In September 2010, financial investment company Metropol, presented a review entitled “ALROSA: a Unique pre-IPO Opportunity,” which examines prospects for the Russian diamond miner in the context of its upcoming transformation unto a public corporation and possible listing on the stock exchange. Several provisions of this work, in the opinion of Rough & Polished, were in need of additional comments which were kindly given to us by the author of the review, Andrey Lobazov, an IFC Metropol analyst.
In your report “ALROSA: a Unique pre-IPO Opportunity” you anticipate shortages of rough diamonds (and correspondingly higher rough prices) in 2012. This estimate is based on the absence of new major diamond fields and an IMF forecast for GDP growth in India, China and the Middle East - the main drivers of the diamond market. At the same time, there are factors working to reduce demand for diamond jewelry not covered in your analysis: the increasing competition from other consumer markets (electronics, cosmetics, tourism) and lack of a coordinated generic marketing. Do you think these factors are unimportant?
From my point of view, the above mentioned examples of consumer goods may not be substitutes for diamonds. The greater part of rough diamonds (by value) is used for manufacturing polished diamonds used in jewelry. Well, just judge for yourself - is it possible that perfume or electronics may replace a diamond necklace for a woman? In the long term, we see a greater risk for the industry coming from synthetic diamonds than on the part of goods in the consumer sector.
You believe that one of the positive aspects of ALROSA is the support it enjoys from the Russian state which reduces investment risks. But the state as the principal owner of ALROSA views the company as a guarantor to maintain a very costly infrastructure in Western Yakutia and implement significant social obligations. In particular, for ALROSA this results in a staff which is almost twice the number of the De Beers personnel and a much lower production volume. In this regard, could the state participation in ALROSA be a factor rather more daunting than attracting potential investors?
In our view, in the current environment of global economic instability government support is a more positive factor for potential investors. Being a kind of "safety airbag" for the company, the state, for example, can contribute to debt restructuring at state-owned banks or create a temporary artificial demand for diamonds, buying them for Gokhran.
In more stable conditions for economic growth, social obligations of the company, of course, have a negative impact on ALROSA’s earning power. According to ALROSA, one of the strategies to improve the company’s earning power may be to transfer its social infrastructure to the state (which would be logical, given that tax revenues from the company account for nearly half of the regional budget).
It is also noteworthy that even carrying a burden of social expenditures the company’s profit margin remains at relatively high levels compared with foreign diamond mining companies.
Today, the minority shareholders of ALROSA have approximately 9.8% of its shares that are traded under "gray" schemes within a price range of $7,000-$10,000 per share. ALROSA’s conversion into a public company (probably in 2010) will possibly bring about civilized treatment of its shares on the OTC market. In your opinion, in what way will this influence equity prices and sales?
Prices and sales will be under immediate influence of ALROSA’s listing on the stock exchange and the company’s IPO due to a whole number of factors, including improved liquidity and transparency. Turning ALROSA public without listing on the stock exchange will only "warm up" investors’ interest towards its shares, since this will be the first step to an upcoming IPO. Higher investor interest to ALROSA’s shares, in my view, would have a positive impact on the value of its shares, but it is hard to judge to what extent.
What type of investor, in your opinion, is basically more preferable for ALROSA: a strategic investor consolidating a package of 20%, or numerous minority shareholders?
Given that the state in any case would remain the controlling shareholder, it seems to me that the option involving minority shareholders would be preferable. First of all, the company’s free float would be greater, and secondly, there would be no potential pressure from another major shareholder on the regional government, which wants to retain influence over the corporation (and thus after an IPO is unlikely to accept less than the blocking stake of 25% + 1 share).
Investment attractiveness of polished diamonds is a permanent subject for discussions in the professional environment as well as the possibility of creating derivatives based on diamonds. Do you think it is possible that such financial instruments will appear?
From my point of view, even if diamond derivatives are possible to appear it is clearly not in the short term.
Galina Semenova, Rough & Polished
