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De Beers Annual Review

Jan 7, 2000 10:33 AM   By Martin Rapaport
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RAPAPORT... The following is an edited transcript of comments made by De Beers Managing Director, Gary Ralfe at his end-of-year telephone conference with leading diamond industry analysts and journalists. The presentation took place on December 20, 1999. Please note that while we have tried to capture Mr. Ralfe’s words as spoken wherever possible, due to transcription errors and the need to clarify statements we have edited liberally and not everything presented here is a direct quote.

Gary Ralfe: Good afternoon ladies and gentlemen. De Beers is pleased and proud to announce record 1999 rough diamond sales of $5.240 billion, 57 percent higher than last year’s sales of $3 345 billion. Sales for first half 1999 were 45 percent ahead of the first half of 1998. What is perhaps remarkable is that sales for the second half of 1999 at just under $2.8 billion, were 70 percent ahead of the second half of 1998 and substantially ahead of the $2.5 billion we sold in the first half. If we look back in history it is difficult to find a year when the second half has been stronger than the first. Perhaps this has something to do with the “Millennium Effect” since the second half was much closer to the magical December 31, 1999.

These are record sales in that it is the first time that the CSO has sold more than $5 billion in nominal terms. If we look at this in real terms (i.e. corrected for inflation) then the sales that the CSO made in the last two or three years of the 70s, when diamond sales were very strong due to the flight to tangibles or in the two/three years between the 80s and 90s, then sales in that period were actually higher in real terms than they are for 1999. We now have a good challenge to try and set a record, in due course, in real terms as well as in nominal terms.

It’s been a pretty extraordinary year as the market is so much changed from what it was this time last year. Last year there was near despair in the diamond markets after what had been an extremely difficult year. There was substantial stock depletion, both in the cutting centers and in the consuming countries, and a very clear erosion of confidence. It’s been exactly the opposite this year. Last year we were telling our clients that of course things were never as bad as they might seem — given the positive results of this year, I do hope that the opposite is not true. Indeed things look very good for the moment. Let us hope that they are properly sustained all the way through down to retail level.

Retail Markets

We are right now in the midst of the so-called Christmas season in the American retail market. Forty percent of all diamond jewelry purchases in the United States are made between Thanksgiving and Christmas. We hear that so far it has been a very good season in America, with many stores reporting double-digit increases compared with this time last year. We believe America will be responsible for about 45 percent of total world consumption of diamond jewelry this year. If we look at other countries we find that there too, things are not too bad, although nowhere quite as good as the double-digit increases we’re expecting in the total diamond jewelry market in America.

Regarding Japan, the world’s second largest market, I can say that the fall in diamond jewelry consumption in Japan, so evident to our great discomfort in the years 1997 and 1998, has slowed down considerably. We are logging only a 3 percent decline in Yen purchases of diamond jewelry. Given the relative strength of the yen against the dollar in 1999, that actually translates into a double-digit increase in dollars. Europe is more or less steady and Asia Pacific is quite sharply up in 1998. That is because of a better economic recovery in places like South Korea, Taiwan and China. And so for the whole year we are looking at a total improvement in global diamond jewelry purchases of something approaching 10 percent. It is this improved retail demand that is underpinning the strength of the diamond market. Of course an 8 percent or 9 percent increase in retail demand world-wide, would be a long way away from the 57 percent increase in sales that we have registered for 1999, and it is important for us to reconcile this very large gap.

I think the first thing to say is that similar to the first half-year actual imports of rough diamonds into the diamond cutting centers have not increased by as much as the 57 percent that we have increased our sales. They have increased by a more reasonable 30 percent — still a very strong increase. The deduction we can make from this is that we at De Beers have enjoyed a larger slice of the total supplies to the diamond markets in 1999. This is what you would expect, given the fact that we held back so substantially on our sales in 1998.

The other reason has to do with inventory replenishment. In 1998 we were holding sales back because of the lack of confidence in the diamond markets. There was a general move both in the cutting centers and in the jewelry manufacturing/consumer centers to cut down on supplies. There were even diamonds coming back from some consuming countries which had been very strong, like South Korea and Japan. And so there was substantial depletion of inventories. Exactly the contrary has happened in 1999. There has been a fairly important replenishment of inventories, about a half a billion dollars in the cutting centers. In the consuming countries inventory accumulation also sustained the growing American market while Japan and the Far East markets took advantage of better exchange rates to restock somewhat. These are the two most important reasons why De Beers sustained better sales this year.

A third reason for our strong sales and is the millennium effect. We have certainly convinced ourselves, and during the course of the year we seem to have convinced many of our partners in the trade, that diamonds and the millennium have a very special relationship. Diamonds celebrate the millennium with a piece of forever. And we hope that this enthusiasm also communicates itself through to the diamond jewelry buying public.

We launched a special collection this year called “The Limited Edition of Diamonds for the Millennium,” branded by De Beers and cut to fairly rigid specifications so that these one- and two-carat polished diamonds will have the maximum luster. The stones not only carry the invisible-to-the-naked-eye brand of De Beers, but also a registration number. Approximately 25,000 stones have been or are in the process of being polished. About one third have already found their way to the consumer at, I am pleased to say, premiums substantially ahead of the price that the stones would have commanded had they not carried the De Beers brand or not been part of a limited edition.

I think you probably are also aware that we have devoted as much as possible of our $170 million budget this year on advertising the millennium opportunity. We focused on reminding the consumer, particularly in America, of the millennium and the opportunity this provided to purchase diamond jewelry.

Prudent Sales Policy

We have been fairly prudent in our sales towards the end of this year. We could have sold more than what we actually sold because there still is unrequited demand in the cutting centers. We had a very strong third quarter in terms of our sights, with three sights, July, August and September all being in the region of $700 million. But the last two sights of the year have been considerably smaller and the reason for this is that the diamonds that will be polished from those sights will miss the Christmas season. This year we want to make sure that the confidence which is riding very strongly on the management of the world’s diamond market by the De Beers’ CSO is still there in January. We hope that the returns from jewelers, particularly from the American season will be minimal. By bringing down our sales for the last two sights we want to give every chance possible for the new year to start on a good note.

Another reason for cutting back on our sights nine and ten was that bank borrowings in the cutting centers, which were running at about $5 billion in the first half of the year, went up fairly sharply over the next few months exactly at the time as we were putting out the very large sights of about $700 million. Borrowings went up from $5 billion to $6 billion and there was a slowing down in inventory rotation along with some increase in receivables. Since the lending banks to the diamond cutting centers are very important partners in the market, we wanted to take into account their concerns as well. I believe that they are happy as well that we have shown restraint in our last two sights of the year.

Now some of you might say, that given the fact that in terms of our strategic review we want to be competitive in our selling and that we have expressed the wish to run down our stockpile, surely we should have gone for more sales.

Certainly, I have been assailed by comments from some of my colleagues in that vein. But I believe that we have done the right thing. We are looking for a sustained and systematic approach to our marketing. We don’t want to maximize one or two sights. What we want to do is maximize our position, to be the preferred supplier over a long period of time and I think that cutting back in sights nine and ten will enable us to better that position for the year 2000.

In the year 2000, we would like to sell at least as much as we have sold in 1999.

We have a business plan to sell that amount and we must manage our affairs and compete successfully taking into consideration all the macro-economic factors that are going to impact on retail behavior worldwide.

Political Issues

There are two items that are important to cover because they are topical issues. One relates to South African exports and issues concerning the Government Diamond Valuator of South Africa. I publicly applaud the recent intervention of the South African Minister of Mines and Energy, Minister Mlambo-Ngcuka and her Department. Since that intervention, diamond exports have been flowing smoothly and with one last export due to be made this year, we shall then be back properly on schedule. Of course we believe that the support and co-operation of the Minister and her department should continue through next year.

The other issue is a much more complicated one. Its heading is “conflict diamonds.” I am pleased to say that De Beers took an initiative, which in retrospect we are very pleased with. In January of this year I wrote to the Secretary General of the United Nations offering our help and support in the matter of sanctions against UNITA. We reminded the Secretary General that De Beers had never traded with UNITA, and that since the promulgation of Section 1173 in the middle of 1998, it had never bought any diamonds in any of its myriad offices around the world that did not have the requisite certificates of provenance. That letter turned out to be a precursor to a very good dialogue with Ambassador Fowler, Canada’s Ambassador to the Security Council who is charged with the matter of sanctions against UNITA. We have continued to have close and I believe fruitful contacts with Ambassador Fowler and other officials at the United Nations.

In early October of this year, we took another important step and decided to stop buying all Angolan diamonds anywhere in the world because of the continuing problems with conflict diamonds including the focus that the Nongovernmental Organizations (NGO) were bringing to this matter, laudably we believe, and also due to the fact that it was becoming apparent that some of the certificates on Angolan diamonds were of doubtful authenticity. We announced that we would stop buying Angolan diamonds anywhere in the world. Since then we have wound down our buying in Angola, removed our buyers, and our company there is in the process of liquidating our buying partnership. We have also suspended our buying operations in the Congo and Guinea.

We welcome the support that we have from President Mandela and the Governments of South Africa, Botswana and Namibia regarding this extremely important matter. Well over 95 percent of the world’s diamonds come from regions that are conflict-free, democratic and peaceful. Indeed let me say that diamonds represent one of the greatest hopes for Africa’s economic development. As President Mandela reminded everybody in his announcement: movement at the consumer level against diamonds could actually destroy the economies of Botswana and Namibia.

De Beers’ position is that it is keen to co-operate with all interested parties in this matter. Including of course, the United Nations, De Beers partner governments in southern Africa, the Government of India, which has of course an enormous vested interest in the diamond industry with close to one million people being directly involved in the cutting and polishing of diamonds, and indeed with the NGOs themselves. They have laudable motives in their efforts to draw attention in the world to the connection in certain limited instances between diamonds, civil war and general havoc.

The important point in relation to UNITA is that well under 1 percent — we estimate it could be as low as 0.2 percent of the world’s current diamond production — comes from the areas in Angola controlled by UNITA. We hope that in the new year we shall be able to reassure all interested parties, including the NGOs and if necessary the diamond jewelry-buying public that the diamonds that are on the shelves of retail stores emanate from peaceful countries where they serve a vital purpose in bringing prosperity to the countries that mine and polish them.

Questions

Wall Street Journal: What is the promotion and advertising budget of De Beers? Did it come down form $200 million?

Ralfe: The number I mentioned was $170 million. I think it had been about $190 million in 1998, but given the very bad year we had in 1998, and the economic decline in Asian markets, we cut back on expenditure. The one country where we have continued to increase our expenditure is the United States because it is now by far the largest diamond jewelry buying country. I don’t have the precise figures myself of how it breaks down on a country by country basis, but I can assure you that if the United States is responsible for 45 percent of global diamond jewelry purchases then probably were spending around 45 percent if not more of the total $170 million on United States advertising.

Wall Street Journal: Is that excluding the trade?

Ralfe: It is excluding the trade. One of the extraordinary revelations resulting from the strategic review was that the in spite of De Beers large advertising budget the total spent on diamond jewelry advertising in relation to retail sales is as low as 1 percent. This includes De Beers and everybody else. This compares with something like 6 percent for watches and 10 percent for other luxury brands. I think a lot of people are relying on us to do the lion’s share of advertising and therefore we must try and incite greater advertising expenditure at all levels of the diamond trade. If we want diamond jewelry to compete with all the other luxury products in the marketplace then as an industry we are going to have to increase our advertising to sales ratio at every level of the distribution system.

WSJ: We have talked in the past about the balance between sales volume and raising the price of diamonds. You made the one price adjustment during the year. I wonder if you could just give us some guidance about your current thinking on prices and sales levels.

Ralfe: This is a very important question and one that is enjoying a lot of attention from us at the moment. What we did in September was rebalance our price book. Diamonds come in so many different shapes, colors and sizes that we have thousands of price points in our price book and periodically it needs revision.

What we did in September was to increase the prices of a great number of our boxes, particularly those that produce polished that was going to be mostly marketed in the United States. We balanced the increases with reductions of other boxes whose polished would be marketed to the Far East where demand has been much weaker. Overall, the readjustment was price neutral.

From January, given the very weak state of the market, we actually discounted our prices. We sold some of our boxes at discounts in order to get them moving again and to ensure our clients an attractive enough margin of profit. As a result, for a certain portion of our sights between January and September, we were actually discounting by selling at below list prices. That obviously must have impacted upon our trading margin during the course of the year.

We do have a large stockpile. It is an essential theme of our strategic review that we want to reduce that stockpile which was stated on the De Beers balance sheet at the end of last year at $4.8 billion. This figure doesn’t take into account the stockpiles of Botswana and Namibia as of that date, nor the full value of diamonds produced in De Beers Consolidated Mines’ own mines.

The value of all the diamonds at our disposal would be something like $6 billion.

In wanting to reduce that to working stock levels of somewhere around $2 billion, we have to have a sustained program over the next few years. It is very clear to us that as we want to move more volume, we need to be careful what we do about prices. It would be silly at an extreme to try and push up diamond prices if the result is that we had to increase our stockpile. On the other hand, we believe that part of the virtuous circle of diamonds is that they are understood by the consumer to be a good store of value. Diamonds have a very particular image which has to do with their value. It is important for the consumer to know that over a long period of time, diamond prices are going up. Indeed, that their value is being well sustained by De Beers.

The lesson to us this year has been to resist temptations to push hard on our prices because for the moment we want to reduce our stockpile in such a way that does not damage the reputation of diamonds as a store of value and in a way that does not impact negatively upon diamond prices. As the world’s largest diamond producer we have as great an interest as anybody else in sustaining diamond prices and consumer confidence.

Michael Rowlinson: How is demand from China? Has Japan been restocking diamonds and will it restock in the year 2000?

Ralfe: We continue to be encouraged by all the signs coming from China. When the Chinese are rich enough to spend as much as the expatriate Chinese in Taiwan, Singapore and Hong Kong spend on diamond jewelry, it will be a very important market. Indeed, there has been continued growth in China and we see that in what is moving through Hong Kong. In the trade, people refer to Hong Kong as the central market for South East Asia and there has certainly been a significant improvement in Hong Kong. As far as China itself, I would say it’s slow and steady. The significant improvement has come from South Korea rather than China.

Turning to Japan, there are some signs of replenishment of stock at the trade level as dealers take advantage of the strong yen but it is not very much so far. All that one can say is that retail purchases have bottomed out after the decline that we have seen in preceding years. If we look ahead to the year 2000, one of the little concerns I’ve had, is that if so much of our improvement this year has had to do with the replenishment of inventories in the cutting centers and perhaps America, what could possibly sustain the trend in the year 2000? Fortunately, there is a very substantial possibility for stock replenishment in Japan, depending upon the state of the Japanese economy and the state of consumer confidence in Japan. If there were to be an improvement in these economic indices, then I am confident that we would see a more concerted effort to replenish inventories within the Japanese trade pipeline.

Jack Jones (CIBC): Gary, you mentioned that one of the key factors behind the strong rise in diamond sales was De Beers increasing market share. I wonder whether you could give us an estimate of where you see the De Beers share of the global diamond market at the moment? Who do you think you are taking market share from at the moment? And whether your position is sustainable through 2000?

Gary Ralfe: The estimate from our research and information department is that probably under 55 percent of supplies to the cutting centers came from De Beers in 1998. That was because we were holding back on our supplies to the markets and increasing our stocks. This year we estimate that at least two thirds (66 percent) of supplies to the cutting centers have come from us, as demonstrated by our very important cash flow in the first half of the year. In the first half we were selling substantially ahead of our own commitment to buy from our partners.

We have also had a good year with a positive cash flow in the second half. I mustn’t suggest that we are going to be registering the same cash flow in the second half, because so many more of our commitments have been in the second half. For the year as a whole these sales of over $5 billion mean that we have been able to reduce our stockpile. And further, it means that we have been able to increase our market share.

When you say sold at the expense of anybody else, from what I know of other suppliers to the market, I think they all enjoyed an exceedingly good year as well. I don’t think our growth has been at the expense of any other supplier. I think that we have all been benefiting from the same extremely buoyant conditions in the diamond market.

Jack Jones: Were Russia and Angola a big factor in the market this year? And do you expect that position to change next year?

Gary Ralfe: Our estimate for Angola is about $600 million this year and it was probably in the region of about $800 million in ’98 but I am subject to correction on that. As far as Russia is concerned, I am pleased to applaud our very important partners in this business and say that outside rough diamond sales by Russia have been few and far between. There are certain amounts of rough diamonds, which, in terms of our agreement, can be legitimately sold from Russia.

We believe that otherwise the contract is being extremely well controlled at the Russian end. There might have been some increase in the sales of polished diamonds emanating from Russia, which is of course entirely within the spirit of our arrangement. That is because there probably has been an increase in diamond polishing within Russia and also because, like everybody else, the Russians have been able to benefit from a good year in running down some of their own polished inventory.

Peter Davey (SG Securities): Just to follow up on the discount of diamonds, which sights were discounted? Would the discount have been at the low end of the quality scale, rather than the top end? Does that then mean that there is any revaluation of stockpile for this year? Over what period of time do you expect to take inventory down to below the $3 billion mark?

Gary Ralfe: The discounting of certain boxes was actually between sights one and seven. The price rebalancing took place from the September sight, so it was for the last three sights that the prices had already been redone. And I must specify again that it was only for a minority of our boxes that we had discounts. The majority, a substantial majority, was selling at full SSV. The discount depended on the boxes in question, and they would tend to be more expensive diamonds rather than cheaper diamonds. Cheaper diamonds have been in great demand all through the year, and we certainly weren’t discounting any of those boxes.

Let me take one box, we sell a box called “fine, 3 to 6 grainer.” It has a wide range of colors, but its particular hallmark is its high purity and clarity. This quality of diamond has very strong demand in Asia and Japan, areas of the world which have always liked piqué-free diamonds. This was a box which we discounted, it produced expensive polished and we knew the list price was expensive. So, if anything, it would tend to be some of our more expensive boxes where the discount was operating. I might just add one other area and that is rough smaller than half-a-carat in the better qualities whose polished went to Japan. And again because of declining demands from Japan we made discounts on those boxes as well.

I am a bit reluctant to answer the second part of your question. My colleagues and I have not yet decided whether we want to go public on the internal target that we have set ourselves to bring down our stockpile. It is subject to a great number of extraneous factors as I have suggested. And so for the moment we would rather keep that to ourselves. All that I can say is that we seem to have made a very important first step in what has happened in 1999.

John Barker (Royal Bank of Canada): Regarding Angola, I heard an unsubstantiated rumor in the market that Endiama possibly signed up an agreement for marketing with another party. Have you any comment on that? If there has been an agreement signed between Endiama and another party, what would that do to the dynamics of the Angolan diamond industry?

Ralfe: We indeed have not only the heard rumor, we now know that a Ministerial decree has been promulgated. It’s difficult for me to comment further than this, because we are still trying to investigate what the implications will be. It concerned both the marketing of Angolan diamonds and indeed the award of prospecting licenses. We continue to have three very important prospecting concessions in Angola, properly awarded, and in which De Beers has continued to prospect where it can provide the security of our people on the ground. But those are the two things that this new decree would seem to interfere with. I can only say that there are a number of important higher undertakings, both in contract and at law, with other parties and I am quite sure that those parties will not stand by idly and let anything be changed to their disadvantage.

Conclusion

I would like to conclude with a few comments about our strategic review, which has been a very important element of De Beers’ year. Indeed, as Nicky Oppenheimer and I have visited staff in London and Johannesburg, the two most prominent themes of this exciting year for De Beers has been first of all the very good sales and secondly the strategic review.

The strategic review has been part and parcel of the refocusing of De Beers, on its core activities. On De Beers redefining its identity as separate from Anglo American Corporation and in De Beers establishing a clear set of strategies that will help it enhance and grow shareholder value, which we realize is our first duty as a public company.

At the same time we believe that this is consistent with growing and enhancing the value of the other important stakeholders in our business, our own employees, our partner governments and indeed our clients and in due course their clients. We are now going ahead very much in the implementation stage of our strategic review. At our March press conference, I hope to be able to speak on this. But for the moment, as we conclude 1999, we can say that this strategic review has had a revitalizing impact throughout De Beers, and has been a very important factor in the integration of the disparate parts of the De Beers Group, mining here in southern Africa and marketing in London; and on exploration in many other parts of the globe. So it’s been a very exciting year for us.
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