RAPAPORT... When it comes to diamond mines, particularly ones that yield consistent and good quality production, there should generally be a buyer. This is especially true given the supply-demand outlook that the diamond industry enjoys. A simple analysis of mining company results reveals that historically, mining has been the most profitable of sectors within the industry and 2011 has been no different.
Indeed, Petra Diamonds has showed its willingness to pay top dollar for what once was the bulk of De Beers South Africa portfolio, and Anglo American expressed its confidence in the industry by more than doubling its stake in De Beers to 85 percent.
However, it was with little fanfare that two profitable mines came to market this week. BHP Billiton announced its intention to sell the Ekati mine in Canada, along with its other diamond asset, the Chidliak joint-venture exploration project, and Gem Diamonds said that it is reviewing its options regarding the Ellendale mine.
Both prospective sales make sense in the context of their respective realities. However, the companies may have a hard time finding appropriate buyers. While both mines have good high-quality production, they also have limited lifespans, making them risky investments.
To be quite frank, from BHP’s point of view, — barring any unlikely takeover of for example De Beers or ALROSA — the company was never going to grow its diamond business. Not for lack of trying, mind you, as the company has explored for diamonds in Angola and Canada during its tenure. But its announcement this week came with little surprise as the market has been awash with rumors for years and an exit was inevitable.
BHP explained that its strategy is to invest in large, long life, upstream and expandable assets. As industry analyst Des Kilalea of RBC Capital told Rapaport News, diamonds no longer fitted any of those requirements, at least not by BHP’s standards.
The move, Kilalea stressed, should therefore not be seen as BHP’s rejection of the industry. Rather, it is an acknowledgement by the company that further exploration and investment will not yield a BHP-size asset. BHP’s diamond unit is just simply not up to BHP’s scale.
Furthermore, the unit’s contribution to the company’s bottom line continues to diminish. BHP’s diamond revenues grew 12 percent year on year to $1.01 billion in the fiscal year that ended June 30, 2011. However, diamonds accounted for just 1.4 percent of the group’s total, down from a 1.7 percent contribution made in the previous year. Similarly, earnings before interest and tax (EBIT) accrued by the diamond unit rose 15 percent to $537 million but accounted for 1.7 percent of the group’s total, down from a 2.4 percent contribution in fiscal 2010.
That’s not to say that Ekati hasn’t been a profitable operation, which it has been over the years, as the aforementioned numbers show. But its production is declining and, most importantly, it has a limited lifespan that is expected to expire in 2018, some 20 years after production was launched.
Already, output has been completed at the Panda pit, which bore the highest grade diamonds of the four pipes that make up Ekati. In May, BHP approved a $323 million investment to resume operations at the Misery pit and production there is expected to resume in October 2017. For now, production consists of a mix from the Fox open-pit and Koala underground pipe. Ekati’s total production fell 18 percent to 2.5 million carats in fiscal 2011.
Kilalea explains that potential investors will value Ekati according to one of two criteria: the attraction of the remaining five to seven years of its lifespan, and the exploration potential that the surrounding ore bodies provide, which may or may not be suitable for a smaller company.
But it is improbable that the top producers will be interested for varying reasons.
Despite reports in October that ALROSA’s management may, or should, be interested in Ekati, Vadim Astapovich, an analyst at VTB Capital, a Russia-based bank and research group, told Rapaport News that an ALROSA acquisition is unlikely. Besides the fact that ALROSA denied the claim, he noted that ALROSA shareholders are focused on the company’s Russian portfolio to drive up value ahead of its proposed initial public offering (IPO).
Analysts at Liberum Capital Mining noted possible synergies between the Diavik mine, owned by Rio Tinto and Harry Winston, and Ekati given their proximity to each other. But while an acquisition would help Rio diversify its portfolio, Liberum’s analysts believe Rio is more focused on its iron ore, copper, coal and aluminium business units. Kilalea dismissed the possibility of a merger, and the potential synergies, between the two mines given the remoteness of the area. “There’s an ice road that lasts for six weeks of the year but for the most part there are no roads there,” he said. “So there may be some synergies but they’re not that great and I’m sure the two companies have explored them before.”
Most agree that De Beers has its hands full with the recent Anglo takeover to embark on such an acquisition. Besides, if anything, De Beers has been streamlining its own portfolio rather than adding to it. Petra Diamonds is invested in extending the life of the Finsch and Cullinan mines it recently bought from De Beers, and in any case, Petra has in the past divested from any exploration activities, which is required at Ekati.
It is equally unlikely that these companies will buy Gem’s Ellendale mine, especially since it faces similar challenges. It also operates in a relatively inaccessible, remote area in North Western Australia, requiring diesel power generation, and, according to Kilalea, also has just a few good years left in it.
Gem recently explained that the resource extension and development programs conducted at Ellendale yielded “nothing of significance” and that at current diamond prices, the life of mine at the active higher value E9 pipe remains at 3 years.
The company has met considerable production challenges at Ellendale since its acquisition just four years ago. It has kept the E4 pipe on care and maintenance since the 2008 financial crisis, while production at E9 fell 33 percent year on year to a “disappointing” 84,997 carats in the first nine months of 2011. Still, sales continue to rise along with the per carat dollar average value of Ellendale’s production, particularly for its fancy yellow production, which it sells to Tiffany & Co., which itself may be a potential buyer.
Neither is Gem’s potential sale of Ellendale surprising given the $280 million investment required to expand its Letšeng mine in Lesotho, which was approved this week, and given its development of the Gaghoo mine in Botswana. The more attractive it became to focus its resources on Letšeng, the less attractive any possible extension programs at Ellendale became.
Neither BHP’s nor Gem’s respective diamond mine sales will make or break either company. Both are focused on other assets, albeit different ones on different scale. However, the fact that they may find it tough to sell should be seen as a reflection of the assets on offer and not the state of the industry.
It’s not that they’re bad mines but they are risky with just short-term potential and there are few buyers for any risky assets out there today. While the industry outlook is positive for the long term, its short term vulnerabilities don’t help.
Companies viewing Ekati and Ellendale will surely bear this in mind and assess the assets in the context of their own development, as BHP Billiton and Gem Diamonds have. They will know that diamond mining is a costly, but potentially profitable business, and one that offers primarily long-term dividends. Then again, the negatives might force a bargain price for the mines in question.
The writer can be contacted at email@example.com.
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