July 31, 2014

BHP vs BBL for Investors in the United States

With the discussion of me buying some shares of mining giant BHP Billiton the other day for the KRIP portfolio, there seems to be some confusion about the difference between BHP vs BBL, and how those are related to the BHP and BBL ADR listings on the New York Stock Exchange.  This is one of those things that is really simple, but people make it far too difficult.  Honestly, a lot of that is BHP Billiton’s own fault.  If they let me write the first 10 pages of the annual report, I could make it far more approachable to the average investor; you just have to break it down into its constituent parts and walk people through it.  Most folks are pretty smart if you have faith in them and take the time to explain what is going on clearly.  For that reason, some of this is going to be simplified, but it should remove all of the confusion in terms of the practical effects of buying into one security over the other.

It’s an important lesson because the structure BHP Billiton uses by taking advantage of two companies, BHP and BBL, has been around along time and can create some interesting opportunities, both for value investors and for those wanting to minimize taxes.  In fact, the BHP vs. BBL situation is nearly identical to how Royal Dutch Shell was structured from 1907 through 2005.  Yes, it is complex, but the benefits are justified.

BHP vs BBL

BHP Billiton is owned by two companies, one in Australia and one in Great Britain.

How BHP Billiton Is Structured

There are two, separate, legal companies in which you can become an owner. One is in Australia, called BHP Billiton Limited. The other is in Great Britain, called BHP Billiton Plc.

Both of those businesses own a stake in the real, underlying holding company called BHP Billiton. That real, underlying company in which they both on stock is the one that owns the subsidiaries with gold mines, silver mines, copper mines, iron ore mines, aluminum mines, diamond mines, coal mines, etc.  It is the one that produces the profits.

A quick search on the Internet found this chart of the legal structure that will help you visualize it:

BHP Billiton

 

When the real, underlying holding company that owns all of the assets and makes all of the money pays dividends, it sends the money to its stockholders – BHP Billiton Limited and BHP Billiton Plc.

Those two companies then distribute the money to their respective stockholders. BHP Billiton Limited receives the cash in Australian dollars and pays it out to its stockholders since it is an Australian company traded on the Australian stock exchange.  BHP Billiton Plc receives the cash in Pound sterling and pays it out to its stockholders because it is a British company traded on the London stock exchange.

In other words, BHP Billiton Limited and BHP Billiton Plc are separate, distinct, legal entities. They are their own business. If you own stock in one you do not actually own stock in the other. However, the primary asset of each is ownership in the underlying real company in a way that 1 share of either business is going to get the same earnings, dividends, and voting power as 1 share of the other.

Thus, if you wanted to buy an ownership stake in BHP Billiton for your portfolio, you could get your hands on the underlying mines by either buying shares of the Australian company or shares of the British company.

There Are More Options for Those in the United States – An Introduction to BHP vs BBL

In the United States, a major investment bank wanted to make it easier for American investors to take a position in either of the two firms without having to deal with all of the hassle of converting dollars to foreign currency or dealing with international brokers.

 To do this, the bank created two new securities.  Think of these securities as a sort of trust fund or mutual fund that only has one holding – stock in an underlying business.  The bank goes and buys a block of the original stock and sticks them in its vault.  It then issues receipts guaranteeing the shares are in the vault (these receipts are called American Depository Shares, or ADS).  It then uses those ADS to issue a negotiable security called American Depository Receipts, or ADR, under a ticker symbol on the New York Stock Exchange or the the over-the-counter market.

In the case of BHP Billiton, the bank did two things:

  1. It went to Australia and packaged a block of BHP Billiton Limited into a new security called “BHP Billiton Limited ADR” that trades under the ticker symbol BHP on the New York Stock Exchange. It packaged it so that every 1 ADR represented 2 shares of the underlying Australian company. When the Australian company pays out its dividends in Australian dollars, the bank converts all of the money into U.S. dollars, withholds 15% of it for the Australian government, and pays out the rest to the American stockholders.
  2. It went to Great Britain and packaged a block of BHP Billiton Plc into a new security called “BHP Billiton Plc ADR” that trades under the ticker symbol BBL on the New York Stock Exchange. It packaged it so that every 1 ADR represented 2 shares of the underlying British company. When the British company pays out its dividends in pound sterling, the bank converts all of the money into U.S. dollars, doesn’t withhold any of it due to a tax treaty between the U.S. and the U.K., and then pays it out to the American stockholders.

The Four Ways an American Investor Can Buy Into Either of the Two Corporations

By now, it should be evident that if you are an investor living in the United States, you have four ways to get your hands on the actual BHP Billiton mining business, depending on whether you want to buy into the Australian company or the British company.

The Australian Shares:

  1. The BHP Billiton Limited shares traded in Australia are at $31.61 AUD with a 3.56% dividend yield.  They trade on the Australian Stock Exchange under ticker BHP.
  2. The BHP Billiton Limited ADR traded in the United States representing two shares of the Australian stock are selling for $58.67 USD with a 4.04% dividend yield.  They trade on the New York Stock Exchange under ticker BHP.

The British Shares:

  1. The BHP Billiton Plc shares traded in Great Britain are selling for £17.295 with a 4.49% dividend yield.  They trade on the London Stock Exchange under ticker BLT.
  2. The BHP Billiton Plc ADR traded in the United States representing two shares of the British stock are selling for $51.91 USD with a 4.51% dividend yield.  They trade on the New York Stock Exchange under ticker BBL.

In practically all meaningful respects, the shares are economically identical.  You get the same earnings, the same dividends, and the same voting power.  With four individual securities trading, though, there can sometimes be an opportunity to get a better deal as one may be cheaper than the other.  

It Is Almost Always Better for Americans Investing Through Retirement Accounts To Buy Into BBL Rather Than BHP

As an American, it is almost always better to buy the British stock because it is likely to trade at a substantial discount to the Australian shares.  This is going to require a detailed explanation I was hoping to avoid, but that I’m going to insert now (I’m editing this post on August 8th, 2013) in response to a question I received in the comments. 

The rules for the dividend taxation rate in Australia are different for corporations than they are for individuals. For individual, there is a tax treaty that allows investors in the United States to take advantage of a 0% withholding rate if the dividend has been 100% “franked”. If the dividend is not franked, you would owe withholding tax.

If you are from the United States, you’ve probably never heard the term “franked”.  Here in the United States, we (stupidly) double tax dividend income – the corporation pays a tax on it, then when you take it out as an owner, you pay taxes again (and then we wonder why everyone keeps shipping jobs and factories overseas) – which is virtually unheard of anywhere else in the world. In Australia, they avoid this double taxation with a special dividend tax system that involves a technique called franking. Basically, to overcome this, the company can opt to pay part of the dividend tax for you, “franking” the dividend. If the dividend is 100% franked, they have covered it all. If they haven’t, you would still owe dividend taxes.

BHP has a policy of 100% franking for its Australian shares, meaning that you get the dividend without any withholding, but attached to that dividend is a franking credit for you to lower your Australian tax bill if you have other investment income generated in Australia and paid to the Australian government. So you aren’t just getting the dividend; you’re getting the dividend plus a reduction in your tax bill.  The means the intrinsic value for the Australian shares is slightly higher for certain investors.

An American, individual investor is likely to find these credits mostly worthless unless you have a lot of investment income coming from Australia that you can use the franking credits to offset.

Large institutions, though, can use those credits, and they do have value. As a result, they can pay a slightly higher price for the Australian shares than they can for the British shares, and still end up in the same boat. Thus, large institutions tend to only buy the Australian shares, driving up the price relative to the British shares. For a large institution, the current prices are, on a net cash flow after-tax basis, about at parity.

This leads to an interesting situation for the average investor, who can profit from the cheaper price in England than the one in Australia as the Australian shares are in higher demand and trade at a premium due to that supply/demand situation caused by the tax incentive.

I also prefer the shares in London because there is no guarantee BHP will always offer 100% franking on their dividend, which would subject you to the dividend withholding tax.  For those of you buying in a Roth IRA, Traditional IRA, SEP-IRA, SIMPLE IRA, private pension, 401(k), 403(b), or who are in a lower tax bracket, you can’t recapture the dividends you paid to foreign governments except in some fairly unique circumstances that only apply to institutional investors running large pension funds.  That means if you bought shares of the Australian company through an IRA, and the franking policy ever changed, you would be giving up 15% of your dividend income for absolutely no reason and, worse, you’d never get it back or receive a credit on your income taxes here in the United States for it.

Thus, for the typical person living in the United States, the British shares, either directly on the London stock exchange or through the ADR traded on the New York Stock Exchange, offer a vastly better deal in almost all circumstances.  Theoretically, if there were a disaster in Australia that caused the stock market to collapse, it could happen that the shares would fall far enough, fast enough that you’d be better off buying them, but that gap would quickly be closed by arbitragers.

Yesterday, I bought the BBL securities traded in New York.  They offered a higher dividend yield and zero taxation.  It also saved me from having to deal with currency conversion since it was a relatively tiny position that I will likely build over time where there would have been no economies of scale. 

Disclaimer: I am not your accountant, nor your attorney, so this is purely for informational purposes as your circumstances may be different.  I disavow any responsibility for providing this information, do not guarantee its accuracy, and it is your responsibility to seek out qualified advisers to provide guidance on your unique situation.

  • Bill

    Awesome post, Joshua. It helps illustrate the idea you were explaining to me in comments about Shell as well.

    • http://www.joshuakennon.com/ Joshua Kennon

      I just published one minutes ago for Royal Dutch Shell that might help you understand it better. You can read it here. Let me know if you still have questions and I will try to explain.

  • joe pierson

    So for taxable accounts that meet the holding period requirements you can claim a Foreign Tax Credit and recover the 15% (minus the time value)?

    • http://www.joshuakennon.com/ Joshua Kennon

      Generally speaking, yes, that is correct. See here and here for more information, or if you are really feeling adventurous, go straight to the source and read the weighty tome that is IRS Publication 514: Foreign Tax Credit for Individuals (PDF) to learn about all sorts of exceptions and loopholes, like dividends paid on foreign mineral rights or allocating the income between spouses to maximize deductions.

  • Jason

    Much easier to understand thank you.
    I wish you broke it down simply like this for Royal Dutch Earlier. I bought RDS.A last year and am now thinking that it might be the wrong share class…..

    • http://www.joshuakennon.com/ Joshua Kennon

      I just published one minutes ago for Royal Dutch Shell that might help you understand it better. It should be visible now if you wanted to read it. Let me know if you still have questions and I will try to explain.

  • segfault

    I don’t think there is such a thing as a “Simplified IRA.” I have a SIMPLE IRA, but SIMPLE is an acronym for “Savings Incentive Match PLan for Employees.”

    The SIMPLE is similar to a 401k plan, but designed for small businesses. Contribution limits are lower ($12,000 per employee per year in salary deferral), and the employer match is capped at 3%.

    • http://www.joshuakennon.com/ Joshua Kennon

      There’s not; I had originally written out “Simplified Employee Pension IRA” instead of SEP-IRA. When I scanned it, I read it as “Simple” and spell check didn’t catch it for obvious reasons.

      Thanks for pointing that out; I fixed it in the copy.

  • Austin from TX

    Extremely helpful Josh! Seems like there would be some arbitrage opportunities here as the equities are ‘essentially the same’ but with different earnings yields and price points. Knowing I’m not as smart as others, I’d imagine the delta in earnings is already priced ‘perfectly’ in accordance with risk I’ve failed to take into account.

    I had a real life “Mail Bag” where someone was trying to preach about how Oil Companies and Big Banks run the world and that governments are puppets etc. One of those conspiracy theories types. Anyway, I asked if he had a $100 and I’d open up a brokerage account and buy shares of each of these ‘bad companies’ then he would instantaneously become owner of the companies and subsequently the man. If these companies are doing as you say, why not buy in and enjoy the fruits of their labor? He didn’t really understand it but I enjoyed it nonetheless.

    Best,
    Austin

  • David Tran

    Excellent post Joshua! Been a long time reader, but first time posting. This article is really helpful! Thank you for all your help!

  • David Wang

    I’m not sure if you have any Australian reading your blog, but perhaps you could provide insight as to which shares are the most tax effective from an Australian investor’s point of view.

    • http://www.joshuakennon.com/ Joshua Kennon

      The Australian shares are almost always going to be better for an Australian citizen because BHP has a policy of 100% franking for the dividend, meaning that the Australian dividend actually comes with an attached tax credit that an Australian investor could use to lower his or her tax bill to the government under certain circumstances (this is what is ultimately responsible for the valuation differential between the Australian and English shares).

  • SWISSFINISH

    Great post. I am a first time reader – will definitely be back.

  • SWISS FINISH

    Does the capital gains tax (CGT) treatment also differ? Buying shares in Australian would also be subject to CGT for non-residents. Does the same apply when purchasing the shares through the UK.
    Thanks again

  • April

    Thanks to all for information here….but I just found a treaty between the US and Australia where Australia agreed NOT to withhold any taxes from dividends paid to American investors! I checked my broker account and saw that indeed no taxes have ever been withheld from my BHP dividends!
    So, knowing all that, does anyone care to know why the shares sell at different prices yet pay exactly the same dividend in US dollars?!

    • http://www.joshuakennon.com/ Joshua Kennon

      I was hoping to avoid this but I suppose it was only a matter of time before someone brought it up. It almost requires an article of its own so stay with me. I’ll try to add an edit to the above article so it doesn’t come up again and oversimplify this in as few words as possible to make it clear.

      The rules for the dividend taxation rate in Australia are different for corporations than they are for individuals. For individuals, you are correct, there is a relatively new tax treaty (can’t remember the exact year but it was within the last decade or so if I recall correctly) that allows investors in the United States to take advantage of a 0% withholding rate IF the dividend has been 100% “franked”. If the dividend is not franked, you would owe withholding tax.

      This now requires a side explanation. Here in the United States, we (stupidly) double tax dividend income – the corporation pays a tax on it, then when you take it out as an owner, you pay taxes again (and then we wonder why everyone keeps shipping jobs and factories overseas) – which is virtually unheard of anywhere else in the world. In Australia, they avoid this double taxation with a special dividend tax system that involves a technique called franking. Basically, to overcome this, the company can opt to pay part of the dividend tax for you, “franking” the dividend. If the dividend is 100% franked, they have covered it all. If they haven’t, you would still owe dividend taxes.

      BHP has a policy of 100% franking for its Australian shares, meaning that you get the dividend without any withholding, but attached to that dividend is a franking credit for you to lower your Australian tax bill if you have other investment income generated in Australia and paid to the Australian government. So you aren’t just getting the dividend; you’re getting the dividend plus a reduction in your tax bill.

      An American investor is likely to find these credits mostly worthless unless you have a lot of investment income coming from Australia that you can use the franking credits to offset.

      Large institutions, though, can use those credits, and they have a lot of value. As a result, they can pay a slightly higher price for the Australian shares than they can for the British shares, and still end up in the same boat. Thus, large institutions tend to only buy the Australian shares, driving up the price relative to the British shares. For a large institution, the current prices are, on a net cash flow after-tax basis, about at parity.

      This leads to an interesting situation for the average investor, who can profit from the cheaper price in England than the one in Australia as the Australian shares are in higher demand and trade at a premium due to that supply/demand situation caused by the tax incentive.

      Make sense?