You can’t keep a good market down. Despite APA’s apparently failed bid for Qantas (ASX:QAN) this weekend, the S&P/ASX futures were up a quarter of a percentage point this morning. But the big news this weekend was not the bumbling, stumbling incompetence that threatens to thrash the shares of Australia’s national airline. The big news is that giant for sale sign now out on the dry lawn of every Australian company, even the biggest.
Maybe Qantas could raise a little extra revenue by towing giant for sale signs behind its 747s when it flies over BHP’s (ASX:BHP)prosperities in Western Australia. It’s just a thought. We flew the Roo on our way up here to Singapore. The flight was three hours delayed departing. And when it did depart, the electronic entertainment system didn’t function properly (we had to read the entire way!). And worst, the early run on the penne chicken left us reluctantly gulping down braised beef. The airline needs either more money or better management, or both.
But the share market may not have long before it begins digesting the impact of other large proposed leveraged buy outs. Over the weekend we learned that Merrill Lynch Australian research analysts Vicky Binns and Duncan Hay have sized BHP like a very fat lamb headed to a very private equity slaughter. In a note to clients, they reckon a BHP broken up into various parts and re-sold on the stock market would fetch nearly $242 billion.
Trouble is, BHP is a ram, not a lamb. It’s a $107 billion company, by market cap. A leveraged buyout of BHP would require a lot of debt to offer a premium on the current share price, a premium sweet enough to make the deal happen. It would also require a large, publicly-listed partner. Likely partners for private equity in such a deal are Swiss giant Xstrata (LON:XTA) or CVRD, the Brazilian iron-ore giant.
You have to give it to the pirates. They think big. BHP is world-class booty. There is a lot of plunder in a company with such a wide array of assets. But there is also a certain perversion to thinking about a company the way you think about Wagyu beef (which we hope to eat when we visit the Margaret River later this week).
Private equity thinks like a scavenger. In BHP’s case, it thinks the sum of the parts is worth less than the parts themselves. Broken into oil, copper and gold mining, and iron ore production, BHP’s component businesses would trade more in line with the underlying resources they produce. That means there is unrealized value on the BHP balance sheet that can be liberated by dismembering the company.
Now let’s think about this in bovine terms for just a second. Some cattle are for slaughtering and eating. Other cows, like dairy cows, are for loving and nurturing and milking. Both provide nutrition and calories. Both are capital assets. But we’d suggest BHP is more of a world-class dairy cow than a bull which ought to be gored for its richly marbled and incredibly tender beef. It is a producing asset, not an asset to be consumed.
What attracts private equity to Australian resource assets is simple: a world-class resource company with world class assets is the best kind of cow of all: a cash cow. Private equity needs regular cash flows to service enormous debts. With base metals and resource prices rising, and Australian firms already hitting capacity bottlenecks (see this month’s OSI), the pirates see strong cash flows. They lust.
And of course it’s not just demand for resources that is high. Demand for assets to invest in is high, too. Why sell BHP as one big company when you can carve it up and refloat it on the roaring local share market in three, four, or even five pieces? Investors want shares. Give them more shares!
It’s all short-term financial nonsense. The whole competitive advantage of being a diversified large miner is that you have economies of scale. BHP’s sheer size makes many projects possible for it that are unrealistic or un- economic for smaller, specialist firms. A larger company has deeper pockets and a larger pool of specialist talent to draw from in capacity expanding projects.
While the private equity analysts look for what a company is worth when sold, the people running the company have to worry about actually running the company profitably, day after day, year after year. It is in the interest of shareholders to have managers who are worried about the long-term viability of the firm (long time frames are necessary in capital intensive mining projects) and not in short-term premiums that deliver shareholders a quick gain, but undermine the global competitiveness of the firm over time.
Still, the world is lining up at your customs and immigration counter Australia. Sooner or later it will get its papers in order. Are you ready?
The Daily Reckoning Australia