In the banking crisis we learned that a group of U.S. banking and insurance firms are allegedly "Too Big To Fail." Now the world's largest mining company BHP Billiton Ltd. (NYSE ADR: BHP) has grown so large it is struggling to make meaningful deals, introducing us to another phrase: "Too Big To Grow."
BHP's dilemma is not surprising. Its downside is that, as the largest mining company in the world, it has outgrown its roots. BHP's current management has shown it cannot pull off a major transaction while handling a company of this size.
Its heavy weight becomes an overwhelming force in any sector it applies its resources towards, which has caused the company to have its last three planned mergers stopped by regulation red tape. Nations are not interested in having their prime natural resource company swallowed up and then forgotten about by a mining behemoth.
BHP last week scrapped a $40 billion hostile takeover bid for Potash Corp. of Saskatchewan Inc. (NYSE: POT) after the Canadian government rejected the offer. BHP called off a $147 billion hostile bid for Rio Tinto PLC (NYSE ADR: RTP) in 2008 because of financial market turmoil, and a $116 billion iron ore venture with that company fell through in October due to regulator opposition.
The unsuccessful M&A deals aren't the only financial blunders the company has suffered.
In Canada, before BHP made the offer to purchase Potash, it was working on a project that would have become the largest potash mine in the world. The Jansen potash deposit is a world-class project with a development price tag of $10 billion or more.
After spending hundreds of millions of dollars, BHP decided to abandon the project, write off the costs associated with it, and make its offer for Potash. Now that the bid failed, BHP is again looking at developing Jansen.
It also has the stigma of the Western Australian Ravensthorpe nickel mine failure, which was supposed to cost the company around $1 billion but grew to around $3 billion in costs and write off expenses. The closing of the mine, less than a year after it opened, was so unpopular politically that BHP was forced to sell it for $340 million to Canada's First Quantum Minerals Ltd. (TSE: FM), which expects to start operations again in 2011.
If the new owners are able to produce it profitably in the future, BHP management should be forced to resign.
So BHP is an enigma. It was built from the merger of two of the largest mining concessions in 2001, and since then management has failed to execute on any project it's attempted.
The three strikeouts have caused the company to reevaluate its future, and with that change comes an opportunity to safely put some money to work, while enjoying a growing dividend. You see, BHP is too big to grow, but has a growing pile of cash that the company has no need for - which means it has to start to return capital to its investors.
That reality is already obvious to the board of directors, as they announced last week a reactivation of their multi-billion dollar share buyback program that was halted in 2007. The company said it would buy $4.2 billion of its shares under a $13 billion buyback program that had been suspended for three years. Look for BHP in the next year or two to announce a series of dividend increases, along with an increased share buyback.
BHP sports a market cap that is worth $234 billion, making it one of the highest valued companies in the world. It pays a 2.1% dividend, which is expected to grow in the near future.
If you compare BHP's performance over the past five years to the Standard & Poor's 500 Index, you'll see it returned 169.34% compared to the S&P's 4.3% decline - netting a nice profit for those investors who got in at the right time. So the question today is, is it time to book those profits, or buy more?
What the company is missing is a sure path toward a larger future. At the political level it is already too large. The company has a management that has not shown an ability to execute. It's going to have to focus on internal organic growth.
Let's do a quick review of BHP:
- It has suffered three failed merger attempts.
- It has abandoned two major development projects.
- It has growing future dividends.
- It has resumed its share buyback.
- It is seeing only slow organic growth.
While I like the assets that BHP holds internally, the management has been underwhelming in its ability to execute for shareholder future value creation. It's this reason and this reason only that I cannot put a buy recommendation on the stock.
If you own BHP, let's consider a covered call program for this position in your portfolio. You can generate a growing cash yield above the current dividend. It is going to be years before BHP is considered a sexy commodity stock again. It has shown that it is just too large to be a factor in future market M&A activity.
(**) Special Note of Disclosure: Jack Barnes holds no share or known exposure in BHP Billiton Ltd.
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