Watch the Alrosa Revolution

The diamond industry seems, at times, so obsessed and intoxicated with the strategic marketing system changes of De Beers, BHP Billiton and others, that somehow the world’s greatest revolutionary diamond play that is currently unfolding within Russia’s Alrosa is less noticed. Somehow, we never expect “real” change in Russia. We never expect it to impact our business directly.

The revolution started with the Kremlin, when President Vladimir Putin decided to put a totally trusted outsider – who knew nothing about diamonds – in charge of Alrosa. It has become clear that Putin in every way wants Kremlin (i.e. central government) control over the diamond mining sector, putting him at conflict with Yakutia – the independent republic in which 99% of the present mines are located.

Yakutia is protesting all the points contained in a secret protocol (of a January 26, 2005 meeting) in which the Federal Government reveals plans to dilute the ownership of the mines by Yakutia and for tightening federal controls over the company’s operation.

The new man who is expected to bring a distinct international orientation to the company is 47-year old Alexander Olegovich Nichiporuk, who “started” his Alrosa career less than a year ago as Vice President to Vladimir Kalitin. Though he is less than three months at Alrosa’s helm, he is unmistakably running – and changing – the business “his way”. Nichiporuk brought to the position a different style and quite a different substance. Moving away from a Yakutia focus, Nichiporuk is considering participation in additional projects in Angola, in Sierra Leone, in the Democratic Republic of Congo and other countries in Africa.

The man is soft-spoken, but exceedingly straightforward. There is no need to “interpret the meaning of his words” – what he says is what he thinks. Before coming to Alrosa he served as President of the Bank for Development of Entrepreneurship, which has exposed him to many different business models, business strategies and diverse commercial philosophies. This experience comes in addition to having earned a Ph.D in economics.

Nichiporuk thinks long term. It is not a coincidence that a company, that always worked in accordance to 5-year plans, is now designing a 10-year plan and is looking for long-term relationships. What are Nichiporuk’s priorities and how do they affect us? One can discern the following priorities: 

·            Nichiporuk wants to overhaul the current sales and marketing strategy and develop a new one. Though he has worked hard to get European Commission consent to an agreement of gradual reductions of rough sales to De Beers – and Nichiporuk considers the relationship with De Beers to remain always a part of the Alrosa business – the company is presently making alternative sales arrangements for the sale of rough diamonds both on the international and the domestic market and are considering additional strategies, including the establishment of sales outlets outside Russia. After selling diamonds (rough and polished) for $2.4 billion in 2004, Nichiporuk expects 2005 sales to reach $2.8 billion. Alrosa’s profits were in the range of $475 million last year and are slated to grow some 13% in domestic currency terms in 2005. In 2004, Nichiporuk now confirms, “Alrosa put its prices up around 25% as supposed to De Beers increasing in the range of 16%-17%.”

·            Don’t expect to see Nichiporuk at social events, conferences, etc. – he has no time for that. He and his colleagues are actively working on “establishing direct relationships with major diamond buyers and implementing arrangements for non-regular customers to buy diamonds from us on a tender or a non-tender basis,” to quote a formal Alrosa strategy paper. In recent meetings, Nichiporuk has expressed being greatly dissatisfied with many of the past marketing practices of Alrosa, especially the sales to local Russian factories, which, in his view, did not optimize the company’s revenues. He also hinted being distinctly interested in doing business with the world’s major mining conglomerates, widely seen as a reference to BHP Billiton and, maybe, also Rio Tinto.

·            Though some 52% of total sales were made to the local Russian market, the new Alrosa president has few good words about “near bankrupt factories” that continued to get rough supplies at preferential terms – believed to be a specific reference to operations in Yakutia, but not only there. While other mines endeavor not to maintain large stocks, Alrosa is increasing its inventory of high­ quality rough diamonds in order to improve the range and consistency of diamonds that it can offer to domestic and international retail customers, meeting such customers’ future demands, increasing sales efficiency and becoming less dependent on the quality of diamonds that it produces in a particular period. This will certainly make Alrosa a more attractive supplier in this most capital-intensive marketing niche.

·            However, we expect that Nichiporuk’s strongest emphasis will be on concentrating on his core business: the production of rough diamonds. At least three mines will move to underground production (including Udachny and Mir), while construction for mining improvements (including enhanced capacity of Zarnitska, Aikhal and international mines) are being expedited, calling for enormous investments and formidable technical know-how. The company's domestic diamond output is expected to exceed $2.18 billion in 2005, according to recent Nichiporuk remarks. However, one of Nichiporuk’s early achievements is getting multi-billion credit facilities from at least three international banks, including Chase Manhattan and Citibank. The financing secured is for mining development projects, not for working capital.

·            Nichiporuk is seen to be possessed by a drive to lower costs and enhance production efficiencies, which will reduce costs by reducing energy costs. Thus the company is now constructing hydroelectric power stations in both Yakutia and in Angola (to serve the Catoca mine).

One may expect a distinct international orientation. In addition to exploring for diamonds in regions of Russia outside Yakutia, such as in the Arkhangelsk region where Alrosa subsidiary Severalmaz operates, Nichiporuk intends to seek geographic diversification by participating in additional joint ventures in key diamond mining regions in other countries. Alrosa is currently focused on Angola, where the Catoca mine (owned 18% by the Lev Leviev Group) is entering into a second production phase which is expected to double its ore-processing capacity. Alrosa is also participating, with the Government of Angola, in the development of the Angolan Lou diamond deposit and other joint ventures.

Local Moscow reports this week highlighted Alrosa’s “preferential allocations of rough diamonds to favored diamond-buyers, discounts, un-repaid credits, unusual service fees, and offshore banking schemes [which] have all been exposed to federal inspection. If not for the first time, these schemes have been identified as multi-million dollar loss-makers, or worse.” Nothing new, we would say – but, for the first time, Alrosa seems to signal a determination to change things. What was is not what will be.

We do expect, however, that Nichiporuk will face considerable “opposition” (he would probably prefer the word “challenges”) and the fight with Yakutia will not be easy. Alrosa’s strategy documents stress that it wants to divest “social assets to improve focus on core business.” It is continuing to transfer to Yakutia and to local governments responsibility for the various social assets which it inherited from its predecessor entities, including residential houses, schools and hospitals. [Interestingly, De Beers has recently gone through a similar exercise.] The company wants to get out, or reduce, participation in business ventures which are ancillary to its core business – the diamond production operations.

There is a lot of market speculation on how the new rules on market liberalization will affect the company. Until now, as a closed-stock company, in which existing shareholders can only sell to each other, ownership changes were mostly a game of musical chairs within the controlling groups. This may change – and nobody knows where this change may lead to. It seems likely that the Kremlin will assume a much greater ownership stake and dilute Yakutia parties. It is not less likely that it may become an “open” stock company, in which outside parties may invest. That would provide very exciting opportunities to many diamond players.

We strongly believe that more news from Alrosa will come sooner, rather than later. And, for the diamond community, the changes seem to be for the better. I suggest that it may be worthwhile for any diamond player to watch this new man, Alexander Olegovich Nichiporuk, very closely. He is someone to do business with.

Have a nice weekend.