“Anglo American is not in discussion with the Oppenheimer family concerning the sale of its 45% stake in De Beers and has no intention of selling this interest. De Beers is highly profitable and cash generative and remains an important part of Anglo American's strategic business portfolio. We regard your article as speculative and incorrect,” says Anglo-American CEO Tony Trahar.

 

Trahar is right on two counts. He is not now negotiating a sale of the De Beers stake. Trahar doesn’t have to know – as we do - that some people at Central Holdings Limited, the Oppenheimer family company effectively holding slightly more than 40 percent of De Beers, is burning the midnight oil to prepare a divorce proposal to separate De Beers from Anglo. And, yes, this present opinion piece is speculative. As De Beers CEO Gary Ralfe pointedly advises: “Chaim, please, stress that this is all speculative opinion and not fact.” Gary – I just did.

 

Trahar wants the cash. It is hard to picture him easily as a “willing seller” but, by the time the Oppenheimers present a proposal to the board, it may have already secured a board majority. The Oppenheimer Family is presently spearheading a major structural change in the worldwide diamond business, taking quite a risk in trying to transform a supply controlled business into a demand driven one. In a truly competitive diamond industry, there will be more price volatility and producer margins may come under pressure. Going back to imposing production quotas, to the maintenance of buffer stocks, or to the artificial management of supply-demand inbalance, are not options anymore.

 

Monopoly structures don’t need entrepreneurial spirits; they need discipline among members. De Beers is dramatically changing its corporate culture, implementing its “demand driven orientation” strategy that was adopted in 1999. Crucial elements of that strategy, such as Supplier of Choice (which is an instrument to add value to De Beers diamonds), exploitation of the De Beers name recognition and brand value (through the LVMH joint retail jewelry venture) and an almost obsessive commitment to organizational efficiency, have all been amazingly successful. Gary Ralfe has reduced working stocks to merely one sight cycle; virtually all of the rough diamonds the DTC will sell in April are still in the ground. Cost-benefit and risks analyses are now associated with each decision, each step. Retrenchment is the “buzz word” around the company, with the next wave expected at the DTC in London in the middle of the year. As far as internal reorganization is concerned, the mission has been accomplished. Now Oppenheimer needs to address the external world – and Anglo American.

 

From Rainbow to Flare

Starting at home with the company’s South African assets, Nicky Oppenheimer’s vision for the De Beers Consolidated Mines (internally called Project Rainbow) is clear. Rainbow is far more than just black economic empowerment (BEE). It is almost like building a “new” company that is fully compliant with the new mining legislation, BEE charter and scorecard. The company has made great progress in identifying the precise nature of the new DBCM’s assets, its organizational structure and its corporate strategy. And, on this point, there is an overlap with another project (code named Project Flare). Flare refers to the development of the De Beers strategic and financial goals for the 2005-2010 period. 

 

To develop Flare, Nicky Oppenheimer (NFO) needs to know what its largest shareholder, Anglo American, has in mind for De Beers. In this context, NFO started the ball rolling last month by sending a formal communication to the chairman of Anglo American, Sir Mark Moody Stuart, querying in a general way what the company’s strategies are overall and, given the fact that De Beers has become a significant contributor to Anglo’s profits, what its thoughts are about De Beers. NFO also raised thoughts about Anglo’s role in South Africa (as NFO is also a major shareholder in Anglo) and made a reference to unbundling, even though the actual word used was, reportedly, “restructuring”. [NFO says: “I have not written to the Chairman of Anglo querying what Anglo’s intentions are in regard to their stake in De Beers.” NFO is technically correct; his letter involved general issues of Anglo strategy, including De Beers, which significantly contributes to Anglo’s earnings.]

 

Indeed, there are serious strategic issues involved. Does Anglo want to run the diamond business for cash, aim at high short term return on equity, as the mining giant comes under increasing pressure to increase dividend yields. [The London Independent wrote last week that Anglo’s shareholders are missing out, that a forecast dividend yield of less than 2.5% is no compensation, and that the shares are to be avoided.]  Or is Anglo willing to sacrifice short-term earnings and consider an accelerated long-term growth for De Beers, which will require considerable investments in the creation of growth in demand? It may also involve significant changes in the arrangements among the producers. Does Anglo favor one of the Flare options, the pursuit of adjacent (downstream or sideways) business opportunities. De Beers is expecting its clients to go downstream (i.e. move away from core business) and, ultimately, may follow suit itself. The solving of anti-trust constraints will open up new business skies. The spectrum of options open to De Beers is huge. It is clear that unless there is a strategic fit between the long-term strategies of NFO (and Botswana) and Anglo American, the parties will be heading for divorce. Separation may also come if the right opportunity arises.

 

It is my understanding that the current direction is towards divorce. I would even be willing to predict that the divorce will be accomplished within a year. Like any marriage, a situation that is obvious to anyone close to the families may not be admitted by the parties publicly, they may not fully realize it – or they may even be in denial. (NFO says: “I am not currently negotiating the purchase of the 45% stake.” No, he currently is not. He – or his lieutenants – are preparing proposals.) Why is the divorce “inevitable” and how will Nicky Oppenheimer – who will be the initiator of the divorce – go about securing the consent of Trahar and the Anglo board?

 

Why Divorce is Inevitable

The urgency is caused by the black economic empowerment of De Beers Consolidate Mines. As the family presently controls approximately 40 percent of De Beers, after implementation of black economic empowerment, the family share might be diluted to just some 30 percent in the South African mining part of the group. That is clearly not an option to the Oppenheimer Family. Years ago, when the late Harry Oppenheimer was asked if he had a preference between gold and diamonds, he replied: “Yes, diamonds every time. I think people buy diamonds out of vanity and they buy gold because they are too stupid to think of any other monetary system which will work – and I think vanity is probably a more attractive motive than stupidity.” The monetary system may have changed since, but, at the 2001 De Beers privatization, the Family clearly chose diamonds. The Family wants to be in charge of diamonds – and certainly at home, in South Africa.

 

When De Beers privatized, “management control” was a major issue. Central Holding Ltd (CHL) secured an arrangement, which would make it impossible for Anglo to sell its 45 percent stake to any other party - as NFO holds a “poison pill”. CHL has a management contract which assures it of a $5 million annual fee and a performance bonus of up to $10 million annually. But, more significantly, CHL is solely responsible for the appointment of senior executives and directors of De Beers. This contract is in force for at least the 2001-2007 period. We are now mid-way. After the seventh anniversary of the contract, Anglo (after consultation with Debswana) has the right to have the contract terminated, following a 12 month notice period. So, in any scenario (provided Nicky holds at least 25 percent of the DBI shares), the Oppenheimer family will continue to manage De Beers well into 2008. No other mining company would, in such instances, ever consider making a multi-billion offer for the Anglo stake. But the clock is running. The closer Anglo gets to the ‘notice period’, the greater the chances are that a third party would be willing compete for the stake.

 

The clock is also running from a BEE perspective. It is logical that Oppenheimer seeks to optimize the value of the new DBCM prior to a BEE transaction. If the family acquires the additional 45 percent stake, the arithmetic on BEE would also be significantly different. Though Trahar’s words are duly (and respectfully) noted, insiders believe that if the issue was only finding the right price for the 45 percent share package, the deal might already have been concluded. However, as with anything involving De Beers and Anglo, matters are never that simple.

 

Coalescence between Government and NFO Objectives

There appears to be a growing governmental frustration with the pace of black economic empowerment at Anglo American. Rightly or wrongly, De Beers is perceived in the market to be making greater progress. However, government frustration is compounded by a far greater concern: Anglo American has become too dominant in the South African economy. It was intimated to us by various sources that the government would like to see Anglo American unbundle, though in a manner that will not transfer the control of assets out of South Africa nor in a way that would negatively impact foreign investors’ faith in the investment climate of the country.

 

It has been suggested to us that CHL reached an understanding with the government. Nicky Oppenheimer, after his Brenthurst Initiative, has become exceedingly sensitive and responsive to the political and economic needs of his country. He undertook to use his influence in Anglo American to get the unbundling done, while, at the same time, the government would positively view the Oppenheimer’s acquisition of the 45 percent stake. The Oppenheimer Family would once again totally control De Beers, with the Botswana government and BEE groups as minority shareholders.

 

Nicky Oppenheimer strongly denies any such suggestion. “I have had no discussions whatsoever with the South African Government in regard to Anglo’s stake in De Beers, let alone reached any understanding and therefore (obviously) have made no undertaking to use influence to push for unbundling of Anglo’s South African assets.” NFO’s categorical statement leaves no room for misinterpretation.

 

Our sources are adamant that any transaction would require a comprehensive De Beers-Anglo-government understanding. Each of these parties has different objectives and also holds leverage. Other elements, such as the mining royalty on diamonds, can be brought into the equation. There is certainly a convergence of interests. NFO’s position is clear – and correct – for now.  

           

The Third Party: Botswana

From a diamond industry viewpoint, there is a further element: Botswana. It holds, through Debswana, 10 percent in DBI and 11 percent in Central Investments DBI (which holds the CHL 45 percent stake in DBI). It would be a major error to take Botswana “for granted.” That message came through just a few months ago. Quite unexpectedly – and without prior consultation with De Beers – the government of Botswana initiated a strategic review of its diamond industry options. It is exploring whether there is scope for downstream added value creation and/or whether it would be more advantageous for Botswana to market its rough diamond output independently. The review is conducted by L.E.K. Consulting LLP, the London headquartered global consulting firm that has pioneered the shareholder value approach to business planning and performance improvement. Botswana’s Finance Minister noted the Strategic Review in his Budget Speech. Interestingly, L.E.K. is driven on the principle that cash flow drives value and, from that perspective, it advises on corporate and business unit strategies, allocation of capital, and performance measurement and rewards.

 

Though L.E.K.’s consultants are apparently drawing, at least initially, much of their information and “diamond learning” from 17 Charterhouse Street, there is no certainty that their findings will necessarily represent a strategic fit with the best interests of the Oppenheimer Family. A purchase of the Anglo share would elevate Nicky’s control over De Beers to 85 percent - which puts the Family in a more comfortable position if L.E.K.’s recommendations to the Botswana government are irreconcilable with CHL’s objectives. In any event, NFO would never risk a confrontation with Botswana and, as noted below, will most likely make Debswana as independent as DBCM.  

 

De Beers will Restructure

With or without the additional 45 percent, De Beers is moving firmly into the direction of a new business model. In this model there will be four, or maybe five, independent and truly competitive diamond companies. De Beers Consolidated Mines in South Africa, headed by Jonathan Oppenheimer; Debswana headed by Louis Nchindo; Namdeb headed by Inge Zaamwani and the London-based Diamond Trading Company, headed by Gareth Penny. Gary Ralfe will remain the CEO of a Luxembourg-based holding, which will allow each daughter company to optimize revenues and develop as envisioned by the respective managements.

 

In order to make each company truly competitive and in order to secure that each company collects, in an undiluted manner, all the profits it has generated, these companies are likely to continue to market their output through the DTC only if this option provides higher revenue prospects than alternative channels. Thus, and this is speculation, the independent companies would have the choice not to market through London.

 

If arm’s length sales were guaranteed by each company, this would, overnight, solve virtually all of De Beers’ worldwide anti-trust problems. It would also eliminate much of the traditional mistrust between the South African government and the company on export valuations. Eliminating the transfer-pricing element, the government would be more receptive to profit-based taxation rather than royalties on turnover. When Snap Lake and Victor in Canada come on stream, there is further room for an independent De Beers Canada company, headed by John Hughes. 

 

In this business model, Gareth Penny would have the most difficult job since he would have to simultaneously convince both sightholders and other De Beers mining companies that marketing through the DTC is a win-win situation for everyone. The groups have unequalled mining expertise. Penny would be continuously stepping into uncharted waters. The unthinkable may happen: the DTC may be forced to grant its customers credit, to mention one probable change. Much will depend on the added services which the DTC will give its stakeholders. There is still considerable uncertainty out there. The European Commission will still formally have to rule on the Alrosa contract; the DTC’s Russian purchases have been declining and Alrosa makes no secret of its courting of other marketing suitors. We still have to see what L.E.K. will suggest to the Botswana government – and Namibia will inevitably want the same, or more. 

 

One final question. CHL acquiring De Beers? Where does the money come from? NFO and CHL and its manager Clifford Elphick are wizards when it comes to generating funds – or settling debts. There are several options. We would conjecture that if the Oppenheimers fully control three or four of the world’s leading diamond mining companies, there is ample room for each of these companies to go public again, with the Oppenheimers remaining in full control. Anyone who thinks that the family made the deal of a lifetime at the De Beers privatization in 2001 will soon conclude that “the best is yet to come”.  Nicky will never cease to amaze – nor to surprise.