Shares in BHP Billiton(LSE: BLT) are rising this morning after it emerged that the company is being targeted by activist hedge fund Elliott Management.
In a statement published earlier today, the activist fund, which has built up a 4.1% stake in the miner, said it believes BHP should unify into one single legal entity and spin-off its US petroleum business to unlock as much as $47bn in value for investors.
Elliott's plan has some merit. BHP currently has two separate legal identities, one based in Australia and another in London. Elliott claims that after the demerger of BHP's non-core assets into South32, the London legal entity now generates just 10.3% of revenue. By merging, Elliott claims the company would be able to reduce inefficiencies and unlock more cash to be returned to investors. Elliott goes on to argue that the firm could effectively buy back shares at a 14% discount to market value by making better use of $9.7bn in accumulated franking credits, which offset taxes on Australian stock dividends. The hedge fund claims that returning such a hefty chunk of cash to investors would help "management to avoid making badly timed acquisitions paid for in cash," and "increase the scope for management to pursue appropriate acquisition opportunities using unified BHP's own shares."
On the topic of BHP's petroleum assets, which the company owns as part of its 'four pillars' diversification strategy, Elliott believes the group should spin-off these assets and list them in New York to help the division realise its full growth potential. Elliott believes these assets could be worth as much as $22bn as a standalone entity. All in all, if management undertakes all of the steps advised, the activist hedge fund believes BHP's shareholder value could increase by about 50%.
Good news or bad news?
The initial market reaction has been positive, but while the proposals may unlock value in the short term, whether or not they will be good for the business in the long term is up for debate.
Activists have a reputation for boosting returns now at the expense of long-term investors, and Elliott's initial demands seem to be following this playbook.
Indeed, BHP established its petroleum division to diversify away from its other three core units, coal, iron ore, and copper. Even though the oil and gas business might be worth more as a standalone entity, it's impossible to tell how much the lack of diversification will cost BHP over a longer timescale.
Also, Elliott is recommending management increases dividends and stock buybacks. Even though this may seem attractive for today, by returning cash to investors, BHP will have to sacrifice some future growth potential, which is not good news for sustainable dividend growth.
The one proposal that could be good news for BHP's investors is the recommended merger of the company's London and Australian legal entities. While such a move may prove costly, it may pay for itself in the years ahead thanks to lower admin costs, and there's no real need for the company to continue to hold two listings on opposite sides of the planet in today's globally interconnected world.
Make money not mistakes
Activists can create value in the short term, but over the long term their motives are questionable. With this being the case, for long-term investors, buying BHP today might not be the best idea.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.