Rapaport Magazine

ALROSA The Diamond Fox

From humble beginnings, ALROSA has ambitious plans to be the world’s largest diamond producer for years to come and its upcoming IPO is part of those plans.

By Avi Krawitz

Overlooking the town of Mirny, a statue honors the legend of the fox who led geologists to discover diamonds in the region. All photos courtesy ALROSA.

Legend has it that geologists were led by a fox to the site where the first diamonds were found in Russia’s Yakutia Republic. The story is not entirely a tall tale.
   More accurately, after recognizing a similar geological landscape to that of South Africa’s kimberlite ore formations, geologists in post-World War II Russia descended on Yakutia, a vast 1.2 million square mile territory about 3,000 miles east of Moscow, scrutinizing the banks of the Vilyuy River for volcanic pipes. By the spring of 1955, geologist Yuri Khabardin was excited to come across a foxhole in a ravine that exposed blue earth, indicating high diamond content.
   Much was at stake as the directive to find diamonds had come from the highest levels. Stalin recognized the need for industrial diamonds to help rebuild Russia after the war and he knew he couldn’t rely on De Beers supply for fear they might boycott supply to the Soviet Union.
   Today, Yakutia is arguably the most diamondiferous region in the world. And as Khabardin’s find developed into the Mir mine, the operation is at the core of a portfolio of projects that make ALROSA the world’s largest diamond producer by volume.

   ALROSA is playing up its production potential in advance of an initial public offering (IPO) that is scheduled for the fourth quarter of 2013. In contrast to other major diamond mining companies such as De Beers and Rio Tinto, which have a strong focus on branding, ALROSA is looking to drive future growth purely via its diamond mining operations.
   That hasn’t always been the case. Over the years, the company built up a portfolio of subsidiaries that included oil, gas, iron ore, hydropower, banking, hotel and aviation units. As part of its IPO strategy, the company has embarked on a program to sell most of those noncore assets and streamline its operations to focus on diamond mining.
   As a result, ALROSA expects to surpass De Beers as the largest diamond producer by revenue value by 2018. If all goes well in the offering and the 14 percent of shares that are up for sale fetch their upper price estimate, ALROSA would be valued at about $15 billion — more than any other diamond company. By comparison, the Oppenheimer family’s recent sale of 40 percent of De Beers to Anglo American for $5.1 billion valued De Beers at around $12.75 billion.
   ALROSA has proposed placing 7 percent of shares owned by the Russian Federation and another 7 percent held by the Yakutia Republic in the offering on the Moscow Stock Exchange. Currently, the Russian government owns 50.9 percent of the company, Yakutia holds 32 percent and eight municipalities within Yakutia own another 8 percent. The company has a small, existing free-float of shares sold to outside investors.
   In a recent meeting with members of the press, Igor Sobolev, first vice president of ALROSA and executive director responsible for mining operations, explained that the IPO will help relieve ALROSA of costs unrelated to its core mining activities, especially its contractual obligations to provide social services and finance capital projects in Yakutia, which include such things as housing, medical facilities and community centers.
   Analysts at Metropol Investment Financial Company noted that despite strong financials in 2012, ALROSA’s bottom line was weighed down by “significantly increased social obligations.” The company has recommended that Yakutia’s share of the funds raised in the IPO be used by the republic to support some of those same services and projects, although, ultimately, that will be the local government’s decision.
   But the IPO will not mark the end of the local and federal governments’ involvement in ALROSA, as both will maintain significant stakes in the company after the offering. Perhaps more importantly, Sobolev stresses that the company will still enjoy state support to buy its diamonds if proved necessary during any market downturn.
   During the 2008 crisis, ALROSA maintained production levels and sold goods to the state depository Gokhran, while most of its peers reduced production or temporarily closed mines. In 2012, again, the company sold about $317 million — 1 billion rubles — worth of goods to Gokhran. “That’s our competitive advantage rather than reducing production,” Sobolev noted. “If we decrease production volume, we lose operating efficiency.”
   While ALROSA has not sold to Gokhran so far in 2013, Sobolev is confident that marginal annual market growth of around 3 percent will help push ALROSA to be the world’s largest diamond miner by value in the next five years.
   Gone are the days when ALROSA sold its goods to De Beers to market and sell. Today the two companies compete for market share even if they ultimately sell to many of the same customers. ALROSA’s sales strategy has evolved in the past five years as it has focused on forging long-term contracts with clients. It currently has supply agreements with about 40 companies, among them the likes of Tiffany & Co., Chow Tai Fook, Kristall Smolensk, Rosy Blue and others, and expects that approximately 70 percent of its sales will be made via these contracts. The remainder is sold through spot transactions and auctions. The company also sells a fraction of production as polished on the open market to test polished prices and provide an indicator for setting its rough prices.

   ALROSA is confident it has the stability of supply to meet these commitments and, in fact, expects that an initial spurt of production from 34.4 million carats in 2012 to 38 million carats in 2020 will help drive revenue growth before production is projected to return to around 34 million carats by 2035.
   ALROSA has a total diamond reserve of 1.154 billion carats spread across its four mining divisions, a number it released for the first time ever in late 2012, with the bulk of its production coming from the Yakutia Republic. However, the region’s contribution is projected to decline from 34 million carats to 24 million carats by 2035. At the same time, ALROSA’s Severalmaz operation — located in the Arkhangelsk region — is forecasted to ramp up production from 559,000 carats in 2012 to 10 million carats annually over the next 20 years to make up for the declines at Yakutia.
   Still, the majority of ALROSA’s mines are located in Yakutia. Sobolov adds that it’s also the region where ALROSA is most likely, and very probably, going to find new deposits. Despite the fact that there is other early-stage prospecting and exploration activity taking place in Angola, Botswana and Zimbabwe, exploration that is already underway in Yakutia remains ALROSA’s most promising possibility for finding new deposits.
   The preliminary sorting of goods among industrial, near-gem and gem-quality goods is also done in Yakutia at its grading centers before being shipped to its various selling points. In Moscow, the United Selling Organization (USO) assembles ALROSA boxes with a mix of diamonds from the Mir, Udachny and Aikhal divisions, while goods from the ALROSA-Nyurba and Almazy Anabara divisions are sold separately.

   But while the company explores a wider area to identify new potential resources, it has also had to dig deeper at considerable cost to tap existing resources. Of its ten mining operations, which include nine mines plus the various alluvial and tailings operations, the Mir, International and Aikhal mines are already underground. The Udachny underground mine is being developed and is scheduled to fully transition from open pit by 2015.
   All operations considered, the underground activity will account for close to half of ALROSA’s total production in the near future. Analysts view this heavy reliance on underground mining as a risk, even while they point out that the company will need to transition more of its operations underground in the near term.
   Doing so is a necessity because going underground significantly extends the life of the mine. At International, for example, open pit mining was completed in 1980 and the mine lay dormant until the underground operation was commissioned in 1991. The project now has consistent production of 500,000 tons of ore a year, anticipated to continue through 2021 before its forecasted depletion two years later.
   ALROSA has also invested in innovation to meet its long-term production goals. Among these are programs to better preserve the integrity of the diamond through the production process and an ambitious project to introduce remote-control mining in 2014 that will make it possible to reach deeper reserves than are possible today.

   ALROSA is hoping these initiatives will lay the foundations for future growth to build on its current accessible resource. When it released the numbers on its diamond reserves late in 2012, the disclosure was one of a string of decisions signaling a more transparent and open company, which is necessary in advance of the IPO.
   Ultimately, it is those diamond resources that are driving up value and investor interest in the company and will determine the selling price per share in the IPO. In initiating coverage of ALROSA in August 2012, Deutsche Bank Market Research noted, “The company in particular and the industry in general have also suffered from a lack of transparency, which is part of the nature of the industry and the exploration and mining of diamonds. However, we are constructive on the outlook of the diamond market and…we believe ALROSA offers value for the patient investor.”
   It may take a bit of patience. But ALROSA appears determined to drum up its self-proclaimed role as “the largest listed pure diamond producer globally.” Like a fox waiting to emerge from its hole in a ravine, ALROSA is hoping to have a rising influence on the market. 

Article from the Rapaport Magazine - July 2013. To subscribe click here.

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Tags: Avi Krawitz