In an attempt to lower costs and increase profit margins,BHP Billiton(LSE: BLT) is splitting in two. Management has decided to unwind the Billiton side of the business, which was part of the mega-merger between BHP and Billiton in 2001.
The new business will be called South32. Specialising inaluminium, manganese and nickel production, the new group will be designed for growth. It will begin life with net debt of $674m compared to assets of $26bn and will immediately set out to cut costs and improve efficiencies.
A growth business
One of South32s key assets will beCannington, the worlds biggest silver mine and a significant producer of lead and zinc. This mine alone will be responsible for around a fifth of South32s underlying earnings.
But while South32 looks to have a bright future ahead of it, many analysts have started to question whether BHP is making the right decision by spinning off the company.
Indeed, assets earmarked for South32 were the only part of the BHP group to report increasing operating profits during the second half of last year. Profits from BHPs flagship businesses, iron ore and oil,slumped.
After stripping South32 out of BHPs earnings, the company will generate just under half of its EBITDA from iron ore. 20% of EBITDA will be from copper production, 31% from oil and potash and 5% from coal. Unfortunately, none of these markets can be called growth markets at present. The coal, oil and iron ore markets are all over supplied and theres no guaranteethat the markets will recover any time soon.
Whats more, the initial figures suggest that BHP is only going to be able to shave $100m a year off its cost base by spinning off South32. Compared to managements targeted $4bn of productivity gains by 2017, $100m is a drop in the ocean.
The demerger makes even less sense when you consider the fact that BHP has already spent $270m planning the separation. Another $468m of costs are expected when shareholders approve the deal, bringing the total cost of the divorce to $738m.
Little sense
Overall then, the deal makes little sense to me. Not only is BHP spinning off the only part of its business that is still growing, but the company is spending nearly $1bn to make it happen.
Based on these numbers, BHP will see a payback from cost savings within eight years. However, while the deal may not make sense for BHP, South32 will certainly have plenty of growth potential as a separate entity.
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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. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.