The world’s most valuable resources company, BHP Billiton, is forging ahead with its plans to spin off key assets into a new global metals and mining company. The demerger will largely undo the 2001 merger between Billiton PLC and BHP Ltd, which created the mining giant. On the other hand, AngloGold Ashanti, has pulled the plug on its proposed demerger to spin off its non-African assets into a new London-listed company. As for eBay, after initially deciding against spinning off PayPal to Fortune, eBay recently announced plans to spin-off its online payments service PayPal into a separate, publicly traded company.
So, what is a demerger?
In simple terms, a demerger is the opposite of a merger or an acquisition. It is a form of corporate restructuring where a company’s business activities are segregated by transferring distinct businesses into separate companies or groups of companies which are then, initially, held under common or related ownership.
Commonly, shareholders of the parent company are usually given an equivalent stake of ownership in the demerged company.
A demerger may be structured in different ways. The choice of structure will generally be tax-driven, and the tax costs and benefits for shareholders, will need to be considered for the parent and the demerged company in each case.
So, why demerge?
There are various reasons why a company may consider demerging. For example, to increase shareholder value, reduce regulatory or financial pressure, or to facilitate a sale to a third party.
In BHP Billiton’s case, the company wants to spin-off its non-core assets including its aluminium, manganese and coal mines in South Africa to reduce costs and improve the productivity of its largest businesses more quickly. While BHP Billiton’s non-core businesses are not failing, weak prices mean some are struggling, and in any event they only represent a small fraction of the group’s earnings. BHP Billiton wants to spin these non-essential assets off into a separate vehicle and focus almost exclusively on its core iron ore, copper, coal, petroleum and potash businesses.
To some, it may also come as no surprise that BHP Billiton’s demerger was announced against a backdrop of events in South Africa such as social and political unrest in the labour terrain, exemplified by the events of Marikana in 2012 and the platinum mine strikes in early 2014, and South Africa surrendering its economic crown as Nigeria leap-frogged South Africa to become Africa’s largest economy back in April of this year. The proposed introduction of the Mineral and Petroleum Resources Development Bill (MPRDA Bill) which appears to advocate a shift on policy that may create areas of difficulty for the mining industry may have also played a part although President Jacob Zuma is holding fire on the MPRDA Bill for now as it may be sent back to the South African National Assembly for amendment.
What are the key issues and documents on a demerger?
In any demerger, a number of practical issues will inevitably arise, the majority of which relate to the unravelling of the relationship between the demerged company or business and its former parent. These are similar to the considerations that typically arise on a corporate sale or an initial public offer. The practical steps to be taken and the documents required to implement a demerger will depend, to a large extent, on the type of demerger structure that is adopted.
Commercial considerations for a company seeking to demerge include, amongst other things, the following:
- The capital structure will be an important feature as to how the demerger is structured because many demergers involve the payment of a dividend by the parent and any Capex will have to be allowed for;
- The demerging group’s existing financing facilities (as well as the allocation of cash and debt on the demerger) will need reviewing and are sometimes a factor in demergers failing to proceed;
- Tax will be an important factor in how a demerger is structured. A lack of tax planning could lead to the demerging group and shareholders facing material tax liabilities so advice on whether certain tax reliefs are available if the demerger is structured in a particular way should be sought early on;
- Splitting shared services and property (including any intellectual property) post-demerger is administratively difficult. A transitional services agreement can provide for the ongoing provision of services and property among the final entities; and
- Significant and unwelcome pension-related liabilities may arise and employee incentives may be adversely affected as a result of a demerger and pension arrangements will also need to be reviewed by pension experts from a legal perspective.
In addition to the above commercial considerations, the following legal considerations should also be reviewed by a parent company seeking to demerge:
- Due diligence should be completed in relation to the demerging company or business to identify any practical obstacles to the demerger and any business issues that may arise from the separation of the parent company and the demerging company or business. For example, constitutional limitations that could affect the demerger and change of control provisions in material contracts that may be triggered;
- Corporate Governance needs to be considered where the parent company remains the owner of a substantial stake in the demerged entity or where there is an overlap of board members;
- Shareholder approval will be required, however the demerger is structured. Approvals are also likely to be required for a host of matters related to the reorganisation and effective disposal of part of the parent company’s business;
- Cross-border issues may also cause difficulty in a demerger. For example, BHP Billiton has a primary listing on the London Stock Exchange however, following the demerger, it is proposed that the demerged entity will be listed on the Johannesburg Stock Exchange and the Australian Securities Exchange. This may be problematic if the company’s UK-based fund managers have investment mandates that prevent them from owning overseas stocks; and
- Local law issues may pose additional hurdles or barriers to the demerger. For example, in BHP Billiton’s case, recent changes to the MPRDA Bill in South Africa may impose additional complications on the company transferring its mining licenses to the demerged company.
There will be a number of principal agreements which will have to be negotiated and put in place, including:
- Separation Agreement – setting out the principal corporate actions which need to happen, including the transfer and allocation of assets, liabilities and contracts;
- Transition Services Agreement – to share central resources until such point in time as they can be economically separated;
- Tax Agreement – to allocate the liability for tax and deal with tax compliance; and
- Employee Issues Agreement – dealing with employment matters and pension issues.
Although research suggests that on average, demergers usually result in an increase in shareholder value, any demerger should be reviewed carefully (with due consideration given to the above factors) in the knowledge that demergers do not offer an automatic guaranteed path to increasing shareholder value.