These changes, affecting about 40-45% of the total rough supplies, raise the basic question of what the future holds for the diamond mining industry and what it would mean for companies in the downstream diamond businesses.\u201d<\/p><\/blockquote>\n\n\n\n
For Anglo, it was the reverse dynamics in place. They had the opportunity to buy the industry leader De Beers with a consistent track record, assets and contracts in place to ensure continued supplies. It would also represent nearly 16% of Anglo\u2019s revenues and about 13-14% of profits.<\/p>\n\n\n\n
The decision to sell goes hand in hand with the timing, and what better time for a seller, than after a year where record revenues and profits were achieved by the business. For the Oppenheimers, it was the best time to try and sell their business, and they did. For the buyers, though, it might not be the best time to get cheap valuations. Anglo naturally paid a premium for acquiring the controlling stake in De Beers.<\/p>\n\n\n\n
The process for Rio and BHP\u2019s sale is still in progress, with private equity companies being quoted as the frontrunners for both these businesses. Given the proximity of Diavik and Ekati and the harsh conditions, there could be synergies between these mines which the buyers will look to exploit. For Rio, selling Diavik separately from their other properties might be easier.<\/p>\n\n\n\n
If the combination of the Rio and BHP businesses fructifies, it would create another large rough producer, with nearly 10% of the market. Large manufacturers gravitate towards offering larger businesses, as it helps them reduce their transaction costs. Any producer would prefer to deal with 10 customers who can buy $10 million each, rather than 100 customers who buy only $1 million each. This is bound to pose challenges to smaller manufacturers, who will undoubtedly find it more difficult to procure rough directly from the producers.<\/p>\n\n\n\n
Over the longer term, the picture looks more fragmented. Most of the new prospecting is being carried out by the smaller players, and these will eventually evolve into important mines. De Beers had perfected the art of buying out mines over the last 50 years. However that was true when the industry was monopolistic. In the current situation, it might be more difficult and expensive for them to do so, leading to more fragmented supplies. Smaller manufacturers might now actually have a choice and there will be less compulsion to try and be a customer of the 2-3 largest suppliers. They can also focus on becoming an important customer of the smaller rough diamond producers, who are more compatible with their production capabilities.<\/p>\n\n\n\n
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<\/a><\/a><\/a>Industry paradigm shift<\/h4>\n\n\n\n
On rough pricing, however, the industry has already seen a pivotal shift in how rough is priced and sold. That is the industry\u2019s legacy of the crisis. One of the few positives which came out of the crisis was that producers understood the best way to manage a slowdown is to keep the goods in the ground. There the diamonds are safe, and can be extracted when required and even do not run afoul with anti-trust regulators! This understanding was demonstrated in the fourth quarter of 2011, when De Beers actually reduced production from their mines by focussing on less profitable areas of their mines as well as on maintenance activities. A part of the run up in prices in early 2011 was also attributed to mines focussing on expansion activities, which led to a drop in supplies. Stable prices help maintain the confidence in the industry, however these need to be realistic.<\/p>\n\n\n\n
What has undoubtedly changed for the worse is the perspective of the producers themselves. These businesses are no longer run by persons who own the businesses. The businesses are managed by professional senior managers appointed by the boards. These senior managers may or may not have experience in the diamond business. Their sole focus is the profitability of the company over the duration of their tenure in office, which is generally around 3 to 5 years.<\/p>\n\n\n\n
The \u201cbenevolent\u201d producer now does not exist, with all the large producers focussed on maximising their prices, rather than ensuring the basic health of the pipeline. The senior management has to justify to his board that he is securing the best possible prices during the course of his tenure. He is not really concerned about whether his customers are profitable or whether the producer is, in fact, the \u201csupplier of choice\u201d. That would be the problem of the next manager!<\/p>\n\n\n\n
Being a sightholder to a De Beers or an Alrosa in the past meant that these companies were assured of reasonably priced supplies, and in turn would be more profitable than companies who depended on open market supplies. That basic premise would be questioned over the next few years. Long-term contracts work very well in cases where prices are rising, as prices are slow to react to market movements. When prices are volatile or falling, the very same contracts become a burden on the diamantaires, where they end up bearing huge losses as contract prices are higher than what makes economic sense.<\/p>\n\n\n\n
It is sad to see that contracts actually are starting to make the clients\u2019 business models more unstable. In this new and volatile world, diamantaires would need to assess whether they are able to make profits across the cycle. I would not be surprised if a few companies actually decide it is better for them to buy what they require in the open market, rather than go for long-term contracts.<\/p>\n\n\n\n
<\/a><\/a>Holding the baby<\/h4>\n\n\n\n
The impact of this shift is even more profound on the banks who lend to the industry. Banks had shown great patience during the crisis and had helped the industry recover. However, in the past diamond banking was relatively easy, especially for sightholders. As a banker you could take the underlying health of the business for granted, with steady annual growth. That assumption is long gone. During the crisis, it first became more important for banks to understand where the industry was headed and now bankers need to even question the basic profitability of the companies. As any banker will tell you, sightholders would have already lost significant monies in 2012, as the price of the goods does not enable them to cover costs. Companies with secondary market purchases would actually have fared much better.<\/p>\n\n\n\n
The industry is characterised by large amounts of working capital and typical leverage ratios are between 1.5 and 2. This makes banks more vulnerable to underlying business health, and if they are not careful, they could be left holding the baby, as happened in a few cases in the crisis. In the new volatile world, with producers looking to maximise profits, banks also need to be taking a proactive role, especially to ensure that producers do not ruin the financial health of the industry.<\/p>\n\n\n\n
The price rise in diamonds during 2011 is already making its impact felt on consumers, with reports of Chinese customer tastes moving towards lower qualities of diamonds and with new luxury designs having lower diamond content.\u201d<\/p><\/blockquote>\n\n\n\n