Diamond prices continue to rise. During a conference call in mid-May, ALROSA’s management said that since the start of the year rough went up in price 5-7% - more than the company had originally predicted for the whole year ahead. Both major diamond producers and the World Diamond Council state that the market is stabilizing, while the continuing growth of demand in China and India will push prices further up. And it is said that depletion of diamond resources will sky-rocket them in the long-term.
It would seem that now the status of a diamond mining company looks quite attractive. However, those wishing to enter into this business are not lining up for some reason, although the market made several attracting offers at once for the sale of diamond assets. Rio Tinto says it does not see any lack of bidders for the purchase of Argyle and Diavik, but no one is ready to name just a few somehow. And it seems that BHP missed a deal for the sale of Ekati - in any case, mass media recently reported that KKR, an investment company, which was intent on buying the mine for quite a while now lost its interest.
BHP Billiton officially announced its intention to withdraw from the diamond business last November, but was rumored to have started offering its only operating diamond mine, Ekati, for sale long before that. It was said that prospective buyers of the asset included virtually a whole assembly of companies, from lightweights to heavyweights: Russia’s ALROSA was mentioned along with Gem Diamonds, a ‘second tier’ diamond miner, and jeweler Harry Winston, which already has a stake in Diavik in Canada, as well as Apollo Global Management, an investment firm. Ekati is the oldest diamond mine in Canada, and its reserves will last only 5-8 years. One should also take into account the need to invest in production. On the other hand, its output of 2.5 million carats per annum (in 2011) is after all a palpable amount capable of bringing in maybe not much, but still a profit.
According to media reports, KKR was the most likely buyer and even planned to consolidate the assets of Rio and BHP. But apparently, something went fut. The wording used by mass media saying that the company’s move “raised questions about demand for such assets" was quite cautious to be interpreted anyway you like. Still, we can venture a couple of assumptions.
Probably, KKR started to feel qualms about the mine. Over the past six months since the announcement that Ekati was put on the block experts offered about a dozen possible estimates for Ekati’s value ranging from $500 million to over $2 billion. The specificity of the diamond business is that even experts in this market cannot say for sure what method exactly should be used to calculate a fair price of a mining company. And people for whom this business is alien are sure to run into a jillion problems.
Every diamond is unique, so it is impossible to predict how much finished products extracted from a ton of mined ore will cost, as well as how many dollars exactly stay buried underground as reserves and resources. Diamonds are not commodities and are not traded on stock exchanges in the conventional sense of the word, so we better forget about forecasting revenues depending on the volume of production. A diamond miner’s reputation which guarantees that rough it sells does not contain "blood" diamonds will play one of the major roles as well. And this reputation is also impossible to measure in terms money. The usual method to evaluate a company by its stock is also not quite true to life in this case. For example, in this market the news about increased production may, on the contrary, bring its stock quotes down because the higher the supply the lower the prices for rough diamonds.
And most importantly, the pricing fundamentals, albeit changed since the monopoly of De Beers, still did not become much more transparent. Previously, De Beers bought up a significant part of the world's mined diamonds and sold them through its distribution division, thus, in effect, controlling world prices. Now diamond miners are typically selling their goods independently, and there is even a notion of average market prices. However, one way or another, they come under the influence of those trends that are maintained in pricing by De Beers and ALROSA. The market "monsters" preserved one more opportunity to control prices - to limit their sales, thereby creating an artificial shortage.
On the other hand, if you think about it, the impact produced on rough prices by buyers appears no less tremendous. Speaking about buyers I mean a cluster of dealers who buy boxes from large companies to form parcels of rough for diamond cutters. Dealers have exactly the same ability to set prices for their customers and they also can accumulate stocks of rough diamonds. Only the dealers are usually privately held companies that do not report their financial results and do not publish reports about their pricing policies, so there is no way even to control them. The dealer’s influence also works in the opposite direction: the dealer can ask the diamond miner to lower prices saying it is required due to reduced financial capacities of diamond cutters.
Thus, there is another important component of the value of a diamond mining company - the availability of its own sales network and a circle of proved buyers, which, in fact, may facilitate rough sales at top prices permitting to get planned financial targets. Once again, how are you going to estimate the value of this component? How many millions of dollars is that worth?
Taking into account all these factors, it becomes clear why there is such a dispersion of expert assessments involving Ekati, ranging from $500 million to $2 billion. And it turns also clear why BHP and Rio were quick to announce that the sale of their diamond assets will take a long time. And it is also true that we shall have to wait for the end of this story for quite a long time.
The complexity of assessing a diamond business reduces the likelihood that this industry will be joined by new players. Investment companies and other third parties often take on diamonds at a greenfield stage - at a time when diamond reserves have roughly been calculated, but a mining operation is not in place yet. This is done just because with the start of production any project goes up in price several times, thus giving investors a chance to have their return on capital one way or another. Or, alternatively, they buy stakes in existing mining companies - those have roughly predictable dynamics reflecting the overall market movement. However, deals involving the sale of existing businesses are made, as a rule, between companies which have experience in diamond mining.
Elena Levina for Rough&Polished
