes the “mismatches’’ in value but the different home market economic and equity market conditions and the different significance of the entities within them.

Elliott proposes to shift BHP’s incorporation and primary listing to the UK, with Australian investors exposed to the group via CHESS depositary interests. In its presentation it says that would cost former Ltd shareholders about $US1 a share, while former Plc shareholders would gain $US1.50 a share.

In other words the unification would shift value from the majority of BHP shareholders to the minority who invest via Plc.

Elliott said that BHP would continue to be Australian headquartered, would be an Australian tax resident and would be managed from Australia. With the post-unification fungibility of BHP shares and the opportunity for more efficient use of franking credits the investor base would migrate towards Australian tax residents that could take advantage of those credits, it said.

There have been previous unifications of DLCs, most notably the collapse of the Shell DLC in 2005 and, in our market, Brambles in 2006. The RBA analysis showed that post-unification the prices of the shares that had traded at a discount effectively rose modestly and the price of the entity that traded at a premium effectively fell modestly.

It said that it wasn’t possible to reach strong conclusions about the way markets value DLC structures versus unified structures, saying that all the results from its analysis pointed to a model where asset prices were determined by more than fundamentals and were influenced by the location of trade, the investors who trade them and the manner by which the trading occurred.

Thus, whether it’s within a DLC or a single company operating via a primary listing in the UK and a CHESS depositary interest in Australia there will almost inevitably be differences in valuation driven by the different contexts the markets are operating in.

Elliott thinks unification is essential in order to unlock BHP’s $US9.7 billion store of franking credits.

That’s not necessarily the case. While BHP would never use the word, the DLC structure actually allows it to “stream’’ dividends and direct the franking credits towards shareholders in Ltd, not all of whom can use them, given that there will be a significant proportion of foreign investors on the Australian register.

It could do, and has done, an off-market buyback of Ltd shares where those who valued the franking credits most would bid the biggest discounts, benefiting all other shareholders in the DLC in the process by leveraging the impact on the group’s performance statistics.

As it happens, despite Elliott’s confidence that the unification proposal wouldn’t face an obstacle in the form of the Foreign Investment Review Board because the Australian headquarters, the tax residency and a form of local listing would be retained, the concept might not even get past first base.

It is the treasurer, on advice from FIRB, who would have to approve the transfer of BHP’s domicile and primary listing from Australia to the UK in the knowledge that the past experience of DLCs and their unifications would suggest that the UK would become the primary market in BHP shares over time.

At some point in future that would place a question mark over the location of the group’s real headquarters and, given that it would be incorporated in the UK, the ability of Australian authorities to govern or influence its board and management.

No Australian treasurer is going to take any risk of losing the centre of organisational gravity of one the country’s largest companies and one of the new locally-based global leaders in its sector, particularly if the transaction is, thanks to the accelerated and deeper access to BHP’s franking credits envisaged by Elliott, largely tax-driven.