Anglo’s unfinished business

[] — AS Anglo American nears the end of its divestitures, which has seen billions of dollars in value released, the elephant in the room is what it will do with its 45% stake in De Beers.

Anglo has made it clear in previous financial results presentations that on a scale of “very attractive’, “attractive’’ and “less attractive’, the diamonds business occupies the middle ground, which is to say, it’s likely to keep its diamonds; it is not a seller.

But there are control issues in the structure of Anglo’s diamonds business that represent unfinished business for the company. There’s also the undeniable fact that diamonds are less important now to De Beers than they used to be: the diamonds business accounted for 5% of earnings in the group’s last financial year, compared to 20% of group earnings in 2003.

The merits and demerits of owning diamonds is a balanced argument for Anglo American. On the one hand, diamonds are a differentiator, providing access to a consumer/retail pipeline of luxury products that, along with platinum, many of Anglo’s peers don’t possess. Conversely, the key Venetia diamond mine is South African-based and attracts unfavourable currency exchanges, at least at present.

Market fundamentals are, however, improving for diamonds which would lend support to Anglo hanging on to its investment in De Beers. According to some research notes, De Beers is likely to return production to the 42 million carat level this year after more than halving output in the aftermath of the 2008 financial and economic crisis, a production cutback incidentally that achieved permanent cost savings of between $400m to $450m.

“The possibility De Beers could be relisted may be linked to considerations Anglo was giving to discovering a proper valuation for the diamond business.”

Not even the Japan earthquake can dislodge the optimism in the diamond market. (In 2010, Japan accounted for 11% of global diamond jewellery demand, just behind China and India, the growth of which should compensate for a loss in Japanese gem demand.) According to estimates, De Beers’ contribution to Anglo’s earnings could increase to 13% in the 2015 financial year.

The long-term outlook for diamond demand is also looking good based on concerns regarding fresh sources of kimberlite deposits; in short, there’s a deficit of new diamond mines. This is a different and more lasting market driver to, say, the bulk mining products, such as coal and iron ore, where deposits are known and varied.

The price hikes for these products are wholly related to delays or timing in commissioning of new production, but there are no concerns new iron ore production is running low.

All things being equal, therefore, diamonds is probably a business Anglo would like to retain. This begs the question where all the relisting of De Beers speculation came from a couple of years ago.

The possibility De Beers could be relisted may be linked to considerations Anglo was giving to discovering a proper valuation for the diamond business. This, in turn, was related to Anglo American possibly increasing its share of De Beers. But why would it want to achieve this?

Well, in the spirit of streamlining its business, Anglo may consider that it doesn’t have enough exposure to that which is best in De Beers’s mining suite of assets – its joint venture with Debswana, Botswana’s state-owned diamond firm which owns the highly profitable Jwaneng and Orapa diamond mines.

Given the current structure, Anglo only gets 20% of the profits from the Debswana joint venture. In a separate but strategically related issue, Anglo doesn’t have any management control over the Debswana joint venture either.

By lifting its stake in De Beers possibly to 50% and seizing control, Anglo can exert more influence over the diamond business, which some believe is happening in any case. Jonathan Oppenheimer has no executive involvement in De Beers, nor does he offer the same gravitas as his predecessors. Already, Nicky Oppenheimer has stepped down from the Anglo board which some have viewed as a prelude to a change in the Anglo/De Beers relationship.

In order to lift its stake in De Beers, Anglo would also have to cancel a $5m/year management contract between the Oppenheimer family and Anglo, forged when De Beers was first taken private in 2001. It’s thought such a cancellation is imminent and is behind the prospect of price discovery a relisting of De Beers may have offered a couple of years ago.

This doesn’t solve the situation much with Debswana, however. Macquarie First South has argued that even if Anglo owned as much as 70% of De Beers, it would still only have a see-through shareholding in Debswana of 35%. Might the Botswana government be persuaded to swap its shares in Debswana for a larger piece of the global De Beers? The possibility has been dwelled upon in the hallowed halls of Anglo American, one hears.

De Beers is valued at anywhere between $7.2bn and $16bn (it was valued at $8.2bn at privatisation in 2001, although this included its cross shareholding 35% stake in Anglo at the time).

Were Anglo to get a good valuation it could work higher ownership of De Beers. In the absence of any price agreement, it’s possible De Beers will remain unfinished business in Anglo’s restructuring efforts, albeit a more profitable one in the future.