When two completely different assets are housed in the same corporate structure, the lowest common denominator sets the value for the whole company.

And when the lowest common denominator drops even lower, you pretty quickly get aggrieved shareholders, a company under pressure and conditions ripe for a demerger.

So it is at Iluka Resources, where years of rallying by activist Sandon Capital and more recently L1 Capital and others, finally has the mineral sands miner formally working with Gresham, Herbert Smith Freehills and Greenwoods on a potential $2 billion spin-off.

Iluka faced difficulty integrating its Sierra Rutile project, which accounts for about one-fifth of the company’s value. The problems sent its shares to a 2½ year low in August and fired up shareholder pressure.

According to the activists, the troubles in the mineral sands business were hiding the value of its Mining Area C royalty – a passive income stream from BHP – at a time when low bond yields and interest rates globally mean the royalty should be worth more than ever.

So we’re at the point where Iluka is formally reviewing the structure and has its bankers and lawyers working on arguably the biggest hurdle to the deal; tax. Iluka will want to secure shareholders capital gains tax rollover relief should it spin off the royalty, and needs to put some thought into exactly how that can be achieved.

Of course Iluka has been down this path before and the obvious question is whether this time is any different. Iluka’s advisers reckon they have a tax solution, which is promising, and shareholders reckon they’re not giving up without a fight.

The other reason why shareholders think this time is different is thanks to BHP itself. Development of BHP’s $US3.6 billion ($5.2 billion) South Flank iron ore mine, located in MAC, will dramatically increase the value of the royalty. Iluka is owed more money as capacity at the site increases.

The development gave investors visibility on when additional royalty cash flows would start and allowed them to value the royalty with more certainty. Now the bulls reckon it is worth $2 billion plus – and they seem to be bringing the sell side along with them.

Should it go to plan for the activists – and should Iluka’s whiz-bang advisers really have the tax solution – the next question is where would the pure play mineral sands company trade? Citi, for what its worth, said this week a demerged mineral sands business would make $550 million to $670 million a year at the EBITDA line in the coming five years. It’s chunky.

Citi put a 3.2 times multiple on the unit, which is more than South32 at 3 times and Oz Minerals at 2.9 times.


By Sarah Thompson, Anthony Macdonald and Tim Boyd

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