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Gareth Penny, outgoing CEO, De Beers

De Beers weighs diamond ETF

Allan Seccombe | Mon, 06 Sep 2010 12:30

[miningmx.com] -- DE BEERS will reach stable production next year and begin repaying shareholder loans while it considers approaches from financial institutions to set up an investment instrument using diamonds, says Gareth Penny, outgoing MD of the world's largest diamond producer.

Penny announced in July that he would be resigning from his post after a tenure covering some five years and a period of consolidation in the diamond firm's operations. His successor has not yet been identified at the time of writing.

Penny says De Beers has been inundated by requests from financial institutions to become involved in a fund that will give investors a chance to invest directly in diamonds.

The idea is that in the wake of the recent financial meltdown – and resulting economic crash – investors prefer physical wealth over shares.

The thinking is the product would be like an exchange-traded fund. Therefore, De Beers is considering offering ownership of its diamonds without physically taking receipt.

"It's very interesting because it's part of a new mindset where people are seeing diamonds as a store of value," says Penny.

"It's very interesting, because it's part of a new mindset where people are seeing diamonds as a store of value"

Unlike gold or platinum, diamonds aren't a fungible product, with no trade in rough diamonds, for which there are so many categories, sizes and opinions of value.

"We've had so many things to get our minds around but we're interested. We're thinking about the implications. There are certainly people already buying diamonds for investment purposes but not necessarily in a formalised fund.

"Those kinds of instruments may well be something of the future, because as diamond prices increase they'll be an attractive option.

"People have taken a bath on all kinds of financial instruments that a while ago would have been regarded as blue chip. Diamonds for a number of people are an interesting incremental element – not a major part – of an investment portfolio."

De Beers estimates less than 1% of diamonds sold would fall into the investment category. It's yet to decide what role it would play in such funds.

A proposal may be that a fund is set up with several hundred million US dollars to buy good quality diamonds, looking for capital gain by selling polished stones at higher prices to replenish the fund.

"Up to now we've said this isn't our business. There are a number of aspects that make it complex, such as the fact diamonds aren't fungible and that people want assurances how it would work. Though it's not going to be a major driver of the business I've certainly not seen this level of interest in the time I've been in this post."

Listing? What listing?

However, a relisting of De Beers isn’t on the cards.

The firm's three shareholders – Anglo American, with a 45% stake, the Oppenheimer family (40%) and the Botswana government (35%) – have given no indication of an interest in returning to publicly listed life.

"A listing isn't something we as De Beers management or our shareholders are working on," says Penny.

"Our focus is to get this business back in shape and reward our shareholders for all their patience and support they've given us."

Some analysts think a listing could be an option and that Anglo is weighing its investment in De Beers.

"Of course, the strong improvement we forecast for Anglo's own balance sheet may see Anglo delaying any divestment decision if it doesn't have suitable uses for the capital liberated by selling De Beers," says Des Kilalea, a diamond analyst at RBC Capital Markets.

"So while we see De Beers as non-core to Anglo and view a listing as an ideal exit strategy for shareholders, if Anglo decides to divest it may well depend on its ease in funding expansion projects.

"With Anglo's capital spending programme peaking over the next two years we believe a potential divestment from De Beers could be delayed if Anglo doesn’t need capital and De Beers' performance is improving."

Loans

Another issue close to the heart of De Beers' shareholders is the repayment of $800m in soft loans.

Penny says that if the rough diamond remains strong and management continues its focus on operations to keep costs down repayments of those loans – which take various forms – will begin next year.

The immediate focus is paying down some of the roughly $1.6bn of debt to third parties likely to occupy management's mind for the remainder of this year.

Shareholders stumped up $1bn in a rights offering to knock De Beers' debt down to around $2bn. It also restructured its debt repayments from March 2010 to 2012, with an option to extend it by another year.

"Our intention is to normalise the business before year-end. The third-party debt level is coming rapidly under control," Penny says, adding that normalising the business means bringing the level of debt to below three times earnings before interest, tax, depreciation and amortisation.

Normalising the business would mean bank covenants – the checks and balances financial institutions put in place for companies with high debt levels – would fall away.

De Beers, a century old company, went through a particularly tough time when the markets crashed in the last quarter of 2008 and finance dried up for mining groups.

In the diamond sector that meant funds for diamond explorers and producers were suddenly unavailable.

Banks pulled back on loans to cutters, polishers and jewellers, forcing them to destock instead of buying fresh diamond supplies. Not only that, consumers put off buying luxury items such as diamonds, which had an exaggerated, knock-on effect down the line to the miners.

De Beers moved quickly and by year-end 2008 it had used the crisis to remodel its business, suspending production at its mines and sold stockpiles to ensure supply matched demand.

De Beers' rough diamond production plunged 49% to 24.6 million carats last year, while the value of diamond sales by marketing the Diamond Trading Company (DTC) fell 46% to $3.23bn.

It's halved costs, not all of which are sustainable. Nonetheless, Penny reckons around $500m in cost reductions can be maintained. The workforce has shrunk to 15 000 from 22 000.

The production forecast for this year is between 30 million and 33 million carats, building up to a sustainable 40m plus carats next year.

The group's peak production was 50 million carats, but Penny says that was because certain plants – such as that at its Venetia mine – were pushed beyond capacity. That resulted in broken diamonds, a big issue for producers.

De Beers has sold five mines, taking 3m carats from its production profile.

"That will put more of a floor under rough prices, since it points to an even more constrained supply of rough from here on," says Kilalea.

The future of De Beers lies in the 8-Cut at the Jwaneng opencast mine in Botswana, which will absorb initial capital of 3bn Botswanan pula and a life of project capex of 24bn pula. That is being funded from revenues generated at the mine.

The cut will take the mine to 2025 and produce 102 million carats. There's an option for a 9-Cut in the future.

De Beers is also working on a feasibility study at a third project in Canada: its Gahcho Kué project is located 90km south-east of the Snap Lake mine, a joint venture between De Beers Canada, which owns a 51% stake, and Mountain Province Diamonds holding the remainder. A feasibility study is under way and should be brought before the board in 2012.

Angola to review laws

Another area exciting interest is Angola, where a number of companies pulled out during the market crash, leaving a few hardy souls behind. That’s created opportunities, says Penny.

De Beers has also been notified by the Angolan government it’s revising its diamond laws.

"We're being informed that by the end of this year there will be a new diamond act in Angola that will create a far more benign environment for companies to operate," Penny says.

"I think the government has clearly taken note a number of major companies aren't exploring for diamonds in Angola and they're asking themselves why. I think they're taking measures to address that."

Whether the lessons imposed on the entire diamond chain by the financial meltdown will be learnt and applied as the markets normalise is an open question at this point, says Penny.

"Only time will tell. We're emerging from this and that's something we'd need to review in six months or a year's time. It may well be that people just go back to what they were doing before, but I think there's an emerging new normal in the diamond business."

"I think the government has clearly taken note a number of major companies aren’t exploring for diamonds in Angola and they’re asking themselves why"

One of the biggest lessons learnt is the importance of Asia.

Businesses that focused just on the United States have seen the benefits of substantially increasing their exposure to the Far East, which is a growing area for diamond demand, he says.

De Beers wants to push ahead in downstream growth, opening new jewellery outlets in Asia, grow its Element 6 synthetic diamonds for the industrial market, and develop its start-up "Forevermark" diamond hallmarking business and roll it out in Asia.

"While De Beers doesn't focus much attention on its value-add operations the company has established the Forevermark brand and could further enhance prices through targeted auctions."

"Given 6% of its diamonds account for around 60% of revenue, the scope to pursue a beneficiation strategy could, we believe, gain more traction in the company," says Kilalea.