In the pre-crisis year of 2007, there were a lot of events in the corporate life in Russia. But even against this backdrop, the deal to acquire a 25 percent plus one share stake in Polyus Gold by a consortium led by ALROSA could stand out. The state-owned diamond monopoly negotiated the acquisition of the country’s largest gold mining company with a clear potential to further increase its share to a majority stake and merge. The merged company looked like an obvious contender for Sukhoi Log, the Europe’s largest gold deposit.
Such megalomaniacal projects were not unusual at that time as several other groups of entrepreneurs were simultaneously discussing the setting up of a domestic analogue of BHP Billiton. Before the crisis, ALROSA managed to acquire oil and gas assets and the Timir iron ore project, and the company’s plans were to diversify its business with the help of these assets. The diamond miner could spend about $2 bn to purchase a blocking stake in the Polyus Gold company from Mikhail Prokhorov’s Onexim Group, which was comparable to ALROSA’s annual turnover. In the end, the parties did not agree on the price.
It is difficult to imagine how events would have developed should the parties had arrived at compromise in their negotiations, because even without taking out a loan to purchase Polyus, ALROSA had to resort to the help of the government soon afterwards. The purchase of diamonds worth $1 bn by the State Precious Metals and Gems Repository (Gokhran) helped prevent the shutdown of enterprises amid a sharp collapse in sales. Polyus, together with another state-owned partner, received a license for Sukhoi Log deposit in 2017. And ALROSA that met the financial crisis with a net debt of $5 bn due to expenses on the construction of underground mines and the diversion of funds to non-core assets, changed the company’s top management team and focused on stabilizing the sales system and restructuring the loans, forgetting about the diversification for a long time.
The company’s gas assets were sold in 2018, and its stake in the joint venture with Evraz for the development of the Timir iron ore-project remained on the ALROSA’s balance sheet. Some time ago, the diversification was actively lobbied by Yuri Trutnev, Deputy Prime Minister and Plenipotentiary Representative of the President of the Russian Federation in the Far Eastern Federal District, who supervised the company, and he suggested that ALROSA should engage in the development of gold and lithium, but even Trutnev’s high status did not help in getting things moving. “... in 2008, when everyone predicted fundamental changes in ALROSA’s business model, erroneous decisions on diversification were taken, the company bought gas assets, entered the iron ore Timir project - the company could hardly sell something even at a loss, some assets still remain unsold,” said the then CEO of ALROSA, Sergey Ivanov, in mid-2020. The negative economic experience of the pre-crisis experiment strengthened the opinion about the domestic diamond mining giant’s unique expertise and the inefficiency of going beyond its core business.
And now, 17 years after the failed purchase of Polyus, ALROSA has acquired one of its assets. This is the small Degdekan gold ore field in the Magadan Region, with balance reserves of 38.3 tons of gold with an average grade of 2.2 grams per ton. Gold mining at the deposit has not yet been carried out, ALROSA plans to put it into operation by 2028. After reaching the design capacity in 2030, the plans are to produce about 3.3 tons of gold per year at the Degdekan mine until 2046. 24 billion rubles ($280 mn at the current exchange rate) are expected to be invested in the project.
The ALROSA’s subsidiary Almazy Anabara that mines diamonds at the placer deposits in Yakutia is the participant in the transaction on part of ALROSA. This company accounts for 11% of ALROSA’s production (about 3.9 mn carats annually), in addition, the enterprise produces about 180 kg of associated gold per year. In 2016, Almazy Anabara received the license for associated mining of gold and other precious metals.
“The ALROSA Group has accumulated a huge experience in associated gold mining, which we will use and improve. The development of the gold ore deposit is expected to provide ALROSA’s business with an additional synergy effect and will contribute to increasing its financial stability in the long term,” commented Pavel Marinychev, CEO of ALROSA, on the deal.
The company’s focus to be involved in areas other than diamond mining was an innovation by Marinychev who took up the post of ALROSA’s CEO in May 2023, and before that, he had been the CEO of Almazy Anabara since 2016. In his first interview after his appointment as the CEO of ALROSA, Marinychev said that the diversification into other types of minerals and even industries was among the options of what ALROSA “could and should do to be calm and confident about its rather long-term future”.
Before its deal with Polyus, ALROSA had already managed to specify its appetite for the assets in the oil and gas industry. On the sidelines of the St. Petersburg International Economic Forum (SPIEF) held last June, ALROSA signed a cooperation agreement in the presence of Aisen Nikolayev, head of Yakutia, on the development of the Ulugursky and the Ergedzheysky promising oil and gas license areas in Yakutia. The Yakut Sakhatransneftegaz company will be the ALROSA’s partner in the joint venture.
The value of the contract for the Degdekan gold ore field was not disclosed, but the BCS company estimates it at $50-$100 mn, which is not a significant amount of money for ALROSA or Polyus, but there is no consensus on its importance and consequences.
ALROSA acquired the Degdekan gold ore field for the sole purpose - a social one - of preserving jobs for its qualified workforce, says Igor Kulichik who was CFO of ALROSA from 2002 to 2017. The personnel will be involved in the project design work that is expected to take about 5 years, as well as in the construction of a mine and a factory.
He does not see a significant economic effect and synergy for the company in the deal as it could only bring about $200 mn in additional annual sales for a period of about 15 years. “This is not about expanding the business, this is about keeping the company’s workforce busy and not losing unique competencies,” explains Kulichik. The former top manager of ALROSA does not believe in effective diversification, “This is just the squandering of effective competencies for cheap. ALROSA has a unique DNA, so nothing else will take root there except the company’s core business.”
By selling a small and low-grade gold ore deposit, Polyus optimizes its resource base not to diffuse their efforts, Kulichik believes.
Sergey Goryainov from Rough&Polished believes that the deal is justified under the current conditions when the problems of the diamond industry are of protracted nature. “The gold market is much more attractive than the diamond market both now and in the medium term, and there are far less problems with gold sales. Almazy Anabara has extensive experience in gold mining and good personnel in this area,” he says.
Chief strategist of the Vector X investment company Maxim Khudalov also believes that ALROSA’s focus on gold mining is determined by the situation on the diamond market. “People have come to the understanding that the company’s single-industry nature, especially taking into account wider use of synthetic diamonds in the jewelry sector, may give rise to vulnerability. In this regard, diversification into gold mining is a smart move, because good times are coming for gold against the backdrop of the global inflation spiral,” says Khudalov.
Export of Russian gold, much like diamond exports, to the G7 countries where the lion’s share of the country’s precious metal output used to go, is impossible due to the sanctions imposed, but discounts on gold sold to other countries are now minimal, according to Khudalov.
According to Reuters, after the closure of the traditional London sales market for the Russian-origin gold, almost all gold exports from February 2022 to March 2023 were distributed between the UAE, China, and Turkey. When entering these countries, especially the UAE, some of the Russian-origin gold may undergo re-refining (i.e. re-marking at the factories having the Good Delivery status), which opens up access for this metal to the markets of “unfriendly” countries, Reuters sources reported.
According to Boris Krasnozhenov from Alfa Bank, the development of the gold ore deposit will provide an additional synergy effect for ALROSA’s business and will also contribute to increasing its financial stability under the current growth in gold prices that have risen by more than 35% over the past year and have now stabilized above $2,320 per ounce. The parameters of the deposit (proved reserves of Degdekan are estimated at approximately 100 tons of gold with an average grade of 2.2 grams per ton) look quite attractive for the classic way of the development of a gold ore deposit in this region, he believes.
Initial capital expenditures in the project of 24 bn rubles are a relatively small amount, given ALROSA’s projected capital expenditures of about 68 bn rubles this year, says Krasnozhenov.
The Memorandum of Understanding aimed at developing competencies in gold mining suggests further intensification of operations, and, most likely, the intensification in the ore gold sector. “We should not expect ALROSA to make any major purchases in gold mining, but the purchase of nearby deposits is quite likely,” says Khudalov from Vector X.
With the deeper possible expansion, ALROSA may face a number of challenges, although its financial situation is more robust than in 2007-2009 (Net Debt-to-EBITDA ratio for the first half of 2023 was negative compared to 4x - 5x during the financial crisis). The development of deposits looks like a greater burden than before due to high interest rates and obstacles to purchasing the technological equipment and mining machinery. At the newly-acquired Degdekan gold ore field, the main risk may be the low quality of the ore, which will require additional technological solutions, notes Dmitry Smolin from Sinara.
The diversification is taking place at a time that is not the most favorable for ALROSA as the diamond industry has been in crisis for more than two years and there are no signs of its recovery yet, as the reports made by De Beers and Petra Diamonds show. The sales situation looks gloomy against the backdrop of the G7 sanctions, but even assuming that all output is sold - and without significant discounts - and payments come to addressees without delays, we must not forget that the funds are mainly used for large-scale projects in the core business. These include the project to restore the Mir mine (Mir-Gluboky, the declared investment volume is 121.5 bn rubles) that is already officially approved, and the project to build an underground mine at the Jubilee pipe that is awaiting the approval (the latest capital investment estimate made in 2019 is 72 bn rubles). Supposing that ALROSA’s management team intends to combine all this with an active diversification into gold, we must admit that the top managers are very optimistic about the future. Perhaps, they are as optimistic as their predecessors were in 2007 when they were considering the acquisition of the Polyus Gold company.
Sergey Bondarenko for Rough&Polished
