ALROSA has demonstrated impressive financial results for 2010: its net profit under IFRS went up 3.4 times compared with 2009, operating revenue increased by 45%, corrected EBITDA soared by 82%, EBITDA margin was 31%, while the company’s net debt went down by 13%, whereas its short-term debt plummeted by 86%. The market conjuncture is currently most favorable for the Russian company and there are all the grounds to suggest that in 2011 ALROSA will gain a record operating revenue for the whole time of its existence – over $ 4 billion. The diamond fields controlled by ALROSA have reserves and resources reaching almost 1.3 billion carats and are able to engage the company at the current level of operations in the course of 40 years. The deficit market and price surge heated up by fantastic demand from India and China make it easy for diamond producers to forget competition and if ALROSA goes listed, which is awaited by many in the industry with undisguised interest, then stock market quotes for the company’s shares may well become material embodiment of Varda Shine’s graceful metaphor about the advent of a “diamond decade.”
However, there is one problem which is called Timir. This project embraces four iron deposits located in the south of Yakutia and requires about $ 15 billion of investments. Its first stage, which is construction of a mining-and-processing integrated works, will take about $ 3 billion in investments. Under the license received by ALROSA in the spring of 2008 the construction is to be started in 2012. On repeated occasions the company said that it was engaged in negotiations with would-be investors to this project, but did not disclose the list of bidders. As it appears by this moment, so far the company has no partner. However, this does not embarrass those who are enthusiastic about developing the iron deposits using the capacities of a single diamond mining company. Indeed, today the diamond market is feeling very well and judging by the record results gained in 2011 there is a possibility to launch an IPO selling off 20-25% of the company’s shares which will possibly bring in the desired $ 3 billion.
Three billion dollars for the first stage of Timir – is it a great or small amount at the scale of the iron market? In 2010, ArcelorMittal, the world’s biggest iron maker, embarked on a five-year investment program aimed at meeting its requirements in iron ore to the full extent. By 2015, the company is to ramp up iron ore output by 40% by way of acquiring new iron deposits and intensifying the development of those it already has at its disposal. The total amount of investments is to be $ 4 billion. It remains to be said that ArcelorMittal’s capitalization runs at $ 53.8, while its turnover reaches $ 78 billion.
The metallurgical giant for which iron ore mining is just the initial link in its vertically integrated production process (i.e. the problem of selling iron ore is just non-existent) and the diamond mining company, which is financially beyond any comparison and having not the slightest experience of operations in this market, are to invest quite comparable amounts into iron ore assets – of course, this looks impressive. And this makes us look at the arguments of those in favor of ALROSA’s industrial diversification at another angle.
The main of these arguments is pinned to depletion of diamond reserves: there are no new diamond deposits, while the quality of the old ones is worsening, so it is inevitable that diamond output will be decreasing disengaging the company’s mining capacities which should be used in the most akin fields of mining and Timir is suited best of all for this purpose. This proposition seemed impeccable prior to making public ALROSA’s reserves and the company’s own estimate saying that these reserves will suffice for a forty-year-long job at the current rate of mining output. Forty years is quite a lengthy term and there is hardly a company currently operating in the diamond or iron markets to forecast how and why these markets will move in the course of such an extended period. But the inevitable decrease in ALROSA’s output in the mid-term does not look so much inevitable any longer.
The second strong argument is not so obvious and evidently stems from non-market considerations. Last May, Yegor Borisov, President of Yakutia sitting on the Supervisory Board of ALROSA, said that Timir should be developed with ALROSA’s direct participation, although he did not exclude that the list of would-be investors to this project may be expanded. So far it remains a secret how much ready the would-be investors are to join the venture, but as for the tough insistence of Yakutia’s administration on ALROSA’s participation in Timir there is nothing to wonder about. This province has a 40-percent stake in ALROSA and its administration’s representatives are included in the company’s Supervisory Board. If ALROSA will remain in Timir having at least a blocking stake, the province will preserve a certain opportunity to control financial flows of this project. If Timir will be completely transferred into the hands of an outside investor its relationship with the province will be limited to the terms of the issued license and tax regulations; the examples of Surgutneftegaz and Mechel may serve to confirm this.
And now it’s time to have a look at the situation through the eyes of a would-be investor. This investor is offered to enter a project which via ALROSA will be controlled by the administration of a subsidized province burdened with an array of budget problems with all ensuing consequences. In the long view there is an obvious conflict of interest even excluding the traditionally hefty Russian corruption component. The participation of a depressive province, even if oblique, in such a capital-intensive project is a grave risk factor, especially for a foreign investor. It should be also kept in mind that the traditional pricing system which existed in the iron ore market for some decades ( the system based on long-term contracts of major consumers with the producing Big Three - Vale, Rio Tinto and Billiton – controlling 2/3 of the market) failed to weather the crisis and Japan’s disaster and collapsed last year. Currently, the iron ore market is to some extent in disarray and factors governing investment risks have acquired additional weight.
What will happen if ALROSA will not be able to attract a strategic investor to Timir and will have to develop it on its own? The amount of required investments clearly out-of-limit for the company will inevitably bring about a higher debt burden which the company just recently managed to decrease to an acceptable level. This will tacitly raze to zero all the advantages of a favorable market movement and prejudice ALROSA’s pace-setting positions. So far as De Beers will continue to implement its strategy of vertical integration going ever deeper into the segment of branded diamond sales where the margin rate is the highest, the Russian diamond miner will try to conquer the market where it has no experience and authority and where no one expects it to be. Having abandoned its search for an investor for Severalmaz and significantly increased its exploration expenses ALROSA is today the world’s number one company in terms of modernizing its exploration unit compared to other diamond miners. Judging by these symptoms, ALROSA may have already decided to focus on its core activity, which would be correct.
Sergey Goryainov, Rough&Polished
