RAPAPORT... The announcement this week that Rio Tinto is considering selling its diamond assets offered some shock value but little surprise. Like its conglomerate rival BHP Billiton, which made a similar declaration four months ago, Rio Tinto is focused on operating “large, long-life, expandable assets,” and its diamond business just does not make the grade.
While diamonds were profitable for both companies, Rio Tinto’s diamond revenues of $727 million accounted for only 1.1 percent of its total in 2011. Likewise, BHP Billiton’s diamond revenues of $1.1 billion accounted for just 1.4 percent of the group’s total in fiscal 2011.
However, Rio Tinto’s prospective divestment from diamonds is of greater significance than BHP Billiton’s. It has a larger portfolio to sell and its mines offer better long-term prospects. Rio Tinto has full ownership of the Argyle mine in Australia, a 60 percent share in the Diavik mine in Canada – with Harry Winston owning the rest - and a 78 percent stake in Zimbabwe’s Murowa mine. It also has the Bunder development project in India.
Combined production at Rio Tinto’s three mines fell 15 percent year on year to 11.73 million carats in 2011. Just four years ago, it stood at 26 million carats but has declined as operations at the aging Argyle mine and Diavik are shifting to underground mining. Considering its diamond sales, the average price of production was in the region of $62 per carat, largely due to the low value Argyle output.
In contrast, BHP Billiton has an 80 percent stake in Canada’s Ekati mine, which only has about five to seven years left in it. Ekati’s production fell 18 percent to 2.5 million carats in fiscal 2011 but the higher value output ensured that revenues grew 12 percent to $1.1 billion. BHP Billiton recently sold the Chadliak exploration project, its only other diamond asset, to its joint-venture partner, Peregrine Diamonds.
While diamond production at both Rio Tinto and BHP Billiton, considered the world’s third and fourth largest diamond suppliers respectively, has slumped in recent years, the investments made by Rio Tinto to extend the life of mine at each of its mines, lend themselves to greater potential-buyer confidence.
As noted previously (see editorial “Diamond Mines For Sale” published on December 1, 2011), potential investors in Ekati will assess their purchase according to the value of the limited remaining years left in the mine and the exploration potential in the surrounding ore bodies.
In contrast, Rio Tinto has the $2.1 billion development of underground mining at Argyle, which is expected to be completed in 2013 and will extend the life of mine to 2019. The new owner will have to carry out further geological and economic evaluation to decide whether it will be feasible to extend the Argyle mine life beyond that.
Expansion is also underway at Murowa and partial underground mining already started at Diavik. Harry Winston is preparing to announce an updated mine plan for Diavik when it releases its financial results next week (April 4). While current mining there involves a mix of open pit and underground mining, a further investment decision to tap an additional underground resource at Diavik is expected to be made later this year.
Once completed, the respective expansion projects were expected to raise Rio Tinto’s production back toward 20 million carats a year. And while under Rio Tinto’s ownership, the mines - or at least Argyle - are anticipated to be depleted by the end of the decade, analysts expect that a smaller diamond-focused company would be able to extend that deadline by a few years.
Rio Tinto’s mines therefore offer better potential and buyers will be able to evaluate further expansion opportunities at each of the mines, as well as their longer-term prospects. “We have a valuable, high quality diamond business, but given its scale we are reviewing whether we can create more value through a different ownership structure,” said Harry Kenyon-Slaney, chief executive officer (CEO) of diamonds and minerals at Rio Tinto.
It is unlikely that Rio Tinto will sell the business as a complete unit, particularly as each mine comes with its own risks ranging from challenging arctic conditions in Canada to the political risk associated with owning a mine in Zimbabwe. Few would be willing to take all of it on, although some might.
Rather, the mines will likely be sold individually and may even offer significant opportunities for one or two junior miners to raise their own bar, in much the same way that the De Beers selloff of mostly South African mines benefited Petra Diamonds.
But while operating diamond mines are a prized possession in the industry, few of the obvious choices are in the market to buy. De Beers has been streamlining its mining portfolio rather than expanding it, while medium-sized players Petra Diamonds and Gem Diamonds are stretched with developments in their current portfolios.
ALROSA could have its eye on an asset or two as the Russian company may be looking to drive up its value ahead of a proposed initial public offering (IPO), and as it appears focused on driving profits through higher quantity production. Some have also indicated that a Chinese firm may sweep in a bid for Argyle given the growing penchant for high-value color diamonds in that country. Apart from its resource of rare pink diamonds, Argyle has long served as a primary source of high quantity, low quality rough. It faces new competition from Zimbabwe’s Marange mines, which have recently started supplying goods suitable to that segment in a significant way.
How Rio Tinto is able to sell Murowa may prove more interesting than to whom it sells. Having got a taste for the diamond business at Marange, the Zimbabwe government will likely want to take the opportunity to expand its influence at Murowa.
But perhaps the most significant opportunities lie at Diavik, particularly given its proximity – or similarity – to BHP Billiton’s Ekati mine.
Certainly, Harry Winston would be considered the most natural suitor to take full control of Diavik. With its mining unit more profitable than its retail segment, complete access to Diavik’s annual production of more than 6 million carats would offer a significant boost for the company. As of October 31, 2011, Harry Winston had $82 million cash and $106 million in its credit facility available, according to its most recent third-quarter financial statements. It would hardly be a surprise if the mine plan to be announced on Wednesday included a financing plan to up its stake.
Then again, the company has also been associated with a possible Ekati purchase. Just this month, Bloomberg reported that Harry Winston and consortiums led by KKR & Co and Apollo Global were in talks with BHP Billiton for a sale valued at between $500 million and $750 million. The report indicated that a deal for Ekati might be struck within a month.
However, with Diavik now on the market, prospects for Ekati may have changed. Buyers may well opt for the Rio Tinto alternative. They may also consider combining the two. It wasn’t so long ago that Rio Tinto and BHP Billiton were considering merging their Canadian diamond units and with both now on the market, combining the Diavik and Ekati operations may well enhance their values.
The startling reality of the major mines up for grabs – Argyle, Diavik and Ekati – is that they would have likely ceased production at the end of the decade had they stayed under the present ownership. Both Rio Tinto and BHP Billiton will therefore have to convince buyers that a smaller diamond-focused company will be able to extract greater longevity (and profitability) from the operations than a mining conglomerate would. Combining Diavik and Ekati would enhance that pitch. The value of the combined Canadian assets may exceed the sum of its individual parts.
Otherwise, neither the Rio Tinto announcement nor the BHP Billiton one before it appear of tremendous significance to the diamond market – apart from their shock value that is. In hindsight, both exits should have been expected.
The writer can be contacted at firstname.lastname@example.org.
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