Demergers are a significant strategy in corporate restructuring, where a business is broken down into distinct components. This approach allows large corporations to untangle various business units or assets with the aim of enhancing efficiency and profitability. However, the question remains: does this strategy genuinely unlock value, and does it serve the best interests of shareholders? Let’s explore this through the case study of BHP and South32.
In 2015, BHP, a leading multinational mining, metals, and petroleum conglomerate, executed a demerger, spinning off select non-core assets to establish a new entity: South32. Before the split, BHP’s Billiton assets were underperforming, as evidenced by a significant decline in market capitalization from $301 billion in 2009 to $123 billion in 2014. Faced with this downward trend, BHP chose to streamline its operations, transitioning from a conglomerate with 41 operating assets to a leaner entity with just 19 assets across five key sectors.
The decision to pursue a demerger rather than divestment was not arbitrary. In an environment characterized by falling commodity prices, the market for mining assets was unfavorable. Other industry players were facing similar challenges, prompting a need for adaptation. In this context, the demerger emerged as a practical solution, enabling BHP to discard underperforming assets without depending on reluctant buyers.
However, demergers come with a substantial cost. The South32 demerger reportedly incurred costs nearing $700 million, reflecting the complexity and intricacies involved in such operations. Despite the financial implications, the strategic rationale behind the demerger was clear: to streamline operations, enhance focus, and ultimately restore shareholder value.
Now, let’s evaluate the outcomes for both BHP and South32 following the split.
South32: A Case Study
In the lead-up to its inception, South32 faced skepticism from analysts, earning monikers like “CrapCo” or “DudCo.” Composed of second-tier assets primarily centered around bauxite, alumina, aluminum, copper, zinc, lead, metallurgical coal, and manganese, the company embarked on its journey with tempered expectations.
However, South32 quickly defied its initial perception, exhibiting remarkable growth in its nascent years. Its market capitalization surged from $4.13 billion in 2015 to $14.09 billion by 2017, marking an impressive ascent. Yet, despite this initial momentum, South32 encountered challenges in sustaining its enterprise value, witnessing fluctuations from $17.65 billion in June 2015 to $14.73 billion today.
Since its inception, South32 has focused on three key areas, as per their 2015 annual report:
- Dividends: South32 intended to distribute a minimum of 40% of Underlying Earnings as dividends to its shareholders following each six-month reporting period.
- Portfolio Focus: South32 aimed to maintain a diversified portfolio of high-quality, cash-generative assets and a strong balance sheet.
- Share Distribution: As a result of the demerger, each eligible shareholder received one South32 Limited share for each BHP Billiton share held on the applicable record date.
So, how have these key pillars turned out in terms of shareholder value? Let’s look at the past five years. Since its inception, South32 has had a Compound Annual Growth Rate (CAGR) of 8.17%. However, in the past five years, they haven’t enjoyed as much success, with a CAGR of -1.33%. The narrative of South32’s performance over the past five years encapsulates a blend of trials and triumphs. Amidst the unprecedented disruptions wrought by the global COVID-19 pandemic, South32 demonstrated resilience, prioritizing safety and reliability across its operations while actively supporting the communities it operates in.
Despite hurdles, South32 achieved notable milestones, setting production records across several operations and surpassing market guidance in select domains. The company’s underlying earnings surged by 153%, buoyed by favorable commodity prices.
BHP: A Case Study
On the other side of the demerger, we have BHP, one of the largest mining companies in the world. BHP Group Limited is a resource company with operations across various regions globally. Post-demerger, BHP reduced its operating assets from 41 to 19, shedding low-quality assets that enabled it to focus on four key areas: coal,, Iron Ore, and Oil. Overall, BHP has a strong focus on operational excellence, cost discipline, and delivering value to stakeholders.
After the separation from South32, BHP (formerly known as BHP Billiton) focused on several key areas to deliver value to its shareholders:
- Simplification of Portfolio: BHP aimed to simplify its core portfolio to 19 assets across eight countries. This allowed BHP to focus on what it calls its five pillars: iron ore, copper, coal, potash, and oil.
- Cost Reduction: BHP aimed to reduce costs more deeply than the competition. For example, it expected to cut unit costs at Western Australia Iron Ore by 21% to $16/t during the 2016 financial year.
- Capital and Exploration Expenditure: BHP planned to reduce its capital and exploration expenditure from $12.6 billion in 2015 to $9 billion in the 2016 financial year.
- Focus on Strong Commodities: BHP planned to focus its capital on commodities with attractive supply fundamentals, such as copper and oil, where it believed grade decline and field decline would constrain industry production and support a recovery in prices over the medium term.
- Dividend Policy: BHP reiterated its commitment to not rebase its dividend following the demerger.
Analysis:
Let’s examine how these key principles have turned out for BHP and South32. As per the graph below, we can see that the short-term cash-generative business gave South32 a strong start, generating a 111% total return by the start of 2018 (compared to BHP’s 27% total return). This growth slowed, though, and eventually decreased due to a myriad of factors, including significantly fluctuating dividends. Between 2015 and 2018, South32 increased dividends, paying out a total of $554M. By 2021, that number had decreased to $115M, showing a 25% decrease from the previous year. This significantly affected the return to shareholders and future outlook. This was in large part due to the accelerated development of the Q&P project at Cerro Matoso and the progress and numerous improvements in life extension studies across that business and other businesses.
Source: Finchat.io
BHP, with the advantage of handpicking their assets from a total of 41, experienced a minimal decrease in overall revenue year over year. This competitive/informational advantage, which
BHP utilized when demerging, allowing them to focus on highly efficient assets, streamline their business, and simultaneously exit high-cost assets of South Africa. This was all in the name of unlocking shareholder value, enabling shareholders to invest in BHP’s key businesses of iron ore, copper, oil, and coal. This strategic move has paid off for shareholders, generating substantial returns over time.
The demerger enabled BHP to increase their Return on Assets (ROA) from 2% in 2016 to 14% in 2023, a Compound Annual Growth Rate (CAGR) of 27.87%. BHP’s Total Revenue also saw substantial growth since the demerger, rising from $29 billion in 2016 to $54 billion in 2023 (CAGR 9.33%). BHP’s Return on Invested Capital (ROIC) transitioned from sub-zero in 2016 to 17% in 2023, indicating greater capital utilization throughout the business.
Ultimately, this case study demonstrates that when executed properly, demergers and spinoffs can unlock value for the operating parties, especially for the side which is prioritized, as shown with BHP.
