Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

So much for that.

Elliott Management Corp.'s three-step plan to increase the value of BHP Billiton Ltd. by about 50 percent looks to have been shot down by Australia's government.

Allowing the business to reincorporate in the U.K., a central plank of the proposal, would be "unthinkable," Treasurer Scott Morrison said in a statement Thursday. BHP might be committing a criminal offense if it tried to carry out such an undertaking, he added.

That feels pretty definitive -- but there's still the germ of a good idea to be rescued from the wreckage of Elliott's activist campaign. The second part of the plan is something that Gadfly has long favored -- a separation of BHP's oil and gas business.

Black Beauty
BHP's petroleum business accounts for more than a fifth of its underlying Ebitda
Source: Company reports
Note: 2016 calendar year figures.

BHP is unusual in owning oilfields as well as mines. There are few obvious synergies between the businesses, and since the world's oil majors sold out of their coal units over the past few decades, natural resources companies have tended to focus on either solids or liquids.

As a standalone business, BHP's petroleum division would count as one of the world's major exploration and production companies. Output of 240 million barrels of oil equivalent in the most recent fiscal year would have made it the sixth-biggest purely upstream business globally, according to data compiled by Bloomberg.

Big Oil
BHP's petroleum unit would be one of the largest upstream companies on its own
Source: Bloomberg, company reports
Note: MMboe = million barrels of oil equivalent. Integrated oil & gas producers have been excluded.

It looks even better in terms of earnings. Adjusted Ebitda of $3.44 billion over the most recent 12-month period would put the BHP business behind only China and India's state-owned upstream companies and Anadarko Petroleum Corp., the data show.

Earning Its Place
Trailing 12-month adjusted Ebitda at BHP's petroleum business would make it a world leader
Source: Bloomberg, company reports

What might such a company be worth? Elliott has argued for a spinoff of BHP's assets in the Gulf of Mexico and onshore U.S. and puts a price of $22 billion on the business -- but those assets account for less than half of the unit's earnings, with offshore Australian fields making up most of the remainder.

A bolder strategy would be to separate a more diversified oil and gas business that includes the Australian assets. Based on multiples for Devon Energy Corp., EOG Resources Inc., Anadarko, Occidental Petroleum Corp. and Woodside Petroleum Ltd., BHP's 240 million barrels of annual oil production and $3.44 billion of Ebitda would have an enterprise value as high as $58 billion.

What's It Worth?
BHP's petroleum business could be a major player if it was valued like its peers
Source: Bloomberg, company reports, Gadfly calculations
Note: BHP valuations based on multiplying reported earnings, production and reserves figures by median multiples of peer group companies. Reserves multiples based on proven reserves only.

That might be overstating it, given BHP's relatively low reserves of oil in the ground. The company would burn through its remaining 1.3 billion barrels of proved reserves in about five-and-a-half years at 2016's production rate, compared with a median of 10 at the peer group. But even on a reserve-based multiple, the business could be worth $31 billion.

BHP investors don't seem to be seeing the value of that in the share price. A very rough sum-of-the-parts valuation of Rio Tinto Group using enterprise value-to-Ebitda multiples gives a valuation of $69.6 billion, pretty close to its current market capitalization of $70.6 billion.

Do the same exercise on BHP's iron ore, copper, petroleum and coal units and you get a figure of about $124.4 billion. That's well above the $86.2 billion the market currently assigns to the company, and pretty much in line with the 50 percent uplift that Elliott sees from its three-part plan. Using the more pessimistic reserves-based multiple for the petroleum unit, it would still be worth $96.4 billion.

Bargain Bin
BHP trades much further below its sum-of-the-parts enterprise value than Rio Tinto
Source: Bloomberg, Gadfly calculations
Note: Chart segments show theoretical valuations based on multiples of 3.5 (iron ore), 12.2 (copper), 8.1 (aluminum), 17.1 (petroleum), 7.2 (coal), 15.9 (titanium), and 5.6 (diamonds).

Why has BHP remained so reluctant to consider a spinoff, particularly in the wake of its largely successful separation of South32 Ltd.?

Management remain deeply attached to the idea that there are under-appreciated benefits from having a foot in both solids and liquids. BHP has been involved with oil and gas since the 1960s, when it drilled Australia's first offshore well with Esso. Chief Executive Officer Andrew Mackenzie is a veteran of BP Plc, whose enthusiasm for petroleum is undimmed by the tendency of the business to underperform the company's iron ore and copper units.

And then there's that $27 billion uncertainty around valuation. If you could increase shareholder value by 44 percent, a petroleum spinoff would be a no-brainer. For a 12 percent uplift, it's probably not worth the candle.

Still, there's enough of an argument there for any activist shareholder looking to convert fund managers to its cause -- and Elliott founder Paul Singer, who spent 13 years suing Argentina over its 2001 sovereign default, isn't shy of a war of attrition. Round one of this game goes to BHP. There's all to play for in round two.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Freeport McMoRan Inc., one of the handful of other miners to also drill for petroleum, sold much of its oil unit last year and now tends to avoid talking about the business, as if it was an embarrassing uncle.

     

  2. We're excluding integrated oil businesses such as Exxon Mobil Corp., BP Plc and PetroChina Co., which have upstream and downstream operations.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net