An IDEX Online Exclusive Interview with Gareth Penny, Managing Director of De Beers Group of Companies
Part 1
Is De Beers in financial trouble? Will DTC box discounting become a permanent feature? Will it now resort to tendering and selling rough to Arab sheikhs? These are but a few of the wide range of questions posed in an exclusive interview with the Managing Director of De Beers Group of Companies, Gareth Penny, earlier this week at the company’s London offices.
In the current profoundly uncertain business environment, Penny needed to slash budgets, implement massive staff dismissals, curtail output and close mines. However, in the more than two-hour interview with Chaim Even-Zohar, the industry leader constantly tried to steer away from crisis-related issues and, instead, focus on strategies shaping the corporate and industry future. As if there is no today – only tomorrow.
As a private company accountable to its shareholders rather than to the public at large, and as a player in fierce competition with other mining companies, we expected that some commercially sensitive issues (such as 2009 sales targets) would be side-stepped – and they were.
Nevertheless, Penny’s genuine effort to be forthcoming, candid and detailed was well above our expectations. While we persistently sought answers to specific current concerns, Penny was clearly thinking about seizing the extraordinary opportunities that have arisen – thinking about the long-term macroeconomic outcomes of the company’s actions. The preoccupation with “tomorrow” is somehow evident in every reply to whatever question.
Will Penny relinquish the helm of the company rather soon and move to other things? Forget it. There is going to be a new post-crisis global order and Penny will be there to make sure that De Beers and its partners will be the founding fathers of diamond business of the future. Extracts of an extraordinary interview follow:
On De Beers Corporate Issues
Even-Zohar: Recently, there have been newspaper articles and analyst reports that suggest that De Beers has financial issues, and will not be able to renew a $1.5 billion credit facility that is due in March 2010. Can you shed some light on these reports?
Penny: Newspapers are full of speculative and inaccurate reports of companies all around the world, and De Beers is no exception. The fact is, we have taken significant steps to realign our cost base and reduce production, so we can remain profitable at significantly lower levels of sales. We are confident that we will service our debt in 2009 and beyond, have the full support of our shareholders and our bankers and, most importantly, world class mines that will generate strong future cash flows for decades to come.
CEZ: The De Beers London staff has in recent years been downsized from some 1,500 to only 300 people. This excludes redundancies on the mining side, and in South African offices. Can you actually manage the business effectively with so few people?
GP: De Beers’ UK staff has been in the process of downsizing over a number of years, long before this current financial crisis. London is one of the world’s most expensive cities and it doesn’t make commercial sense to be undertaking activities there which could be done more cost effectively elsewhere, principally in southern Africa. The current complement in the UK of 380 people is appropriate for our new decentralized business model, where most sorting activities are carried out in the producing markets and where technology has reduced manpower requirements significantly. While it has allowed us to significantly reduce costs at the centre (by some 50 percent), it will not impact on our ability to deliver on our Supplier of Choice and marketing commitments.
CEZ: You have not only reduced operational costs, but also slashed capital expenditures and exploration budgets. What will be the long term implications of these policies? How long will it take you to “go back to normal” after this crisis is over? Are the southern African governments supportive of these output cutbacks?
GP: Given the challenging trading conditions in Q4 2008 and Q1 2009 it was essential that De Beers, like many companies, quickly reduced our cost base to bring it in line with reduced turnover. The men and women of De Beers have responded with great determination and professionalism to this challenge. We have reduced capital and operating expenditure, but not in a way that will harm the long-term fabric of our business. In fact, to the contrary, we believe that the new cost base that we have achieved in 2009 will stand De Beers in good stead in the years ahead when we revert back to more normal market conditions. In effect, it will make us a more profitable business in future. Southern African governments have fully understood the need for these actions in the short-term to sustain the business through the global economic crisis.
CEZ: Just a follow-up: So much has been speculated about the indebtedness of De Beers, ranging between $3.5 to $4 billion. What caused these debts? How comfortable are you that they can be reduced significantly?
GP: De Beers’ external debt of $3.5 billion (down from $4 billion at the end of 2007), has principally arisen because of the range of major new capital projects that have been undertaken over the last five years. These projects have included Snap Lake and Victor mines in Canada, Voorspoed and the "Peace In Africa" vessel in South Africa, and our share of a range of capital projects in Botswana, Namibia and elsewhere. All of these decisions were taken many years ago, given the length of time mining projects generally require but they provide us with mines that are an important part of De Beers’ future. Fortunately, unlike some other companies, we had largely completed our capital projects enabling us to reduce capital expenditure sharply in 2009 without jeopardizing projects under construction. When the recovery comes, and it will, with our lower cost base and excellent diamond assets we will be in a good position to generate strong cash flows to reduce our debt.
CEZ: Do you expect major changes in De Beers corporate or shareholding structures? Is there likelihood that the government of Botswana may acquire a greater stake in either Debswana or De Beers? (In DBI for that matter.) Related to changes, when can we expect Element Six to start marketing gem quality synthetics? Would you be willing to say “we will never do so?”
GP: While the shareholding in De Beers is a shareholder matter, there has been no decision, that we are aware of, to change the current shareholding.
With regard to synthetics, we have made it clear over the years that De Beers (through Element Six) is the leader in synthetic industrial diamonds and that we have no plans to be in the business of manufacturing synthetic gem qualities.
Rough Marketing and Beneficiation Issues
CEZ: You have projected a reduction of some 40 percent of 2009 mining output and 2009 rough sales are expected to come to around $3 billion. If we take into account the price reductions, your 2009 revenue might well be 50 percent below 2008, while your profit margin also may dip well below the normal 19-20 percent margin (in your diamond account). Can you comment on this?
GP: We have and will continue to reduce mining output in line with client demand for new rough diamonds, but have the flexibility to adjust this level up or down as we proceed through 2009. Importantly, we are not saying that we expect sales to be half of what they were in 2008, but rather that if they are, we should still be in positive profit territory as a result of our determined and rapid effort to lower our on-mine and off-mine costs by 50 percent.
CEZ: Do you believe that rough prices have bottomed?
GP: It does seem that rough prices have bottomed, and we may well see some shortages in certain categories as the year progresses.
CEZ: As recently as 2004, you passionately argued that beneficiation in Southern Africa did not make any economic sense. Soon thereafter, you made a commitment to Botswana with binding contracts that even penalize you for factories not reaching certain thresholds in employment or rough purchase levels. Some of the 16 factories there have closed, while others are struggling. Were you right in 2004, or do you now feel that beneficiation makes good economic sense, and that these factories can compete effectively in the world markets? Aren’t there “too many” factories and would you encourage consolidation?
GP: I have never argued "passionately," as you say, that beneficiation in southern Africa did not make sense. Rather I have always been aligned with southern African governments in understanding their desire to encourage local added-value, but fully aware of the competitive challenges in doing so. I would not say there are too many factories but would say to those that have made commitments there that this is likely to be, in the long run, a good strategic decision.
CEZ: You haven’t yet moved the Sight aggregation function from London to Botswana. This brings me to three different questions: We have reported that the delay is due to De Beers tax (Income and VAT) problems in London. Can you explain what these are and give a timeline on when they will be resolved? And finally, how important is aggregation? Would it not be better for each of the production companies to sell its own output?
GP: We remain committed to aggregation as part of an agreed overall way of doing business for one simple reason. Our customers have consistently given us feedback that they appreciate the scale and consistency that aggregation allows, and they see this as a core benefit of DTC’s product offering. At the end of the day, it is the needs of our customers that matter most, as any business knows.
While there has been a delay in moving aggregation from London to Botswana, it is not due to tax problems in London. There are a few issues that still need to be sorted – both operationally and of a more general business nature – to ensure when aggregation does move, which it will, that it happens successfully and Botswana can be proud of it..
CEZ: Related to the foregoing, pressures are exerted on the government of Botswana to change its marketing regime and optimize revenues through tender sales, at least for those parts of the output which are not sold locally to beneficiation partners. Why are you so opposed to tendering, and will you drop your opposition if your partners insist?
GP: De Beers believes that the vast majority of its own production and that where we are in partnership with others, should be sold on a long-term contractual basis. We believe this is economically efficient, that it is of benefit to our customers, allows them to build sustainable businesses, maximize long-term returns for major producers and it is reflective of the very product we sell, namely, a unique “treasure of nature.” This is not to say that an element of this production could not be tendered and indeed, we have already done so through our subsidiary, Diamdel. In the current climate, we feel that tendering may be less effective, but it nevertheless remains an option within the parameters described above. For producer governments it is even more important that factories in those countries are given consistent supply. Diamantaires are having to make multi-million dollar investments in infrastructure, technology and training and they need confidence in terms of supply. Otherwise, all incentive to establish such factories is likely to be removed. Interestingly this seems also to be the view of most other major producers.
