Whilst a lot of the focus will be on the demerger process, perhaps the big question should be is what implications the demerger announcement has on potential for a buyback and DLC collapse.
BUYBACK
Most analysts calculate the demerger to be 3-4% dilutive, however if an off market buyback was carried out at the same time would reduce dilution. On top of this, it is likely the demerged vehicle will take ~$2bn debt, a move that not only improves the balance sheets ability to undertake a buyback but given the “NEW BHP” will be a lot higher margin, higher FCF, shareholder friendly company it would be a surprise not to see an off market buyback announced as part of its FY result tomorrow.
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DLC COLLAPSE
Given the non-core assets BHP is looking to spin off are mainly ex Billiton assets, the rationale for keeping a Plc listing post demerger is negligible i.e. Plc entity won’t have any assets. Also buy offering every Plc shareholder 1 Ltd share for each Plc share they own would allow all shareholder to benefit from the $14bn in franking credits BHP has available to distribute to holders of Ltd shares. DLC collapse would see material increase in index weighting and forced passive / active buying i.e. 2,112 Plc shares x $38 = $80bn uplift or increase from ~9% weighting to ~14% weighting. An $80bn increase in market capitalisation would trigger around $8bn passive buying assuming domestic funds retain a 10% weighting in BHP
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If BHP decide that the DLC structure is worth holding onto, its likely funds that were expecting a DLC restructure would unwind DLC spreads, thus creating more demand for BHP Ltd shares i.e. there is currently A$300m of short interest in the Aussie line and US$775m in the ADR’s. In this scenario BHP would move to release more franking going forward, supporting the case for the Ltd premium back toward 8-9% for franking.
We argue a DLC restructure is the key event to look for. In its absence we likely get a Ltd not Plc buyback, solid result, expectation of future capital returns, and DLC unwinds supporting the Ltd leg.
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