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Nicky’s Big Deal - Rapaport Analysis
Mar 2, 2001 10:25 AM
By Martin Rapaport
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In a surprise move that will have wide ranging ramifications for the diamond industry, Nicky Oppenheimer has put forward a bid to take De Beers private. DB Investments (DBI) a new consortium consisting of the Oppenheimer family (45%), Anglo American PLC (45%) and Debswana (10%) has announced plans to buy De Beers for approximately $17.6 billion or $43 per share. If the deal goes through DBI will buy all the outstanding shares of De Beers and take the company private in a complex leveraged buy out (LBO) transaction. Since the announcement De Beers share price has surged $10 (31%) to $43 per share and Anglo’s share price has jumped $5 (8.5%) to $67 per share.1
To understand why Nicky Oppenheimer wants to take De Beers private we must analyze the real value of De Beers relative to the market value that the stock market puts on De Beers share prices. Historically, De Beers share price has severely discounted the value of De Beers diamond business and/or De Beers significant $9.7 billion holding in Anglo American PLC. Nicky’s deal and the valuation of De Beers is highly complicated by significant crossholdings between De Beers, Anglo American, the Oppenheimer family and Debswana – an equally owned joint venture between De Beers and the government of Botswana.
A primary problem for De Beers has been the fact that De Beers share price and resultant stock market value (i.e. share price times the number of shares) does not reflect the real value of the company. Sometimes the situation is absurd. For example at year end 1998, De Beers share price was $12 meaning the company was worth a total of only $4.6 billion of which $2.5 billion was in Anglo shares. This meant that all of De Beers diamond business, the mines, the DTC, and $4.8 billion of inventory were only worth $2.1 billion. Furthermore, at year end 2000, De Beers diamond business was valued by the stock market at only $3.1 billion even though the company made $1.7 billion of profits and owned $3 billion of inventory, not to mention the DTC and the best diamond mines in the world.
Apparently, stock markets investors hate De Beers. It’s nothing personal they just don’t want to bid up the price of De Beers shares to real market values. There maybe many reasons for this. The fact that De Beers major assets are in South Africa and the stock is listed on the Johannesburg stock exchange; the linking of shares with De Beers Centenary, the U.S. antitrust investigation of the company, the mysterious nature of the diamond business and finally and perhaps most importantly the very weird and extremely confusing cross ownership between De Beers and Anglo.
Crossholdings
Over the past few years about 70% to 80% of the stock market value of De Beers was based on its ownership of Anglo shares. When an investor bought De Beers they weren’t really buying De Beers. 70 to 80 cents of every dollar invested in De Beers was really an investment in Anglo shares. Most investors figured, if I want to buy Anglo, I’ll just buy Anglo why play around with De Beers.
If someone wanted to buy De Beers without Anglo they couldn’t. In fact the only investors that could buy De Beers were folks interested in both Anglo and De Beers. It’s like forcing your customers to buy certs and Indian melee in the same deal. You really limit your customer base that way and the price you get will be a lot less than if you sold the goods separately.
Now to add insult to injury and confuse investors even more, Anglo owns 31.6% of De Beers. So every time you buy Anglo you get a bit of De Beers which gets you a bit more of Anglo which gets you a bit of De Beers etc. The thing is a mess. Why would an investor who is pretty scared about trusting a monopolist with hard to value diamond mines put his money into a house of mirrors? The cross holdings are like a bid red flag warning investors to keep away from De Beers. Investors get the message - Oppenhiemer is just to smart for me.
Ernest Oppenhiemer, Nicky’s grandfather certainly knew what he was doing. Cross ownership was designed to protect the family’s interests in both De Beers and Anglo as it made a takeover almost impossible. It also gave De Beers the financial strength to borrow money against their Anglo shares when times were tough and the rough markets needed support. However, In 1998 with De Beers diamond business valued at only $2.1 and the diamond industry in decline due to the collapse of the Far East markets De Beers management came to the realization that they simply could not go on doing business the old way. The value of the company was steadily declining something had to be done.
Fixing De Beers
In January 1999, management implemented a broad ranging strategic review. A primary goal of the review was to increase the market value of De Beers diamond business to $10 billion by 2004. De Beers low share price became a motivating factor encouraging management to take the necessary steps to reinvent the company. The thinking was – if we do what it takes to get our share price up then we will be creating a better, more efficient, more valuable company. The new mantra of the company became – Shareholders First.
Management delivered. They changed the strategic objectives and priorities of the company. De Beers would no longer be the custodians of the diamond industry and most of the diamond stockpile was sold off. The new focus on adding value took hold. PPP, Supplier of Choice and the new De Beers branding initiative with LVMH have become realities. Operations were trimmed and the management structure reworked as the company became more transparent. Over the past three years management has done everything it could to increase De Beers share price and the market value of their diamond business.
Business has been excellent these past two years. Look at the graphs and tables. Record sales, record profits, inventory down – all capped by a fantastic 137% increase in 2000 profits to a record $1.7 billion. But hold it – what has happened to the share price. Unbelievable, it went down because Anglo went down. De Beers is in top shape but all management and shareholders get for the successful efforts is a measly $1 billion increase in the value of De Beers diamond business. How unfair. How frustrating.
Obviously, De Beers efforts to improve market value by reinventing the company have been stymied by the company’s corporate structure. No matter how good De Beers really is, investors don’t want to buy into a company with messy crossholdings. The message is loud, simple and clear. De Beers has to get rid of its Anglo holding. The only question is how?
Getting Rid of Anglo
Getting rid of Anglo is not as easy as it looks. Essentially we have three players. Nicky, Anglo and the outside shareholders. In some ways all the players have competing interests and agenda’s, although Nicky has been able to align his interests with Anglo at what some would say is at the expense of the outside shareholders.
Since Anglo is the biggest player we will start with them. Anglo certainly doesn’t want 35.4% of their shares worth $9.7 billion dumped on the market. Furthermore since they are De Beers largest shareholder with 31.6% of De Beers worth $5.5 billion their views and interests in this deal carry great weight. Essentially De Beers can’t get rid of its Anglo shares unless Anglo approves of how the shares are sold, swapped or distributed to De Beers shareholders.
Fortunately, Anglo not only wants their shares back they need to get them back or at least out of De Beers hands by June. An important component of Anglo’s share price is their inclusion in the primary index of the London Stock Exchange the FTSE. Not surprisingly, FTSE does not like firms whose shares are cross-held with other companies. If Anglo’s shares remain with De Beers their FTSE status will be downgraded and their share price will fall come June.
While Anglo wants De Beers to release their shares they also want to remain owners of De Beers. This may have something to do with the fact that Nicky owns 7.2% of Anglo but frankly De Beers is looking good and will probably look even better when the components of the strategic review are fully implemented. Anglo likes the new De Beers. Doesn’t everybody?
Nicky’s Plan
Nicky has put together a brilliant plan that directly addresses the immediate needs of Anglo and De Beers while preserving his strategic interests in both companies. Furthermore, the deal is practically cash free with the equity interests being paid for by shares that are already owned by the partners. While the complex share transactions and payouts are well beyond the scope of this story, suffice it to say that Nicky really knows what he is doing.
Nicky’s equity interests in De Beers and Anglo are such that he will only need $37.5 million in cash to acquire 45% of the new privatized De Beers. Debswana will get their 10% for their existing shares and a $200 million load in the form of preferred shares. Anglo will make a similar $700 million loan to DBI and do some very sophisticated share swapping and retiring fro their 45% share.
Nicky’s plan is complex. Essentially it is a combined LBO, Anglo spin off with a share distribution twist. Quite a cocktail.
Here is an oversimplified explanation. Nicky’s buyout group, DBI, buys De Beers for about $18.1 billion (based on current Anglo share prices). It then spins off or swaps off De Beers $9.7 billion of Anglo shares. So now we are talking about an $8.4 billion deal. DBI borrows $4.4 billion from the banks and another $900 million from Anglo and Debswana to pay off outside shareholders ($5.3 billion). The balance of $3.1 billion needed to finish the deal comes from shares in Anglo and or De Beers that the DBI partners already own.
The twist part is that outside shareholders are not paid off all in cash but get a combination of cash and Anglo shares in payment for their De Beers shares. Every shareholder of De Beers including the DBI group gets $14.40 in cash and 0.43 of an Anglo share for every De Beers share (see DBI Offer table). As of Feb. 27 the 0.43 of an Anglo share was worth $27.95. But this value will fluctuate based on Anglo’s volatile share price. If Anglo goes up De Beers shareholders will get more money if it goes down they will get less. So Nicky’s bid is really a variable bid based on the value of Anglo when the deal closes - hence the twist. To further confuse things a bit Nicky says he is offering shareholders an extra $1 dividend but that is not really part of the offer as the dividend will be distributed even if Nicky’s deal does not go through.
The Outsiders
The largest, most fractious and perhaps disgrumpled group in this deal are the outside shareholders. These folks own 61% of De Beers worth about $10.6 billion. The larger shareholders are professional institutional investors who manage large pension or investment funds. These investors do not have a strategic stake in the diamond business but as professional they have a fiduciary responsibility to their clients to get the best price for their De Beers shares.
The outsider are a very powerful part of this deal because in order for the deal to go through 75% of the outside shares will have to vote for it. If a few of the large outsiders get together they can kill the deal rather easily.
On one hand the outsiders are or should be very happy. In a declining equity market, Nicky has made them heroes. De Beers share price started the year at $26.375. By January 31, a day before Nicky’s deal was announced it had increased 24% to $32.65. Then after Nicky’s deal on February 1, De Beers jumped another 31% to $42.64 on February 27. Altogether De Beers share price has increased 62% since January 2. Not bad. Not bad at all.
Now some of this increase, say half, is probably attributable to De Beers record profits that were also announced on February 1. But these profits were very anticipated and built into the price jump during January. At least 30% of the increase is the direct result of Nicky’s deal. Does anyone think that De Beers price would have reached $42 if Nicky had not put it there by making his offer?
Now before we ruin our reputation and become know as founders of the Nicky fan club we must point out that not all shareholders are happy with Nicky’s deal. In fact the vast majority of investment analysts that we have spoken with are against the deal. Here is why.
Debundling
As explained above a primary reason De Beers share price never fairly reflected De Beers real value was because it was bundled together with ownership in Anglo. In a normal world one would expect De Beers management to sell off, spin off or simply distribute its Anglo shares and sit back and watch the De Beers share price go through the roof. But that isn’t happening here.
Instead of sitting back and letting the shareholders get all the gravy from the debundeling, De Beers management in the form of Nicky, and preferential shareholders in the form of Anglo and Debswana, are running away with the company and the economic benefit of the debundeling. There is a strong perception in the analyst community that the big guys are really putting it to the little guys in this deal. There is also the perception – fiercely denied by management – that De Beers management is compromised by present, past and/or future relationships with Nicky - that there is something very much “not hands-off” with this deal.
Now some folks will tell you the analysts are upset because if De Beers goes private they will be out of work or have to find other companies to analyze. But the fact is that there is something very frustrating about what De Beers management is doing.
Here we have De Beers creeping along with a lousy stock performance for the past ten years. At last, finally, management gets its act together and starts implementing solid strategies for future growth. Finally there is great upside for the investor. And then - poof the company is gone. The upside is gone. As soon as things get good or look good at De Beers, Nicky comes along and takes the company away from everybody. It’s like the kid with the football leaving in the middle of the game just when things are getting interesting.
Step By Step
The big question is what would happen if De Beers management separated the two parts of Nicky’s deal. If first De Beers unbundeled Anglo and then, say a year later Nicky took the company private? From the perspective of many of the outside investors this would optimize the deal for the shareholders. The benefits of the unbundeling could accrue to the shareholders and Nicky could then buy the company at a future date based on a fair market value established in the marketplace.
Nicky’s view (see interview page one) is that there are many inhibitors to De Beers share price and unbundeling alone would not solve them. He believes that if the unbudeling was separated from the LBO both De Beers and Anglo’s share prices would fall below current levels. Therefore he maintains that it is in the best interests of the shareholders to combine the LBO and the unbundeling.
Frankly, in the opinion of this writer De Beers management would be well advised to allow the outside shareholders the option of voting on this issue. There should be two proposals at the extraordinary shareholders meeting. One to do the deal the way Nicky wants and another to allow for unbundeling first and LBO later. While Nicky’s opinion of what is best for the shareholders is important the shareholders should be free to decide. After all if Nicky really believes that unbundeling first will result in a lower share price later he will then end up getting the company at a lower price.
While opinions, including mine, are interesting they don’t really matter that much. Nicky’s offer is Nicky’s offer. If the outside shareholders have the courage to sit down with Anglo and explain that they are unwilling to approve the deal unless they are given the option of separating the debundeling from the LBO. But to do this they will have to bear the risk that the deal may fall through and De Beers price may go down. It’s a reasonable risk since as far as unbundeling goes the cat is out of the bag. Whether or not Nicky’s deal goes through it is hard to imagine a situation whereby unbundeling will not take place sometimes in the very near future. The key question is how much would unbundeling alone add to the value of De Beers share price. Is it more or less than the $43 DBI is currently offering?
So What’s De Beers Worth?
The value of the De Beers Anglo stake will depend on the value of Anglo at the time of closing the deal. The Anglo component of the DBI offer is fixed at the price of Anglo times 144.28 million, the number of shares of Anglo.
The real question is the value of De Beers non-Anglo assets. We have prepared a detailed table with our estimated valuation. Our valuation is based on the value of all De Beers diamond assets in addition to our estimate of $380 million for non-diamond assets. We have not included the $400 million dividend payment in our valuation because this dividend will be paid even if the deal does not go through.
Our estimated valuation for the diamond business comes to $10.743 billion or $26.36 per share. The comparable DBI offer is $7.958 Billion or $19.53 per share 26% lower than our estimate. The difference between our estimate and the DBI offer is $2.785 billion.
If one uses the NASDQ closing price of Anglo ($67.5) and De Beers ($42.64) on 2/28/01. Out total valuation for all of De Beers is $20.482 billion or $50.26 per share. The comparable DBI offer would be $17.697 billion or $43.42 per share 13.6% lower than our estimate. The reason the discount is lower for all of De Beers is because the value of De Beers is much higher but the differential of our estimate is the same $2.785 billion.
Readers are advised that there are significant differences of opinion as to the proper valuation of De Beers mining assets particularly the assets in Botswana and Namibia. Furthermore, we have valued De Beers diamond stocks at their declared value even though part of these diamond stocks may be relatively illiquid and certainly should not be considered a liquid cash asset.
Money Talks
Frankly, we are not at all surprised that De Beers has come in at 26% below Rapaport for the diamond component and 13.6% below for the whole De Beers. In fact 26% below is probably a pretty good price. Outside shareholders deceive themselves if they think any buyer would pay full price in a $10.7 billion deal. Perhaps some shareholders would like us to provide a low-ball estimate so that they could feel better. We are not going to do that.
So how much is De Beers worth. Lets see. On December 31 the stock market said it was worth $10.5 billion, on January 31 it was worth $13 billion. Then on February 1, Nicky made it worth $17.6 billion and the stock market backed him up. Clearly De Beers assets did not appreciate 60% since the beginning of the year.
There is a lesson here from the diamond business where people trade stones that are difficult to value. De Beers is worth what someone with the money is willing to pay for it.
Perhaps some shareholders out there that feel bad, they think that De Beers is worth more and Nicky is getting a free ride. But pray tell where were these shareholders when De Beers was worth $10.5 billion in January? If you think that De Beers is worth more than step right up. Make an offer.
(1) Values in this article are rounded and based on NASDQ closing share prices of 2/27/01. De Beers $42.64 and Anglo %67.50.
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See also exclusive interview with Nicky Oppenheimer: Oppenheimer - Taking De Beers Private and De Beers Estimated Evaluation
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Tags:
Anglo American, Banks, De Beers, Debswana, DTC, Government, LVMH, Namibia, South Africa
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