Giving Credit to De Beers

For as long as I can remember, the publication of the De Beers annual results has always represented an occasion for considerable pride and glory in which the chairman, flanked by the managing director, finance director and (not always) the DTC director, would face analysts and journalists in televised press conferences linking London, Johannesburg and Cape Town.

Questions were often hard and biting, but the good humored De Beers management generally made sincere attempts to give straight and as-complete-as-possible answers.

This is the first year in recent history that upon releasing the results De Beers relied on Anglo American Corporation to face the analysts’ music. De Beers itself only uploaded a video message in which its managing director, Gareth Penny, gave a passionate presentation of the “family of companies’” activities.

The corporate PR department sent out a minimal press release. Why minimal? Because it has not mentioned that shareholders have been tasked with coming up with a $0.5 billion loan for 2009 on top of last year’s $300 million loan. Nor did De Beers disclose the amounts and maturity dates of its credit facilities.

The press release did say, however, that the company has a $3.55 billion interest-bearing debt. Why stress “interest-bearing"” Because this debt does not include the now additional $800 million, which has a two-year interest-free grace period before market rates will be applied.

Last year’s DTC sales were $5.93 billion and, according to our estimates, they are likely to be only about $3 billion this year. Gross profits may come to 20 percent, before deduction of expenses and overhead. Net profits will be minimal. Will profits be sufficient to service the mounting debts? Can additional leveraging be avoided?

All in One Boat

I don’t know whether it’s scary or comforting to see that De Beers is facing the same struggles as many other diamond companies. It is scary because knowing that producers are financially stable and robust boosts confidence in the market. Though De Beers is not a “basket case,” we are not sure that DTC Managing Director Varda Shine would even consider accepting De Beers as a potential Sightholder based on its financials. Luckily, De Beers owns the goods. They were theirs to begin with.

As discussed in a detailed article in this week’s Diamond Intelligence Briefs (available to subscribers via IDEX Online), De Beers will need to renew maturing credit facilities. A $0.5 billion facility needs to be renewed in April 2009; a further $1.5 billion is due in March 2010; and a hefty $2.3 billion needs to be renewed in 2012 and beyond. In other words, in the next 12 months or so, De Beers needs to repay some $2 billion in debt or obtain extension in facilities. True, not all facilities have been fully drawn at this point. But there would have been no call on shareholders to bring money from home if De Beers didn’t intend to fully utilize its credit facilities.

This week’s temporary closing of all Debswana mines will not give De Beers much respite. The managing director of Debswana is now calling for revising the company’s cash flow and dividend policy. Debswana wants to “hoard” money at the corporate level to have a financial cushion for future contingencies rather than immediately turn the funds to the shareholders as dividend payments, as has been the time-honored practice. This is certainly an unexpected, additional blow to De Beers.

More Cash Injections Needed

Can De Beers raise funds in the present credit crunch based on its balance sheet and commercial prospects? How many more cash injections will be needed by the company in 2009? De Beers isn’t talking. Unquestionably, it was a major mistake to avoid questions at such a critical time.

The Anglo American finance director, René Médori, assured analysts that “as of today De Beers might not need further cash injection from all shareholders” and that “as of today, the three shareholders are confident that De Beers’ management will be able to go through this downturn without further cash injection.” The words “as of today” indicate skillful hedging. Tomorrow may be a different day. It will be. It must be.

Anyone following the financial press this week cannot help but be quite shocked by comments on De Beers. One South African journalist actually wonders what the market value of De Beers would be today; somehow implying that it would be merely a fraction of its current debt level. Of course, no valuation of any company (or bank for that matter) is realistic today, therefore, not too much importance should be given to this kind of speculation. Unless, of course, some shareholders of De Beers are in the market for either buying or selling shares, and yes, we believe they are. The chances that shareholding in De Beers and in Debswana will be different a year from now are greater than the chances that they will stay the same.

The shareholding may be related to further constraints such as the debts of either the De Beers mother company, DB Investments, and those of the Oppenheimer family company, Central Holdings, which were incurred to finance the privatization of De Beers in 2001. These are, of course, a private matter – but they shouldn’t be ignored.

Selling of Inventory

It is clear that the financial pressures are impacting many, if not all, of De Beers’ present actions. In addition to making 25 percent of the De Beers London employees redundant by April 1, 2009 and the retrenchments on the mining and sorting levels, the DTC will now be “supporting the reduction in inventory levels in the first half of 2009.” In plain English, this means selling off those goods that Sightholders are not taking. We haven’t seen any evidence yet of goods being sold to non-Sightholders, which is something that De Beers would not be able to do without permission from the European Commission. However, clients are now encouraged to make offers on additional parcels outside their regular allocations. De Beers wants to sell rough but not at any price. The industry still expects further rough price reductions.

The DTC sales director, Mahiar Borhanjoo, however, seems to expect decreases in polished prices as well. He told clients at a presentation during the Sight that polished prices may fall further. In the U.S., he says, diamond jewelry sales were down seven percent in 2008, and they will decline an additional eight percent in 2009. The decline of the U.S. market in the last quarter of 2008 was 22 percent, reaching a plateau that will remain throughout 2009. (The detailed global market situation (2008 pipeline) will be published shortly on our website.) The above mentioned figures are mainly noted in the context of De Beers’ prospects of 2009.

Will De Beers find the funds to sustain its pared-down operations? South African journalist Jim Jones reminds us of how the fortunes of De Beers have turned. “In the ‘good old days,’ Anglo and De Beers – run by an Oppenheimer patriarch – would call in the group’s bankers, tell them what was needed and the terms. Today, the bankers are calling the shots, and the squeeze is on…”

Now De Beers is in the same boat as its clients in trying to convince bankers that our business is worthy of their credit. Welcome to the club.

Have a nice weekend.