The Terms Of The BHP Billiton Spinoff Of South32

I’ve been conversing with the investor relations department at BHP Billiton trying to figure out the terms of the South32 spinoff of BHP Billiton for American shareholders that own American Depository Shares (ADSs). As an aside, the name South32 is because BHP Billiton will be spinning off assets that are located in both Australia and South Africa, and they both share the geographic 32nd South parallel line of latitude.

Although the regular shares that trade in Britain will be spun off with a 1:1 ratio, each owner of an ADS share in BHP Billiton will receive 0.4 shares of South 32. If you own, say, 100 shares of BBL and the demerger gets approved, you will have 100 shares of BHP Billiton paying you $248 in immediate annual dividend income (because the management indicated that the dividend won’t be debased to a lower amount to reflect the South32 spinoff) and you will also have 40 shares of the new South32 after the spinoff.

The dividend amount for South32 has not yet been set (because shareholders have yet to approve the demerger and we won’t know until May 6th whether this will officially go through or not) although the management team set to run South32 has indicated that the company will pay 40% of its trailing profits to shareholders as an initial dividend payout (this puts South32 in that rare league with Progressive Insurance and GlaxoSmithKline where the dividend is tied to a certain percentage of profits rather than a fixed rate).

Usually, there are people who ask me whether they should purchase the Australian shares of the ADS that trade under the ticker symbol BHP or the British shares that trade under the symbol BBL. It depends on your perspective and status, but most American investors that are buying stock in a retirement account will want to buy the BBL shares that trade at $44.25 rather than the BHP shares that trade at $47.24.

The difference in the share price has to do with franking, a concept that is of little relevance to an American investor building a collection of blue-chip stocks within a retirement account like a Roth IRA. Because of the U.S.-Britain tax treaty, investors that purchase BBL will have no tax burden on the dividends in a retirement account and they will pile up without fees just as if you are investing in shares of Clorox, Colgate-Palmolive, or Dr. Pepper in a retirement account.

A potential exception—some brokerages charge anywhere from $0.06 to $0.12 per share that gets reinvested (so you have a $180 dividend you may see a $0.48 fee for automatically acquiring 4 new shares through dividend reinvestment) but this is a fee charged by your brokerage house as a maintenance expense for international investing rather than a cost related to tax consequences.

The reason why the shares of BHP that trade on the Australian exchange cost over $47 per share is because those dividends are 100% fully franked. This means that the withholding fees are going to be 0% because the franking is a payment on BHP’s behalf to cover your tax burden, but it also comes with a tax credit that lowers your tax burden on Australian investments that are not franked. The only way an individual American investor owning ADS shares of the Australian BHP could benefit from this would be if he had other Australian investments that are not franked, and he wanted to use the excess tax credit from BHP Billiton to lower his tax burden.

For a large investor with complex investments—or at least a diverse portfolio of Australian stocks and bonds owned in taxable accounts—paying the $3 premium to buy the shares on the Australian exchange might make sense. If you are an American investor using a retirement account, these franking benefits won’t get used and you should acquire more ownership for your money by purchasing the BBL shares of the mining company because the tax benefits will be a useless benefit to you.

Also, you should keep in mind that BHP Billiton will not issue fractional shares after the spinoff. Say you’ve owned BBL shares for a few years and have been reinvesting your dividends along the way and find yourself owning 255.36 shares of the company. When you collect your 0.4 shares of South32 in the demerger, you would initially be entitled to 102.144 shares of the new South32. In reality, you would collect 102 shares and, at the end of the day, the 0.144 shares would be sold on the open market and you would see cash deposited into your account for the value of that fractional ownership. BHP hasn’t set the price of the South32 spinoff yet, but if was around $20, you would see $2.88 deposited into your brokerage account in addition to the 102.144 shares.

The short version: U.S. investors should prefer owning shares of BBL instead of BHP because the latter shares are more expensive because they include a franking tax credit that is useless unless you own non-franked Australian assets and seek to lower your tax bill. Each share of BHP Billiton owned by American investors through the ADS system will create 0.4 new shares of South32, so that someone with 100 shares of BHP Billiton will own 100 shares of BHP Billiton and 40 shares of South32 after the spinoff. If you are entitled to a fractional number of BHP Billiton shares, the fraction component will be sold for cash at market value on the ending day of the spinoff and converted into cash for your brokerage account. The BHP Billiton will not be debased so the dividend payment with continue at $2.48, and the South32 dividend has not yet been specified but management has indicated that the payment will be around 40% of profits.