* Likely to include aluminium, manganese, nickel
* Many of the assets came to BHP from Billiton merger
* Shareholders welcome the announcement
* Shares up 2 pct, outperform UK mining sector (Adds net debt figure, demerger options for UK investors)
By Sonali Paul and Silvia Antonioli
MELBOURNE/LONDON, Aug 15 (Reuters) - Diversified mining company BHP Billiton declared its preference for a demerger of its aluminium, manganese and nickel assets on Friday, setting the stage for the formation of a separate business that could be worth at least $12 billion.
BHP said its board was considering a spin-off at meetings ahead of its annual results announcement next week. An Australian newspaper said those plans were well advanced and would include the Nickel West business that the world's biggest miner has been trying to sell.
"A demerger of a selection of assets is our preferred option," the company, which has a market capitalisation of $185 billion, said in a statement to the Australian stock exchange.
BHP has long aimed to sell or spin off its manganese, aluminium and nickel assets, which contribute little to its earnings. Simplifying the company would "generate stronger growth in cash flow and a superior return on investment", it said on Friday.
Some of the largest shareholders in BHP welcomed the announcement.
"It's good to see BHP taking the lead in the sector on this. It reassures you as a shareholder. It makes me more willing to have it as a significant bet within my fund," said Christopher Moore, portfolio manager of Fidelity Global Industrials Fund.
"Really we should see more of this in the mining sector. I would expect others to take BHP's lead. Rio Tinto, Anglo American could also follow suit in doing this."
BHP's rivals Anglo American and Rio Tinto have both said they would focus on the parts of their portfolio that can deliver higher return.
BHP is likely to offload between $1.0-2.7 billion of its debt to the new vehicle, according to analysts. Any more than that could be challenging to handle for a company that relies on assets whose profitability can be volatile.
Its net debt as of Dec. 30 was $27.1 billion.
Shares in BHP were up almost 2 percent by 1511 GMT, outperforming a 0.6 rise in an index of London-listed mining companies.
IRON ORE DRIVES BHP PROFITS
BHP is relying on iron ore for the lion's share of fiscal 2014 earnings after beating its own guidance for full-year output.
"Spin-offs have the potential to crystallise value that the market may not have been able to see," said Neil Boyd-Clark, a portfolio manager at Arnhem Investment Management, which owns shares in BHP.
The Australian Financial Review (AFR) newspaper said the separate company would comprise BHP's aluminium, manganese, nickel, Cannington silver mine and South African energy coal assets and would be worth $14 billion.
Analysts were divided over the precise value of those assets, with estimates ranging from $12 billion to $23 billion.
BHP was also debating whether to spin off its coal assets in New South Wales, the AFR said, without citing any source. The new company would be based in Perth and led by BHP's Chief Financial Officer Graham Kerr, it said.
It would have a primary listing on the Australian stock exchange and was likely to take a secondary listing in South Africa, the AFR added.
BHP declined to comment on the AFR report.
"Whether to list in Australia and South Africa will be a marketing decision. It's a question of matching the investor base," said a banker familiar with BHP's thinking. "Looking at the base metals space you don't have many listed names in Australia. And in South Africa, you can tap some money from pension funds who can only invest in rand."
Analysts and investors expect BHP to offer its existing UK shareholders - some of which may not have a mandate to own shares in companies listed abroad - the option to take shares in the new vehicle or an equivalent payment in some form, potentially through a buy back.
"I think if you have a global fund like me you will hold the Spinco (spun-off company)," Moore said. "If you are a UK-focused fund you wouldn't want the Spinco. Ideally the arrangement will incorporate that flexibility."
In its statement to the market, BHP said it expected to consider a demerger when the board meets next week and would announce any material decisions immediately.
BHP is scheduled to announce full-year earnings on Aug. 19.
UBS analyst Glyn Lawcock said last month he expected BHP to go through a three-step process, selling its Nickel West business, then spinning off its manganese, aluminium and South African energy coal businesses as a separate company to all shareholders, before unwinding its dual-listing in London.
Most of the assets that analysts expect it to shed came into the company through London-listed Billiton when it merged with BHP in 2001.
At the time, those assets were touted for the diversity they brought, creating a mining giant with roughly equal earnings from aluminium, base metals, coal and iron ore.
But they barely contribute to the company's profits now, overshadowed by a decade of soaring growth in its iron ore, copper and coal businesses driven by China's rapid economic expansion.
At the same time, BHP has expanded in oil and gas through shale acquisitions in the United States.
"By increasing our focus on these four pillars, with potash as a potential fifth, we will be able to more quickly improve the productivity and performance of our largest businesses," the company said in its statement.