Not only the Chinese are wantingMilking the BHP cash cow
Stephen Bartholomeusz
Published 1:01 PM, 1 Feb 2011
In the lead up to the imminent release of their results, BHP Billiton and Rio Tinto are being subjected, again, to a campaign by their UK institutional shareholders to return some of the massive cash flows they are generating to shareholders rather than deploy it in acquisitions. BHP Billiton thought it had outlets for its embarrassment of riches, initially through the aborted Pilbara production joint with Rio and then via its $US39 billion bid for Canada’s Potash Corp. Regulators blocked the joint venture and politicians the bid for Potash Corp.
For a group with minimal net debt which is likely to generate a profit of $US20 billion-plus this year and which, despite spending about $US15 billion on brownfields expansions, is likely to have swelling free cash flows, it will be more difficult for BHP to resist the pressure to return capital to shareholders.
The cash is flowing into the group faster than it can deploy it, despite a massive pipeline of prospective projects.
The constraints for BHP relate not to its capacity to fund organic expansion or projects to invest in, but rather the depth of the reservoir of existing management within the organisation. It has accelerated the timelines for its proposed Jansen greenfields potash project in Canada and could bring more urgency to bear on the expansion of Olympic Dam, but its existing capabilities are being stretched.
After the failure of the Potash Corp bid BHP Billiton reactivated the last $US4.2 billion tranche of its original $US13 billion buy-back program but if it doesn’t make another big takeover it will soon again be confronted with the prospect of holding net cash.
High commodity prices, record production volumes and the success of its campaign to move its major commodities to market-related pricing (which means it is capturing the price spikes) may not necessarily be permanent – the prices are highly sensitive to China’s levels of economic activity and there is also a delayed supply-side response occurring in the post-crisis environment – but in the near term BHP Billiton is experiencing a deluge of cash.
The prospect that the settings may not be permanent, and the ambition of BHP Billiton’s board and management to take advantage of the industry settings to grow the group’s base of high-quality but depleting assets for the truly long term, will make the group cautious about shrinking its balance sheet materially in the short term.
It doesn’t make compelling logic for a group that, despite the scale of its capital expenditures, generated a 26 per cent return on capital in more difficult conditions last year to return big slabs of capital, provided it can identity projects/acquisitions that meet its hurdles for longterm returns.
There is an expectation in the market that BHP Billiton will continue to edge up its dividends and maintain a relatively modest (in the context of its own size) capital management program rather than embark on the major returns its UK shareholders are lobbying for. (Given the performance of fund managers in recent years, you’d wonder why they think they can invest those funds more profitably than BHP Billiton).
If it is to resist that lobbying, however, BHP Billiton will have to pull off the major acquisition that so far, through no real fault of its own, has eluded it. It is obvious post-Rio and post-Potash that its size and market power has created significant regulatory and political obstacles to growth.
It is equally obvious that the one area in which it does have expertise and where there are unlikely to be major issues with grow by acquisition is the oil and gas sector, hence the continuing speculation of a bid for Anadarko Petroleum of the US or, more recently, Britain’s BG Group.
The problem, even in petroleum, is in finding companies whose assets largely fit BHP’s focus on tier one assets – large, low-cost, long-life assets.
The other difficulty is that BHP – and any prospective target – knows that it cannot make another failed takeover bid without repercussions for the existing management, regardless of the reasons for the failure. It’s unlikely to be able to acquire anything without paying a full price.
While the problem of having too much cash and capital is a nice one and, as Rio could testify, a hell of a lot better than the alternative, unless Marius Kloppers and his team can finally pull of a major acquisition that meets their own criteria in the relatively near term, there may not be any alternative but to abandon their natural instincts and ambitions and succumb to the pressure to become a cash cow for their shareholders for the remainder of the boom.