Economists generally say that every crisis is a positive phenomenon because it gives an incentive to change, even in the areas that seemed unshakable. The framework involving major diamond market participants seemed to be something like this, a constant. It has not changed even after the 2008 crisis. But now, three years later, it started to change dramatically, just in the course of one month. And all this is taking place despite the fact that another crisis is looming somewhere nearby, though it is yet not here in full swing.
Diamonds are forever. Confidence is not.
The coming exit of the Oppenheimer family from the ranks of De Beers shareholders (which is hardly something anyone doesn’t know) is primarily written off for the problem of "fathers and sons." Allegedly, the idea that it was time to abandon the diamond business dawned upon the family a long time ago, and it came to all but Nicky. Allegedly, Nicky clang to the last hope that Jonathan would be able to continue the family business in a duly manner. And once again allegedly, Jonathan did not show adequate business merits, which caused tension. The most intriguing thing about it all would be to know what percentage of those writing about these family difficulties had ever a chance at least once to get in touch with this family personally.
Maybe someday some of the Oppenheimers will undertake a memoir which will raise the veil of secrecy over the psychological side of the situation. In the meantime, we’ll try to address the side of the matter which is pure economics.
The diamond market is going through a second crisis over the past 3 years. And it is well known how De Beers weathered the previous one. The company had to halve its output (which is not recovered until now) and incur losses. And its shareholders had to pour more and more money into the company’s capital being, of course, deprived of dividends. And if Anglo American is a powerful multinational corporation with a diversified business having many sources of revenue, the Oppenheimer family had De Beers as their key and almost the only source of income. Can you imagine a water well into which you have to pour water all the time?
Now the situation on the market looks the same as three years ago. Rough prices have dropped. Diamond mining companies are reducing the volume of supply: DTC is trimming its sights (and Debswana is already officially cutting its production plan), while ALROSA has once again abandoned the open market and is selling only under long-term contracts. Perhaps all this makes the Oppenheimers be aware of a further scenario played circle wise: once again they may have to bear losses and provide funds to support the company afloat.
This is implicitly proved by the deal: $5.1 billion for a 40-percent stake. According to market experts, the real value of this package is at least $1.5 billion more. If the price is really undercut, the deal looks like an attempt to get rid of a bad asset in time and duck into cash.
Perhaps the reasons were quite different. But confidence in a bright future of the diamond industry seems to be fading among other major market participants as well. BHP Billiton announced that it called into question its further participation in the diamond business and said it was considering options to sell both of its Canadian assets.
The only currently operating diamond enterprise of BHP is the Ekati Mine in Canada turning out about 3 million carats of diamonds every year. Ekati has been developed since 1998 and its proven reserves may last for only a few years of mining, while its prospects for expanding the resource base are unclear. However, BHP in its press release explains its desire to sell the mine not by the fact that this deposit is exhausted, but by the lack of newly discovered large-scale diamond deposits, which could facilitate significant business expansion, as it is required by the company's strategy.
If the decision to exit the diamond business was dictated by its strategy only, it is unlikely that BHP came to it just a while ago: the world has not seen any new large diamond deposits discovered for several decades. And even the exhaustion of Ekati is hardly news to the market. And even if the logic of business says that a dead-end asset should be sold to get free cash, BHP has chosen a strange time to sell. Selling the mine at a peak price for diamonds could give a much better chance to make the most of the deal in terms of money, than selling it now.
Rather, it's just different. Rough diamonds mined at Ekati are sold by BHP via auctions. During the last few months prices for rough sold at auctions were exceptionally low. This could safely be put up with in the short term, but unfortunately no one knows how long this short term will be.
Incidentally, shortly before the publication of this press release the media reported that Ekati could be bought by ALROSA. However, both sides have confirmed neither the intention nor any negotiations, nor even the existence of interest in such a transaction. What was it then? Could it be a move to create the impression that the asset was viewed as a good buy?
The intention of BHP to “examine whether a continued presence in the diamonds industry is consistent” with the company’s strategy (which basically reads "we shall certainly sell, if we’ll find a buyer") is the kind of behavior typical for any large diversified mining company. A global company has no "moral" attachment to any industry and is guided solely by economic expediency. In this sense, the future of De Beers passing under the full control of the mining giant is also not very clear. No, it is unlikely that we shall see its management changed, assets sold, business reorganized, or some other drastic measures. But what will be the change in the attitude?
Changing of the Guard
While some diamond market players seem to lose their confidence, others on the opposite are gaining it. For the first time in its history Russian diamond monopoly ALROSA went to the stock exchange. So far its shares are traded in the non-listed segment of MICEX, but still it is stock exchange trading where anyone can buy or sell securities. And among other things, this is an opportunity to gauge a real value of the company, which until now was impossible.
By the end of the third day of trading ALROSA shares went up 2.2 times compared with the opening price. Based on the MICEX quotations, ALROSA’s capitalization reached $28 billion. It is noteworthy that capitalization of De Beers based on the sum of the transaction between Anglo and the Oppenheimers is about $12.75 billion. In other words, for a few days ALROSA was the world’s most expensive diamond company by market capitalization.
The sharp rise in prices for ALROSA shares is attributed to the "euphoria generated by the start of stock exchange trading." However, it should be said that the amount of traded stock is so far small: a large portion of shares is held by the company's employees, who took advantage of an option plan 10 years ago. Many of them would now want to sell their shares, but it will take time to get a permit to take part in trading. Therefore, share prices will definitely undergo correction.
But if transactions on the stock exchange are taking place, it means there is demand for the company’s equities - most likely it comes from investment funds. ALROSA’s shares had earlier been bought by investment fund Vostok Nafta, and recently Suleiman Kerimov, a Russian businessman, joined the ranks of the company’s shareholders. ALROSA is tipped by market experts to turn into a "blue chip" after IPO, which means that funds are confident that its stock will be gaining value. And the current volatility in the market does not dissuade them from this confidence.
Elena Levina for Rough&Polished
