BHP Billiton's coal-heavy spin-off has a whiff of Excel to it

HEAVY selling of BHP Billiton shares after this week’s proposal from the company to create a “coal heavy” spin-off reminded Hogsback of a similar event 10 years ago, and the high cost suffered by nervous investors.

Staff Reporter

Back in 2004 Excel Coal was a first-week flop as foundation investors scurried for the exits, allowing their $2 shares to slump as low as $1.88 in opening trades.

The Excel situation was repeated on Wednesday when BHP Billiton shares fell 4% partly as a result of British investors quitting a company that will only be listed in Australia and South Africa, and partly because Australian investors are wary of coal.

Back in 2004 there was a comparable whiff of concern in the air with Excel’s first day failure blamed on reports of a slowdown in Chinese demand for coal, as this direct quote from a news report at the time shows: “The less than inspiring early trade [in Excel shares] was blamed mainly on China’s recent move to slow the pace of economic growth”

Roll forward a decade and not much has changed, but whether the comparison remains true over the next year or so will be the really interesting bit because after the initial sell-off Excel shares started to rise sharply.

By mid-2006, little more than two years after floating, Excel was acquired by Peabody Energy for an eye-popping $9.50, a share, a whopping 375% profit for foundation shareholders who stayed the distance, and 405% for anyone who snapped up some stock at that float day low of $1.88.

The story of Excel might not be repeated exactly by what happens to the BHP Billiton spin-off after the tortuous legal process expected to start later this year, and run until mid-2015, but the principal of an unloved business being catapulted to stardom could be repeated.

Where a reminder of Excel is most useful is to consider the cyclical nature of the resources sector and the speed at which the fashionable can become unfashionable – and vice versa.

Coal today is obviously a commodity under pressure, but not from a dramatic slump in demand. The problem, which The Hog has banged on about many times, is supply with too much coal depressing the price.

BHP Billiton’s split into “loved and unloved” assets will lead to its coal interests being shared by the parent and NewCo, the spin-off yet to get a name.

Queensland’s metallurgical coal mines stay with BHP Billiton but the met-coal operations in New South Wales go to NewCo, as do the energy coal operations in South Africa.

It might be stretching the point to describe NewCo as coal-heavy given it will also contain manganese, silver, nickel and aluminium interests but in terms of profit generation it is likely that coal will make a disproportionately heavy contribution to NewCo’s earnings.

One reason for coal arguably being the most attractive asset in NewCo is that the other parts are less attractive. Aluminium, for example, has been a disaster area for the past eight years. Manganese is getting better, but can be highly cyclical, as is the case with nickel.

What coal represents to NewCo is stable earnings, plus the added appeal of New South Wales met-coal being included thanks to the troubled Nickel West business being sidelined because its performance has been so poor.

What happens next is what interests The Hog because just as Excel was irresistible to Peabody in 2006 (though undoubtedly less appealing today) so too might BHP Billiton’s NewCo spin-off prove irresistible to a predator looking for an easy start as a global miner.

X2, the comeback vehicle for former Xstrata boss, Mick Davis, has been conspicuous by its absence from resource sector deals despite sitting on a reported $US3 billion in capital and having a hunger for deals.

Davis, like his one-time colleague, Glencore’s Ivan Glasenberg, has a deep understanding of the coal industry, and a proven track record of buying the discards of big companies and turning them into objects of greater value.

It might be The Hog’s imagination working overtime but with the inclusion of an extra coal asset (NSW met-coal), BHP Billiton has created a business that could prove to be very tempting for Davis and his X2 financiers.

Whether X2 would like all of NewCo is unlikely, but it is often easier to start with a single big bite followed by a discard process, choosing the best time in the commodity-price cycle.

History never repeats perfectly. But the Excel experience, and the way Xstrata and Glencore grew from a base in coal, are reminders of how to build a mining business, and why the best profits come when you buy low and sell high.