An IDEX Online Exclusive Interview with Gareth Penny, Managing Director of De Beers Group of Companies
Part 2
Diamond Markets
CEZ: De Beers has actively been promoting the “lasting value” aspect of diamond purchases, and you yourself have made efforts to draw outside investors into the diamond market, not just for purchasing polished, but also for rough. Traditionally De Beers has always apposed “diamond for investment” schemes. This has obviously changed. What are your views, your aspirations and your expectations of diamonds for investments? Have you been able to attract outside investors?
GP: De Beers believes implicitly in the lasting value of diamonds and indeed we have no investments or interests outside of the diamond business. The fact that we have invested billions of new capital in this business is a testament to our shareholders’ faith in it. Recently we have had a number of approaches from investors who understand and agree with our view of the extraordinary product we sell. In these uncertain times, they are looking for new asset classes that will provide a greater long term store of value than has been the case with a number of other investment categories. Given the changing world in which we live, De Beers has been keen to understand the opportunity to encourage new players (such as Sovereign Wealth Funds), who might be interested in diamonds as an asset class. We have not made any final decisions, but there are some interesting and prospective opportunities that are being looked at, but importantly, it will always be a niche opportunity for long-term investors and must not negatively impact the core diamond jewelry business.
CEZ: You can only in good faith support the rise of an investment market if you are convinced that long term rough and polished diamond prices will increase. Why do you think so? Can you put a figure to the expected rate of growth? Any time table? Do you expect greater price volatility in the future, and how will this impact your policy of only increasing prices if you believe that prices are sustainable on a higher level?
GP: We do believe that in the long term rough and polished prices will increase. If you look at historical data, it is clear that, immediately following a recession, the bounce back in rough diamond prices has been dramatic, and we would expect to see a similar situation soon after the current recession is behind us. This was even the case in the Great Depression where prices largely recovered within a year. We are also very aware that there is little new supply coming on to the market and indeed, overall supply of rough diamonds is projected to decrease as existing mines begin to tail off. On the demand side, there has been significant demand growth over the past years and with new and emerging consumer markets, like India and China, we see a significant supply and demand gap developing in the years ahead. Our pricing strategy has always been to look at a considerable number of inputs and to try to provide long-term sustainable prices to our customers.
CEZ: The performance of most large jewelry chains are public record. The De Beers jewelry venture is somewhat clouded in terms of performance. How many stores do you have? What are their turnovers? What are the profits? What are the prospects? Will De Beers and LVMH have to inject more funds beyond the amounts agreed when the venture was launched (I think $400 million altogether)?
GP: As a private company, we have the good fortune of not having to disclose what is competitively sensitive information. However, I would like to say that De Beers Diamond Jewellers has, over the last few years, been making excellent progress in building a network of over 40 stores in most of the major world markets, and rapidly increasing turnover to well over $100 million per annum. Like most all high end retailers, the economic crisis has impacted DBDJ from the fourth quarter of 2008. In 2009, again, like most jewelry retailers, DBDJ has scaled back expansion plans, focused on inventory and cost management and targeted the more robust areas of business like engagement rings, until such a time as the trading environment improves. In the medium and longer-term, we believe, we will re-establish the strong growth of the previous four years and succeed in building De Beers Diamond Jewellers into one of the leading international jewelry brands.
CEZ: Related to De Beers JV, there have been complaints in the market about excessive delays in payments to suppliers, suggesting an infringement of Best Practice Principles. One Sightholder was believed to contemplate legal steps. Are these issues of concern to you?
GP: I understand that an unexpected and rapid change in trading conditions over Christmas impacted most all retailers’ cash flow forecasts, but De Beers Diamond Jewellers is, to my knowledge, up to date with all its payments to suppliers and has certainly not infringed Best Practice Principles.
CEZ: De Beers has lately resorted to a two-tier system of selling prices, affording discounts to large volume purchasers. The DTC asserts that these goods don’t reflect standard Sight assortments, but the market has a different view. How do you reconcile these discount sales with the De Beers undertakings to the EC on fair competition among all the Sightholders? Will this become a permanent feature of DTC sales, thus enormously strengthening the so-called “supertanker” clients? Will those who made large purchases be further rewarded in the future?
GP: Firstly, let me say that the industry rumor mill has been working overtime on this and is largely inaccurate with regard to both the scale of discounts and the goods involved. DTC communicated openly and clearly its strategy with regard to large volume transactions. With the end of an ITO period, this program applied only to goods which were slow, or not moving at all, and where our stocks were getting significantly out of balance. Discounts were not applied to fast moving goods, and we do not envisage it being a permanent factor, but something designed for the particular and extraordinary market circumstances of the time.
Financial Issues
CEZ: As the global economic crisis is foremost a “credit crunch,” we would like to have your take on the depth and width of the equity and debt issues in the downstream industry. SoC has led many diamantaires to reduce equity and rely more on borrowings; the industry debt has doubled since the onset of Supplier of Choice. What has this crisis taught you? If you look at major industry defaults in the last few years, these were all either Sightholders or companies tied to a Sightholder’s group. Have Sightholders become the weaker links in the value chain?
GP: Contrary to your suggestion, Supplier of Choice criteria has sought to improve the equity to debt ratio with the objective of ensuring the financial soundness of all its customers. However, we all know that the story of the last decade, across many industries and consumers has been the availability of cheap credit and the resultant increase in leverage, an issue the entire corporate and financial world is now wrestling with. The fact that diamond industry debt has increased is not unusual.
Nonetheless, it has reminded us all of the need for prudence and to ensure that there is alignment between debt and equity in every business. Your comment that major industry defaults have been tied to Sightholder groups, I feel, is misleading, in that Sightholders represent the largest, and most significant diamond manufacturing and dealing companies in the world, with contacts and relationships with most, if not all, of the major retailers. It would be surprising if it were any other way. I certainly do not believe they are the weakest link in the value chain.
CEZ: Questions have arisen lately about the continued attractiveness of the diamond industry to the specialized lending banks. Though one or two banks have been joining industry financing, they are outnumbered by those who are dramatically decreasing their exposure and reassessing their commitments. What can and should be done to instill the confidence of the banking community? Bankers (and credit rating agencies) lament the low profitability of the downstream sector. Are you concerned about that, and, as leader of the industry, what can you do to change that situation?
GP: The diamond industry remains an attractive opportunity for lending banks which over many years have experienced good returns on the loans that they have made to the industry and with a relatively low level of default. Clearly, we are in unusual times, but I believe that as the market returns to normal, banks will be pleased to be involved in our sector. This is not to say any of us must be complacent or that our industry can return to the practices of the recent past. The banks must continue to demand that their clients’ businesses are run efficiently, effectively and soundly.
Closing Questions
CEZ: We all look for silver linings. We all hope that someone has the magic words for what we, the industry, need to do in order to come out of the crisis stronger, better, more resilient, with a bright future. If I would ask you to summarize what you think should be done, what would they be?
GP: I am pleased you asked the question about silver linings. While no business leader would wish for the current environment, it is always important in dealing with the challenges of today to consider if there are opportunities that could only be achieved in this environment that will improve the business, but for De Beers some of the things include: permanently change the corporate culture and ensuring all we do is simple, fast and effective; working more closely with our producer partners and Sightholder customers; ensuring all our mines move permanently down the cost curve; reducing the size of the corporate centre and driving accountability to the operating units; developing new marketing approaches (for example: the industry marketing association); consolidating operations to reduce duplication.
CEZ: And a personal question: You always intimated that you looked at the managing directorship of De Beers as something you might do for a year or five, and then you will move on. Are you nearing the end of your De Beers career, or have you still targets that you are determined to achieve before considering a change?
GP: Your final question is a personal one, and I am pleased to respond accordingly. I have been in De Beers and the diamond business now for over 20 years and cannot conceive of a more exciting company, nor a more interesting industry in which to work. I am also tremendously proud of this positive role De Beers is playing in the development of countries in which it operates. I am motivated and challenged by the current circumstances and the opportunities that they will generate and am looking forward to working in the months and years ahead with all the stakeholders in our business, to build on the successes and lessons of the past and to find new and innovative ways to create value in the future.
