(Adds comment from CEO Graham Kerr) MELBOURNE, March 27...

(Adds comment from CEO Graham Kerr)

MELBOURNE, March 27 (Reuters) - South32 Ltd said on Monday it would return $500 million to shareholders, rewarding investors who had been waiting for the company to use its strong balance sheet and cashflows on bigger payouts or acquisitions.

The diversified miner, spun off by BHP Billiton (BHP) two years ago, said it would launch an on-market share buyback in Australia targeting 4.5 percent of its share base, which it expected to complete over 12 months, depending on market conditions.

"Working capital has continued to unwind, prices continue to hold up strongly so we continue to accumulate cash into our bank account," South32 Chief Executive Graham Kerr said.

"The reality is that we don't have a need for that cash today. So the $500 million dollar on market buyback we announced is the best way to get that cash to our shareholders over the next 12 months," he told Reuters in an interview.

South32 shares last traded at A$2.66, about triple the value they were in January 2016 and about 28 percent higher than their launch price in May 2015.

Kerr said S32 still has plenty of ammunition for mergers and acquisitions.

"After the buyback we will have just over $500 million in net cash. We've always said our balance sheet could actually run at $500 million of net debt so I've still got about $1 billion's worth of opportunity fund sitting there."

South32 has proposed a $200 million acquisition of Peabody Energy's Metropolitan colliery in Australia, although the plan has raised competition concerns over control of the local coking coal market.

It also said last month it had entered into an alliance with Australia's Ausquest Ltd (AQD) to develop new projects, and has signed an exploration deal with Canada's Northern Shield Resources.

"Longer term, we would have a bias towards base metals, copper, nickel, zinc, cobalt because they are used at different stages in economic development, rather than iron ore and metcoal which is more about the front phase of economic development," Kerr said.