BHP Billiton is one of the world's largest diversified natural resources group, engaged in mineral exploration and production. It has operation in sectors such as Petroleum, Aluminium, Base Metals, Diamonds, Specialty Products, Stainless Steel Materials, Iron Ore, Manganese, Metallurgical Coal, Energy Coal etc. BHP Billiton extracts and processes minerals, oil and gas across the globe. Their sales are geographically diversified however concentrated in emerging economies.
BHP Billiton is a Dual Listed Company (DLC) comprising BHP Billiton Limited (Australian Listed) and BHP Billiton Plc (UK Listed). The two entities continue to exist as separate companies, but operate as a combined group known as BHP Billiton. BHP Billiton was created through the DLC merger of BHP Limited (now BHP Billiton Limited) and Billiton Plc (now BHP Billiton Plc), which was concluded on 29 June 2001. The merger proved to be a wedding of two highly complementary companies, which has now realised the heavy hitter with a market capitalisation of around $180bn.
The headquarters of BHP Billiton Limited, and the global headquarters of the combined BHP Billiton Group, are located in Melbourne, Australia. BHP Billiton Plc is located in London, United Kingdom. Both companies have identical boards of directors and are run by a unified management team. Shareholders in each company have equivalent economic and voting rights in the BHP Billiton Group as a whole.
The DLC structure maintains pre-existing primary listings on the Australian Stock Exchange (through BHP Billiton Limited) and London Stock Exchange (through BHP Billiton Plc), along with a secondary listing on the Johannesburg Stock Exchange (through BHP Billiton Plc) and American Depositary Receipts listings on the New York Stock Exchange.
BHP Billiton's Corporate Finance Policies and Practices over the Last Five Years
BHP Billiton has the long term dividend policy which provides very lucrative yield and very strong balance sheet.
However, BHP Billiton's financial state depends on commodity prices. However the diversity in its business within natural resources provides a better horizon to BHP Billiton. Though BHP Billiton has very strong finance with them, recently they have been failed on various acquisition fronts due to competition commission's interventions. The Potash bid and Rio Tinto are the recent examples.
BHP Billiton's corporate finance policies are long term growth oriented. Their huge investments in petroleum sector are now providing fruitful result and huge profit margins. BHP Billiton has world class assets which provide required cash flow for their new projects and expansion plans. They have given consistent dividend over few decades due to their strong financial policies. BHP Billiton has very solid financial strength which reflects in their solid 'A' credit rating. Their capital management program is focused on to return extra capital to their shareholders; reinvest capital in most financial viable projects which provides regular return irrespective of economic climate and very strong balance sheet.
BHP Billiton has announced massive increase in earnings and invested heavily in expansion plan in last five years. BHP Billiton has plans to spend tens of billions of dollars over the next year and expressing confidence the commodities boom will last for several more years. BHP Billiton has expressed its confidence that, while prices might be volatile, the outlook for demand and prices for their key commodities is for a continuation of the right balance between supply and demand that has under-pinned the soaring prices. Due to their strong financial state, they will be investing over $80bn in next five years. All they want to increase the production capacity of their iron ore business.
As the commodity prices remain strong for several years, the profit of BHP Billiton also soaring high. The market-related pricing for iron ore over the past year, which has been driven by BHP Billiton, has seen prices soar and the increased margins flow almost immediately into their profits. BHP Billiton is trying to drive through a changed approach to the pricing of coking coal, where prices have been set on a quarterly basis. Many countries steelmakers are complaining that BHP Billiton has proposed monthly pricing for at least half the volume of coal it supply them. The mills are vehemently opposed to the concept, arguing it would inject too much volatility into their costs and make it too difficult to draw up production plans.
Coking coal prices are also going up towards record levels, with the impact of the relatively concentrated supply more influenced by the series of floods in Queensland, the key source of production. That has given BHP Billiton even greater negotiating leverage over the mills, at least in the short to medium term.
For BHP Billiton expanding their low-cost assets during periods of peak prices makes a lot of sense, given how quickly the investments will pay for themselves. There are several factors which affects the financial policies of the BHP Billiton are detailed below.
Fluctuations in commodity prices
Fluctuations in currency exchange rates
Failure to discover new reserves, maintain or operations
Influence of China and impact of a slowdown in consumption
Actions by governments or political events across globe (Middle East is current example)
Inability to successfully integrate acquired businesses
Inability to recover investments in mining and oil and gas projects
Operating cost pressures and shortages
Unexpected natural and operational catastrophes
Climate change and greenhouse effects
Inadequate human resource talent pool
Breaches in information technology security processes
Breaches in governance processes
Impact of health, safety and environmental exposures and related regulations on operations and reputation
Strategic Investment of BHP Billiton
BHP Billiton has planned to do strategic investment of $80bn over next 5 years in buying natural resource assets, oil and gas exploration and acquiring natural resources companies. Their current liabilities are $13.5bn however their current cash reserve is $16.5bn. They have total liabilities of &39.5bn however the total asset of $89bn. This provides them with net asset of $50bn. They have recently tried to takeover Potash however the bid was aborted by the Canadian Government. They are now investing in Jensen Project, which is a Greenfield potash project in Canada.
Due to their strategic investment over last 5-10 years in natural resource assets, even during the recent recession; BHP Billiton has done exceptionally well. As the global economic outlook has improved, emerging economies are driving the growth of their natural resource business. The long term prospect of the BHP Billiton's business is very strong. Some analysts say that BHP Billiton has overgrown and there is not much further scope for expansion of their business. Currently three natural resource companies are dominating the world market. These are BHP Billiton, Vale and Rio Tinto. BHP Billiton's investment strategy is clear and long-term focused. They have unchanged strategy in natural resource business since 2001. They focus on large, long-life, low-cost, upstream, high-quality assets, diversified by commodity, geography and markets. This strategy means more predictable business performance over time which, in turn, underpins the creation of value for their shareholders, customers and employees. Due to their long term strategy, its resulted in a profit from business of S$19.7bn, an increase of 8.3 per cent. Net operating cash flows were S$17.9bn, out of which $7.7bn was reinvested in new growth projects.
Many Analysts criticise BHP Billiton's cash pile policy. Their current $16.5bn cash can create a different problem for BHP Billiton from investor's perspective. This cash pile has accumulated due to the last three successive failed bids for Potash worth $39bn. Due to their excess cash pile up and their progressive dividend policy suggests that last year's $4.6bn dividend payments will be exceeded this year, starting with the interim pay-out. Share buy-backs option may compensate investors for BHP's failure to complete the Potash deal or an iron ore tie-up with Rio Tinto.
The company said on November 15, 2010, that it would buy back its shares worth $4.2bn from market. This means that they will complete the share buy back option which was started in 2006 worth $13bn.
The excess cash may be used for fresh $15bn-$20bn [buy-back] programme when results are announced, as per a mining analyst from HSBC.
In this huge cash pile up situation, BHP Billiton has few options to use the cash mentioned below.
Return to shareholders through 'super' dividends or share buy-backs;
More investment and expand production capacities as much as possible;
Try for some more acquisitions.
Keep cash with them and adopt wait and watch policy for further developments.
However there are limitations on bigger acquisition due to competition commission objections. However they can invest more money in diamond, uranium and oil & gas business. However any Greenfield project in oil and gas takes 3-5 year to reach in production stage. In case of the BHP Billiton debt is not a problem its extra cash reserve due to higher commodity prices is posing a threat to their financial management.
Due to the strong cash generation, the net debt of the BHP Billiton has fallen to $3.3bn and a gearing ratio of 6%. The net gearing of the company of which is 6% is stressed to demonstrate the ability to increase debt in order to purchase PotashCorp in future. This figure is the most positive leverage-related ratio from the balance sheet. The regular debt-to-equity ratio is 80% and will exceed 100% after the acquisition if succeeded.
As the current natural resources market is 80% controlled by the three major players (BHP Billiton, Rio Tinto and Vale) hence there is very grim chance of further consolidation due to International Competition Commission Policy and intervention.
Risk Free Borrowing for Acquisition/Expansion
As a DLC, BHP Billiton can afford significant amount for its future acquisition or expansion plans. BHP Billiton can afford an estimated $70bn to $90bn as a risk free debt for its future expansion plan. As world's a biggest miner, BHP Billiton, can spend up to $90bn for developing its asset. Currently they are looking for diversification of their portfolio to minimize the risk.
Based on their excellent credit rating which is A+ grade as per Standard & Poor's and A1 grade as per Moody's, they have very high bargain power for getting cheaper debt in current market scenario. In year 2010, BHP Billiton has arranged a syndicated loan worth $45bn to back the Potash hostile bid, with six banks involved in the financing.
The following key figures explain the BHP Billiton's current financial situation.
Total Cash: BHP Billiton has huge cash in its kitty. Their total cash has risen by $7bn in last 5 years. In year 2010, they had $18bn total cash in their balance sheet as shown in Figure 1.
Figure 1
BHP Billiton's cash reserve was $12.5bn in year 2010, up from 1.35bn in 2006. This provides BHP Billiton a huge opportunity to go for expansion through acquisition and organic growth. BHP Billiton is a cash rich company and highly geared as well. "The strength of its balance sheet and ability to generate cash set BHP Billiton far apart from the competition" says PSG Alphen Asset Management's Van Schaik. Because of its huge internal cash generation, BHP Billiton is able to fund many of its big projects internally. BHP Billiton's long life and low cost assets provides deep cushion in comparison to its competitors.
Total Debt: BHP Billiton has negligible debt on their balance sheet. BHP Billiton's total debt has risen only by $7.5bn in last 5 years. In year 2010, they had $16.5bn total debt on their balance sheet as shown in Figure 2.
Figure 2
BHP Billiton's debt are so low that institutional investors cannot find relatively risk-free debt instruments at the right rate of return, so BHP will have no problems finding buyers for its debt: it's one of the biggest companies in the world with a solid credit ratings.
Total Equity: BHP Billiton equity value is rising continuously over last five years. BHP Billiton's total equity has risen by $25bn in last 5 years. In year 2010, they had $49.5bn total equity on their balance sheet as shown in Figure 3.
Figure 3
Gearing: BHP Billiton gearing ratio is very low and lowest in mining sector compared to its competitors. They are able to keep low gearing over last five years as shown in Figure 4. BHP Billiton enjoys a strong credit rating and they can easily borrow $80bn to $90bn for their expansion plan without endangering its balance sheet. BHP Billiton's gearing ratio would not rise significantly dangerous if the company expansion plan is fully funded by debt.
Figure 4
Beta Value: BHP Billiton has current beta value of 1.41. This reflects their market worthiness, their strong balance sheet and future outlook. Beta value a stock is nothing but it shows the relation of a stock or group of stocks to its index. Statistical calculations and formulas using to identify the exact beta value of a stock. Knowing the beta value of a stock will give us better idea on the volatility side of a stock against its index. An investor can identify the beta value of a sector, that is a group of stocks, to even know the volatility of the sector or stocks in that sector against the index. BHP Billiton's has beta value of 1.41 means that when the index coming down to 10%, the stock price of BHP Billiton will come down to 14.1%.
Weighted Average Cost of Capital (WACC): BHP Billiton has WACC as 11%. Investors use WACC as a tool to decide whether to invest. The WACC represents the minimum rate of return at which a company produces value for its investors. As BHP Billiton has yielded Return on Investment of 23% in year 2010 and more than 126% in last 5 year has a WACC of 11%. This means for every dollar the company invests into capital, the company is creating 12 cents of value. WACC serves as a useful reality check for investors.
As total asset of the BHP Billiton Group is estimated worth $180bn, hence they can afford to spend $80bn in expansion as a group. The commodity prices are soaring all time high and emerging markets countries are willing to pay higher commodity prices. The profit of the BHP Billiton is rising year over year. BHP Billiton's other commodities, especially oil, are also mostly rising in price which provide company a better bargaining in arranging cheap debt. The company has negligible debt and even a spare $11bn to throw at a share buyback.
However a 2008-style recession which is unlikely, will have very bad affect on BHP Billiton's balance sheet which will be stretched by the $80bn debt. However during recent recession BHP Billiton was able to generate very healthy returns on its asset. As a fundamental of expansion, BHP Billiton have now preference for building asset, rather than buying assets is a welcome change of style. The BHP Billiton is doing what it has always done since merger in 2001, increasing spending at 20% a year. On almost every financial measure (dividends, buybacks etc), BHP has outperformed its peers for years.
Kloppers also tends to argue that BHP, with its concentration on large, low-cost mines, runs a simpler model than the big oil companies. But spending $80bn represents a real test of the theory.
One analyst said: "This is one of the strangest positions for a company to be in: but BHP should not underestimate its predicament. Shareholders are on the warpath."
The cause of the tension is cash - though for the first time in years, it's a question of too much rather than a dire shortage.
BHP, along with the entire resources sector, is riding on the crest of the biggest commodities boom in recent history - and as a result is throwing off cash.
BHP, which relies for profits on the most diverse set of minerals, is expected to blow rivals away and reveal it is on track to report the biggest corporate profit in British history - of as much as $30bn - at its full-year results in June.
The cash bonanza is, obviously, welcomed by all. The problem lies with how to spend it. One way, of course, is a mega-deal. With global population growth, plus the rapid urbanisation of emerging markets, the demand for commodities seems insatiable.
The land-grab for natural resources has been ferocious already - but plenty believe it is just warming up. This incentive, mixed with plenty of cash, makes for a powerful aggregate for ambitious and competitive mining bosses. And the shareholder's know it.
One of BHP's top institutional investors said: "Having lots of cash is very dangerous. We know from bitter experience, and there are lots of studies too, that back the fact that companies looking for ways to deploy surplus cash often get it wrong.
The shareholder added: "You've got to remember that just a couple of years ago many of the mining companies were as good as bust. We could be back there in a flash. There is fear that BHP will spend its money on the wrong thing, such as a big deal."
Another investor said: "We've made it clear that we want the surplus cash to come back to shareholders. This weekend, BHP insisted there was no division between shareholders and management and that the directors were committed only to creating shareholder value.
Yet in business he has a reputation for being one of the most aggressive, deal-hungry executives in the FTSE 100.
BHP Billiton in October 2007, launched a $150bn takeover bid for Rio Tinto. The combined business would have been a resources superpower with a market valuation that was bigger than Microsoft. The deal ultimately collapsed, largely because of the onslaught of the financial crisis.
BHP has already paid down billions of pounds deb. Last year BHP poked a stick in the Canadian establishment's nest by launching a $39bn hostile bid for PotashCorp of Saskatchewan. Again, the deal failed after the national regulators raised a series of insurmountable hurdles.
According to the company, BHP has since 2001 increased capital expenditure by an average of 18pc a year, while boosting cash dividends by an average of 25pc a year. Since 2005, BHP has completed buy-backs totalling $12.7bn and paid out $17.9bn in dividends. Over the past year, BHP says it has been sensitive to investor concerns about the soaring levels of cash in the business and their demands for cash. At the annual meeting last November, the company pledged to "consider all future options for capital management, including the level of our progressive dividend and on and off-market buy-backs".
This week, BHP is expected to go further by announcing big increases in its dividend payment and another fresh share buy-back programme. The company is also expected to give guidance on its capital expenditure programme for the future. As one insider said: "We are directing the cash into the business and to shareholders, not acquisitions."
But there is a limit to how much a company can spend on investment. Nothing in the sector ever happens quickly. Even when a company decides to invest in new projects it takes many years to get the permits, agree royalty payments and start construction.
In this environment, with the price of base metals and other resources soaring, potential acquisitions are also arguably at their most expensive. At the very least they are hard to value long-term. One investor said: "With prices at this level, most acquisition opportunities simply look like a waste of money."
And many were supportive of BHP's bid for Potash too. One said: "Of course the strategy is right sometimes. But this is not the time for big acquisitions for which we have to spend years waiting for results."
But both the company and investors know they are living in an uneasy status quo. Commodity prices are likely to stay high for some time - filling miners' coffers even further. Driven by booming global population growth and rampant emerging markets, the mining cycle is not expected to fall away for many years.
First, there's a big upsurge in mergers and acquisitions (M&A). BHP Billiton's $43bn bid for Potash is only one example. It makes sense. If a firm can borrow money at less than 1% and go out and buy a business yielding 6% or 7% a year, then it isn't very hard to make a deal stack up financially. When CEOs thought 0.5% rates were temporary, they held their fire. Now they're looking permanent, they're starting to do deals based on very cheap money.
The one thing you can say for certain is that if a price is at a three-century low, there is nothing normal about it. It's clearly exceptional. The think tank Policy Exchange predicted last weekend that interest rates could be back up to 8% in two years, as the impact of the huge expansion of the money supply fed through into prices. That may or may not be accurate. But one thing seems certain: a return to a more normal rate of around 5% is guaranteed at some point in the next two or three years.
When that happens, it is going to be a shock. Companies will have made huge takeover deals based on free money. People will have bought houses thinking they would only have to pay 3% on their debt.
But by allowing that rate to remain in place so long, it is taking a big risk - that companies and individuals get so used to free money, they won't be able to cope once rates do finally start to go up again
Last week, however, this small northern city and its agricultural history were thrust on to the global stage in spectacular style. BHP Billiton, the Anglo-Australian mining giant, made a $130 (£83.70) per share offer for Saskatoon's largest company, the Potash Corporation of Saskatchewan (PotashCorp).
Rebuffed, BHP went hostile and took the near-$40bn (£25bn) offer directly to shareholders. The offer formally launched on Friday and will now stay open for the next 60 days at least, as BHP seeks approval from a minimum 50pc of shareholders.
Saskatoon may be small, but its resources are vast. More than two thirds of the world's potash lies in the region, and PotashCorp is responsible for around 20pc of capacity.
In contrast, BHP Billiton's core business is industrial commodities, and only three years ago chief executive Marius Kloppers was chasing more of the same with a $66bn all-share offer for rival Rio Tinto.
Rio rebuffed Mr Kloppers but it took 12 months, with the financial crisis well under way, for him to finally walk away. Had the deal succeeded, it would have meant a vastly complex integration of two mining giants.
Here, Mr Kloppers is pursuing a different strategy. Concerned about BHP's exposure to cyclical industrial commodities, he is attempting to insulate BHP by diversifying.
Prices have since fallen, in part because the credit crunch saw speculative money disappear from commodity markets, which along with a food shortage was pushing up crop prices.
But Mr Bain believes prices will rise over the long term. "The population is growing so you need more food, but on top of that there is increased demand for meat from developing countries [such as China and India] as diets become more varied."
Prices are currently around $350 a tonne, but most analysts expect them to rise above $400 in the short term and then continue upwards.
As UBS noted in a recent report to clients: "The potential for long-term prices at $550 a tonne is sufficient to keep mining companies interested [in potash]. We believe that BHP will continue to show significant interest in the commodity and believe it unlikely that potash is taken off the exploration agenda."
However, not all analysts are convinced that diversification is the best policy. In a note to clients called BHP Billiton: Walk Away Before You Overpay, analyst Heath Jansen explained the bank's "pessimism".
"Potash is a non-core mining commodity. When coupled with the petroleum division, these two commodities would account for around 35pc - 40pc of the EBIT [earnings before interest and tax] base of BHP.
"We believe that the large level of earnings being generated from non-traditional mining businesses could see BHP lose its lustre as the pre-eminent miner, as investors look [for] direct mining exposure through other vehicles such as Anglo-American or Xstrata.
"To that extent, we believe that if BHP wants to do a big deal, one in the true mining space would be a better strategic fit. While the assets may not be world class, we believe that it could deliver a better fit than potash."
The price, he argued, failed to reflect growth prospects or recognise the unique value of PotashCorp's assets, especially in an industry with such high barriers to entry, and would deprive shareholders of full value, given that the fertiliser industry is poised to recover from an unprecedented demand decline.
PotashCorp has adopted a Shareholder Rights Plan, intended to ensure the board has time to explore other options and it could act as a poison pill. For now, it is understand to be looking for white knights. These could be miners, such as Brazil's Vale, which already has potash assets; other potash players; sovereign wealth funds; or state-controlled Chinese chemicals group Sinochem, which said it is watching the bid closely.
The world of potash is small, dominated by a handful of players, many of whom hold stakes in each other. According to Robert Van Batenburg, head of equity research at LCM, PotashCorp has stakes worth around $8bn in rivals, including Israel Chemicals and Arab Potash.
Few can compete with BHP on financial terms. The market is already looking for a price of around $145 - $150, and some analysts believe that BHP, which is taking out a $45bn loan to help sweeten the deal, could go as high as $170 or $180 before it becomes earnings dilutive.
BHP is cash rich and an attractive proposition for institutional investors. "The actions of European and US central banks have led to an erosion of fixed income yields," says Mr Van Batenburg.
BHP does not need approval from its own investors, but they may still need convincing. For instance, James Bruce, a portfolio manager at Perpetual Investments, has a £200m stake and is arguing for a share buyback. He believes $130 is fair value and that any more would be overpaying.
Citigroup also favours a buyback, arguing that if the price went to $145, a buyback funded on the same terms and at a similar value would result in more free cashflow and therefore be "the optimum scenario".
Regulators should, however, be easier to win over. Unlike the proposed tie-up with Rio, BHP's acquisition of PotashCorp would be straightforward: BHP owns a greenfield site in Saskatoon, but has no active potash business.
Citigroup's Mr Jansen does not foresee any problems. "Historically, the regulators have not been hostile towards foreign investment, nor has the current Conservative government. In BHP's letter to PotashCorp's chairman, it made undertakings which look clearly aimed at addressing any potential concerns. They appear in line with what Rio Tinto promised in obtaining approval for [its 2007 acquisition of aluminium producer] Alcan."
Indeed, the act could work in BHP's favour, as rival bidders may find it harder to circumnavigate. Opposition may be a little more strident on the local level. PotashCorp is fondly thought of in Saskatoon and the company has worked hard to forge strong ties with the city and its suppliers.
BHP is already in Saskatoon because of the Jansen project, its greenfield potash site. But developing a mine takes around seven years and can cost as much as $4bn. Buying PotashCorp would result in BHP benefiting from new earnings streams from as early as 2011 as opposed to 2015, when the first batch of potash is estimated to come out of the Jansen mine, according to analyst Charles Kernot at Evolution Securities.
Mr Kloppers' attempts to buy Rio were audacious, aggressive and risky. In comparison, his moves to buy PotashCorp seem on a smaller scale and less significant. But just as Saskatoon can be deceptive, so too is this bid. Pursuing PotashCorp is arguably the more radical option. There are risks. Mr Kloppers needs to win over shareholders in PotashCorp and BHP, convincing them that both the price and the strategy are correct. He needs to convince the City that whatever the final price, he is not over-paying. After the failure to land Rio, his reputation as a bold chief executive and deal-maker is on line with PotashCorp.
