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A learner and fitter De Beers?

Trouble with its Russian operations, the outcry over blood diamonds and the ending of its virtual sales monopoly made for uncertain times at De Beers, but the company's remarkable half-year performance reported last August has boosted investor confidence and powered a programme of overseas expansion Tom Nevin reports on how De Beers is reinventing itself.

Announcing a higher than expected reduction in the diamond stock pile, De Beers' MD Gary Ralfe said: "We have set ourselves big, hairy, audacious goals." Strong demand for luxury goods has driven De Beers' earnings to unanticipated high levels.

Earnings before tax for the six months to June of $958m was higher than the full year earnings in 1999. The market responded by driving up the value of De Beers' shares to R190 a share, a gain of R11 from the previous week.

The diamond miner's sparkling performance followed its resolve to reduce its gem mountain from a $4bn stockpile at the beginning of 2000 to the current level of around $2.7bn. This was good news for shareholders and marked the beginning of the end of De Beers' legacy as the world market's diamond custodian. In that capacity it was obliged to soak up much of the market's excesses, with little enhancement in shareholder value.

When sanctions were put in place by the UN some two years ago, De Beers complied and later went beyond that call to place a complete embargo on diamonds from Angola, regardless of whether they are accompanied by an Angolan certificate of origin or not. De Beers no longer buys diamonds on the open market anywhere in the world.

While the results announcement was an occasion for celebration, there was some caution about what may be happening on Wall Street. If the American economy about faces and the US markets take fright, De Beers could feel the pinch, given that the American takes up around 50% of the gem diamond market.

However, stockholders will take comfort in the company's trading discount of 28% against net asset value, and De Beers itself might consider a share buy-back a good investment, although that will probably happen only if cracks appear in the US economy. The company's current cash holding is around $2bn.

Said an elated De Beers Chairman Nicky Oppenheimer: "These are an excellent set of results. The strong cash flow gives us the opportunity to look at investing further in the diamond business."

Asset value you can touch

The difference between De Beers and IT stocks that over the past decade grabbed so much investor attention and attracted so much capital market support is as fundamental as the difference between asset values you can touch, and those you can't. The upshot was that De Beers was probably the most undervalued counter on earth, trading at times at discounts nearing 40%.

Today, more than ever, De Beers is affirming that diamonds are forever, while stocks come and go - with some notable exceptions.

Perhaps the circumspection was caused by the fact that De Beers is so visible a company. Its ups and downs, and the peculiar circumstances under which it operated (many of its own making), were ever under microscopic scrutiny and the subject of endless debate and speculation in the business media and the investment community.

To say that De Beers is asset-wealthy would be an understatement. Apart from its own worth, it also holds 35.4% of the Anglo American mining colossus, while Anglo controls 32.2% of De Beers. The reciprocal receipts are equivalent to about 46.8% of Anglo and converts the company into a virtual mining mutual fund. Through its participation in Anglo American it has a 17.8% investment in AngloGold, the same in Amplats and 10.4% in merchant banker FirstRand. The list goes on.

In its core diamond mining business, De Beers has only recently begun to venture from its African backyard. The company's main mining activities are in southern Africa while it has prospects and exploration on five continents. Nearly 38% of its exploration budget is sunk into North America and just over 32% in Africa. The rest funds the hunt for diamond fields in Australia, Eurasia and elsewhere.

Rereshaping the world diamond market

The tripling of its half-year sales launched the company's strategy to reshape the world diamond market as it seeks greater geographical diversity and an increase of its slice of production. Some of the nearly $1bn cash generated will help underwrite new exploration and acquisitions.

Part of the new burst of activity is the purchase of Canada's Winspear Diamonds for C$305m, negotiations for Ashton Mining in Australia and expansion of its existing operations in Africa.

The Canadian deal was finalised when the Winspear board recommended its shareholders to accept the bid and they have also committed their own 15% interest in the business to De Beers.

However, if the Winspear acquisition is anything to go by, De Beers will have to fight a lot harder in future to expand its international turf. When the South African company attempted to grab the entire issued share capital in the Canadian exploration company, Winspear rejected the C$259m cash offer. De Beers, the sole bidder, refused to back down or revise its offer, insisting it was "full and fair and offers significant value for Winspear shareholders," according to De Beers' Mark Irvine.

Randy Turner, Winspear's CEO, came out fighting: "The board of directors' initial view is that the offer is opportunistic, hostile, highly conditional and does not reflect the underlying value of Winspear."

The Canadian company's share price soared by 75% on the Toronto Stock Exchange on news of the revived De Beers offer as stockholders and new punters endorsed the bid. The deal gave De Beers 68% of Winspear's Snap Lake project, which is at a far more advanced stage than any of De Beers' current exploration projects in Canada. (Winspear's principal asset is its 67.76% share of the Camsell Lake property, on which a diamondiferous kimberlite dyke system has been discovered. Winspear is currently undertaking a feasibility study and are the operators of the project.)

De Beers recognises that Canada is an important diamond producing country of the future and would like to bring a diamond mine into production there as soon as possible. The South African company already has in place a sales agreement with BHP to market 35% of the production of Ekati, Canada's premier diamond mine.

Need for more territory

The deal was important to De Beers for another reason: with the exception of Tanzania, other diamond areas in Africa such as the Democratic Republic of Congo and Sierra Leone are so called conflict areas, and the gems they produce are not welcome on world markets.

"A conflict diamond, according to the definition now recognised by the UN, other government authorities and the NGOs, is one that is mined or stolen by rebel movements in opposition to the recognised government of a country," De Beers spokesperson, Tracey Peterson, told African Business. "But not all of the diamond producing areas of these countries - particularly the DRC - are controlled by rebel forces and are therefore not defined as being conflict areas."

De Beers is still actively searching for new deposits in Africa in countries such as Botswana and Guinea while expansion of operations in South Africa, Namibia and Botswana are already funded and well underway.

The company's search for ventures outside Africa, according to Paterson, is to increase its geographical production spread. In addition, its exploration ventures into Russia were proving nettlesome, making Canada and Australia of particular significance.

In the event, the De Beers cash offer of C$5 per share won the day with all conditions being accepted. The revised bid of C$42m on top of the original C$259m, secured its first operational foothold in North America. Snap Lake is expected to yield 1.75m carats a year in full production.

With Winspear in the bag, De Beers has turned its attention to buying the entire issued capital of Ashton, with a September 6 offer of A$1.62 cash (less declared dividend) for the Australian diamond miner. Ashton's prime asset is a 41% stake in the 225,000 carat a year Argyle diamond mine. The offer closes on October 13.

The Ashton deal is a tougher nut to crack with the London-listed Rio Tinto mining company hovering in the wings, and punters expecting to profit from a bidding war. The board of Ashton had opposed De Beers' initial R2bn bid as inadequate, and have been marking time waiting for other offers to emerge.

De Beers' all-cash takeover offer for Ashton represents a premium of 62% to Ashton's July share price. De Beers' MD Gary Ralfe described the bid as "full and fair" taking into account underground extensions at the Argyle mine.

Ralfe added that the offer for Ashton was "a serious and strategic one for our company. The Argyle mine will broaden our geographic production base, while expanding the range of diamonds we can offer to our sightholders."

The formal diamond industry worldwide has taken to heart international concern regarding 'blood' or 'conflict' diamonds that are mined in war zones and sold for arms procurement. In mid-July, the De Beers group announced it was taking the lead in introducing best practice principles to ensure the diamond industry is run in an ethical and professional way.

De Beers' Diamond Trading Company (DTC), has made it a condition of supplying its sightholders that they too agree to comply with the principles.

Squeezing the blood diamond market

The best practice principles were formulated following De Beers' 1999 Srrategic Review when it was recognised that the company had to "honour consumer trust and conserve the allure and mystique of natural, untreated diamonds, countering anything that could bring the industry into disrepute," according to De Beers' spokesperson, Tracey Peterson.

"With the advent of instant global communications, consumers are becoming more aware of potential threats to the integrity of diamonds," says Peterson. "This, combined with new technologies to alter and imitate gemstones, means that consumers need to be reassured that the diamonds they purchase are natural, rather than synthetic or manmade, and have not been tampered with in any way; for this reason the principles provide for full disclosure."

The best practice principles ensure that diamonds sold by the signatories have not been sourced from areas where this would encourage conflict, be associated in any way with the use of child labour or connected with harmful or dangerous practices which affect the health or welfare of individuals.

The Russian connection

Russia's Almazy Rossii-Sakha (Alrosa) mines produce about 24% of the world's diamonds by value, compared with De Beers' output from its South African, Namibian and Botswana mines of 44%. De Beers markets about 60% of world diamond production through its sales and marketing arm in London, the Diamond Trading Company. A little over 40% comes from its own mines and its partner mines in Botswana, Namibia and Tanzania, while the balance comes from sales agreements with Alrosa (Russia) and BHP (Canada). It appears that the state diamond company of Angola, Endiama, has awarded all existing sales contracts to a company called Ascorp, headed by an Israeli, Lev Leviev. Namibia is said to be in talks over a new offshore deal with Russia.

De Beers' buying safaris into Canada and Australia are an effort to reaffirm its status as the world's number one diamond company.

"We have in place a contract with Alrosa which runs until December 2001," says Peterson, "and this is working extremely well. We are, of course, already starting to put in place with our partners some tentative plans for the extension of that contract."

MD Gary Ralfe is on record as saying that although there have been some "off-stage noises", at a panel discussion with Alrosa in London, the "very clear message from Alrosa is that they have confidence in their marketing contract with De Beers and in its continuation.

We meet regularly with our Russian partners and any changes to the future contract which may be proposed are discussed in that forum."

De Beers buys a little more than half of the total productive capacity of Alrosa which is currently running at around $1.6bn per annum.

In May this year, De Beers Centenary and Alrosa issued a joint statement announcing that De Beers had agreed to sell its 27% interest in Severalmaz, the Russian company which holds the licence for the Lomonosov deposit in the Arkhangelsk region of north west Russia, to Alrosa. The parties agreed that as the major diamond company in Russia, Alrosa was better placed to take this development forward as the legislative framework, fiscal regime and investment climate in Russia is more favourable to a local operator than a western company. Alrosa intends doubling Russia's diamond output, which would take its production of mined rough stones to about $3.2bn.

Tackling the market head-on

After a year-long soul-searching strategic review, De Beers embarked upon a new sales and marketing package it called 'Supplier of Choice', a bold step designed to increase demand for diamonds by tackling the market head-on in a new trading environment created by the dismantling of its Central Selling Organisation (CSO), and described by De Beers chairman Nicky Oppenheimer as "one of the most significant developments in the diamond industry since the 1930s".

To be the 'Supplier of Choice' in a world of great opportunity, De Beers will provide the best value-added service to clients and, through them, their downstream partners. We believe that this strategy will make our DTC marketing arm the first choice for rough diamonds," said Oppenheimer.

"There is a huge untapped opportunity for all of us in the industry to grow the diamond business and match the growth rates enjoyed by leading luxury goods companies. That sector has demonstrated that brands are a catalyst for growth," according to Ralfe.

The luxury goods market is growing at 10% per annum and typically spends 6 to 10% of sales revenue on marketing; on the other hand, the diamond jewellery industry spends little more than one per cent of revenue.

The four main planks in the 'Supplier of Choice' platform comprise a new corporate identity for the company's marketing arm, the Diamond Trading Company, which will be supported by the group's international marketing campaign; a package of value-added services for clients; the establishment of a code of professional and ethical standards called 'best practice principles'; plus the introduction of a policy statement which will emphasise efficient distribution and marketing abilities.

"While our core business will remain the mining and marketing of rough diamonds," reported Ralfe, "in five years time, we envisage an industry in which there are multiple and competitive brands. As we have learned from other industries, competing brands stimulate global demand. In due course, we hope that the De Beers brand will be one of those."
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Title Annotation:New business plan
Author:Nevin, Tom
Publication:African Business
Geographic Code:6SOUT
Date:Oct 1, 2000
Words:2482
Previous Article:How Asia rose from the dead.
Next Article:Harry Oppenheimer.
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