Tempelsman to Shareholders: Rough Diamond Prices Unsustainable

Few corporate chief executives can write a letter to shareholders as well as Maurice Tempelsman, chairman of Lazare Kaplan.  While most senior executives laud platitudes about their business, Tempelsman always “calls it as he sees it.”  He is not afraid to criticize, challenge, or praise, but only if they are truly deserved. 

In his letter to shareholders in the company’s recently published annual report for the fiscal year ended May 2006, Tempelsman expounds on his view of the present and the future of the diamond industry.  We have excerpted key points from his letter.  The full version is available online at the Securities and Exchange Commission web site. 

“2006 was a challenging year for the company as well as for the industry as a whole.  The changes in the macroeconomic environment, brought about by the decision of the Federal Reserve Bank and other Central Bankers to gradually shift from a stimulative accommodating monetary policy and low interest rates to a more restrictive posture draining liquidity and raising interest rates, had its impact on discretionary spending by consumers, dampening their spending patterns and their willingness to incur further debt.  This resulted in more conservative buying and restocking by our jeweler customers, as well as industry-wide liquidity issues that require careful and prudent attention from the company’s management.

“In last year’s letter to shareholders, we pointed out that while the structural transformation of the diamond industry from its historic supply-driven anchor to an increasingly demand-driven business – including the elimination of the buffer stock regulator and the consequent increase in price volatility – was progressing well – in fact better than expected – the new dispensation taking its place had yet to be tested by a cyclical downturn and its consequences.  While the downturn the industry is now feeling was not entirely unexpected, as it is part and parcel of the normal business cycle, it is putting structural strains as well as cyclical strains on the industry.  Pressures previously masked by the benign macroeconomic environment of the last several years that is coming to an end are now becoming apparent.  So far, these structural strains primarily have manifested themselves in the downstream manufacturing and distribution segments of the pipeline.  For some time now, these segments have suffered from inadequate operating margins and excessive leverage. 

While this reality is painful to the companies operating in those segments, a dysfunctional pipeline will in time affect the other segments of the business.  Although the structural issues are more fundamental in nature, the immediate triggering events were a series of unjustified and excessive price increases by rough diamond producers driven by cyclical euphoria that could not be translated into higher prices for polished diamonds and an exceptionally accommodating lending policy by banks financing the industry pipeline.  As the present situation is unsustainable it is bound to self-correct or require important structural industry-wide adjustments?  [Bold added by editor]  All the company’s stakeholders, i.e. producing countries, mining companies, and banking institutes that finance the pipeline as well as the manufacturing segments have a vital stake in how and over what period of time the corrective measures play out. 

“The company expects that the SoC (Supplier of Choice) program will have to be recalibrated to reflect the industry-wide structural strains, including the changing relationships between the major producing countries of Botswana, Namibia and South Africa with the London based DTC, to reflect the more vigorous implementation by these producing countries of their policies on local beneficiation and employment, as well as their desire for greater input on how these depleting natural resources are developed and on the benefits that these countries derive from them.”

While others whisper in tight circles about these issues facing the diamond and jewelry industry, Tempelsman brings them to the forefront of the industry’s attention by prominently discussing them in his letter to shareholders.  Perhaps more in the industry should listen to his voice.