BHP Billiton: Unlocking Value for Shareholders

The Oxford Income Weekly Issue #96

BHP Billiton (NYSE: BBL) shareholders are cheering the company’s decision to unlock value by spinning off its South32 subsidiary. The separation of the two companies will serve two purposes:

1. It simplifies BHP Billiton’s existing business. The company will now operate 19 mining assets on three continents instead of 41 assets on six continents. The smaller geographical area will be easier and less costly to manage. The move is estimated to save at least $100 million annually. Additionally, BHP Billiton will focus on oil and iron ore while the new division will mine manganese, nickel, coal and aluminum.

2. Shareholders will get paid. Shareholders will receive shares and dividends in the new company, while maintaining the existing shares and dividend in BHP Billiton.

That last point is key. Often, when a company spins off a division, the dividend is reduced to reflect the lower earnings and cash flow.

However, BHP Billiton’s management emphasized that there will be no adjustment to the dividend and that it aims to continue to raise it as it has done every year for 12 years.

Shareholders who own the American Depositary Shares (ADS) will receive 0.4 shares of South32 for every one ADS of BHP Billiton. This is not an exchange. You will still own all of your shares of BHP Billiton and receive an additional 0.4 shares of South32.

Once you receive the ADS shares of South32, you are free to keep them or sell them on the open market. Note that your shares of BHP Billiton will likely fall by the price of the new South32 shares.

Shareholders located outside the U.S – in Great Britain, Canada, Australia, South Africa, New Zealand and a few other countries – can sell their South32 shares directly through the company without paying any brokerage fees. You’ll have to fill out a Share Sale Facility Form, which must be received by BHP Billiton by May 22. You do not have to sell your shares, however. You are free to keep them if you choose. It’s simply an option to sell the shares directly through the company.

U.S. shareholders do not have that opportunity. If a shareholder located in the United States wishes to sell his or her South32 shares, they will have to do so in the open market when South32 begins trading.

The spin-off (also being called a “demerger” by the company) is up for a shareholder vote. You should receive voting instructions shortly, if you haven’t already. I recommend you vote for the transaction to occur. You’ll still receive the great 5%-plus dividend of BHP Billiton and receive another dividend from South32. The company said that South32 will pay out 40% of its earnings in the form of dividends. We don’t know what that will be yet and commodity prices are low, so it has plenty of room to grow.

I have not decided if we will keep the shares of South32. I’ll want to see some financial statements from the separated company before making any moves, so it may be a few months until we do anything.

But take a look below to see how this demerger is set to unfold.

It’s important to note that you may have to adjust your stop on BHP Billiton as we get closer to the transaction date. As I mentioned, the share price of BHP Billiton will drop by roughly the price of the new shares of South32. That could trigger your stop, depending on your broker.

Every broker has different rules regarding this type of situation. You can call your broker to ask how they handle stops and spin-offs. If they tell you that they automatically adjust them to account for the spin-off then you won’t have to do anything. However, many do not. So in early May, I will send out an email recommending that you temporarily remove the stop on BHP Billiton to ensure you don’t get accidentally stopped out. Once the deal is complete, we’ll put the stop back in.

But you don’t have to do anything now. I’ll remind you in May. I just wanted to let you know this will occur so you’ll know to look for it.

BHP Billiton has worked out great for us so far. We’re up about 13% compared to the S&P 500, which is up less than 4% during the same period. We’re getting a near 6% yield that’s also about to go higher with the new South32 dividend.

If you don’t yet own BHP Billiton, it is still a “Buy” in the Instant Income Portfolio.

Mailbag

How do you project the performance of REITs, MLPs, BDCs and closed-end municipal bond funds as interest rates are increased? You have several of each of these in The Oxford Income Letter.

– Gary B.

Note that I do not have any municipal bond funds in The Oxford Income Letter. I do not like bond funds in this low interest rate environment as I think they are guaranteed to lose money over the long term.

Any investment based on fixed income will decline in value as interest rates rise. So a closed-end muni bond fund and many REITs will decrease.

However, not all REITs will. Many of them have riders that increase the rents to keep up with inflation. Several of our positions should be relatively unaffected. Digital Realty Trust (NYSE: DLR) is not your typical REIT. It rents out space in server farms, so it doesn’t have the same correlation to real estate that most REITs have. Omega Healthcare Investors (NYSE: OHI) is a nursing home landlord, so it also is not closely correlated with the usual real estate cycle.

MLPs shouldn’t be impacted too much either as their share prices and dividends are usually based on cash flow. That is, unless the company borrows a lot of money to build its pipelines or other assets. Then as interest rates rise, so will its borrowing costs.

BDCs often have much of their assets invested in fixed-term loans, so higher rates can lessen the value of their portfolios. One of our positions, however, New Mountain Finance Corp. (NYSE: NMFC) has stated that a one percentage point increase in rates will have a small negative effect on net investment income but if rates go up two percentage points or more, the change will be positive.

Lastly, higher interest rates could negatively affect share prices of any dividend payer as conservative investors may flock to less risky assets than stocks, such as bonds or CDs. Long term, however, Perpetual Dividend Raisers should continue to outperform nearly every other asset class as they have for decades.

Hoping your longs go up and your shorts go down,

Marc

New Portfolio Highs for the Week

Instant Income Portfolio

Meredith Corp. (NYSE: MDP); Raytheon (NYSE: RTN)

Compound Income Portfolio

Darden Restaurants (NYSE: DRI); The GEO Group (NYSE: GEO); Meredith Corp. (NYSE: MDP); Raytheon (NYSE: RTN)

Retirement Catch-Up/High Yield Portfolio

Macquarie Infrastructure Company (NYSE: MIC); New Mountain Finance Corp. (NYSE: NMFC)

Oxford Income Ex-Dividend Alert