BHP and the amalgamation arbitrage
BHP Group Limited (ASX:BHP)
Price at posting: $48.86
Like so many Australians stranded in London, BHP has finally been able to return home. On 31 January 2022, BHP announced that the unification of its corporate structure had been sanctioned by a UK Court. This puts to an end a 20-year-old arrangement in which an Australian company and a British company gave the appearance of a single BHP. The arrangement had been put in place following BHP’s merger with Billiton in 2001.
As part of this arrangement, BHP shares had been listed on both the ASX (known as ‘Ltd shares’) and the London Stock Exchange (known as ‘Plc shares’). Under the unification agreement, all BHP shares will now be listed on the ASX. BHP Chairman Ken MacKenzie said the unification transaction would cost between US$350 million and US$450 million to complete. (And you thought your Qantas flight home was expensive.)
What makes this interesting is that the high likelihood that the dual listing would come to an end had the effect of making BHP the most shorted stock on the ASX, with close to 18% of its equity sold short. To understand why this was the case, it is first necessary to understand the differences between the Ltd shares and the Plc shares.
Franking credits versus dividend allowance
Ltd shares have typically traded at a higher price than Plc shares due to the differing tax systems in Australia and the UK.
Australian tax law includes a dividend imputation system. This allows companies to attach a franking credit to dividends paid to shareholders. A franking credit is a tax credit that considers the tax already paid by the company as paid by the shareholder. It is a means of avoiding double taxation.
The UK no longer operates a dividend imputation system. Instead, shareholders can access a £2,000 tax-free dividend allowance. After reaching this limit, dividends are taxed in the hands of the shareholder without taking into account the tax already paid by the company on profits.
Because more tax may be paid on dividends issued from Plc shares, the shares are less valuable to investors as a whole than Ltd shares and this is reflected in the price. This difference in prices means that the unification brought with it a potential arbitrage opportunity.
The trade
The unification of the shares was to take place via a one-for-one swap of Plc shares for Ltd shares.
Traders could therefore take advantage of the price discrepancy between the two shares by buying the less expensive Plc shares and short selling the more expensive Ltd shares. The short position could then be covered when the swap took place providing the trader with an almost risk-free return.
Prior to the 31 January announcement, there was of course some risk that the unification transaction would not go through but in the end, the trade was indeed profitable. Not since the Qantas ‘Feels Like Home’ ad campaign has the return of a miner brought a tear to the eyes of so many ordinary, large global hedge fund managers.
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