Botswana’s 15% Stake in De Beers: To Sell or Not to Sell is Not the Question – The Timing Is!

The Botswana government is repeatedly asked whether it will sell its 15 percent shareholding stake in De Beers. Anyone closely following the governmental strategies towards diamond mining and diversification will come to the inevitable conclusion that Botswana will sell – and probably sooner rather than later. Selling its stake in De Beers is, for many reasons, in the best interest of Botswana. Selling “early” (before someone else will puts its stake on the market) may give it a market premium as its small stake would enable either the Oppenheimer's or Anglo American to gain absolute majority control. Control over De Beers, however, is also a function of the duration, expiration, or expansion of the management contract presently in the hands of Nicky Oppenheimer. It is that contract that sets the “time window” for an attractive deal; however, there are also many other factors that may beg for an early sale of the shares.

            Anyone listening carefully to what Botswana is saying openly will also understand what it is not yet publicly admitting. The rather authoritative Mineweb reported this week that the Botswana government says on the one hand “it is not currently looking to sell its 15 percent stake in the world’s largest diamond miner,” but in the same breath it says “it has not unambiguously ruled out the future possibility.” The government asserts that “the reasons for having it [the De Beers shareholding] are still valid, so we shall probably hold it for some time,” says the country’s Minister of Minerals, Energy and Water Resources Charles Tibone.

            This sounds unconvincing, as he immediately adds, “the original reason to have a stake was to gain a board position in De Beers and insight into the diamond industry. At the time the diamond industry was known for its secretiveness and even though we were getting assurances that we were getting as much information as needed, you could not really prove that that was so, and just take comfort in that – so it was felt [useful] having a foothold in the boardrooms of the entity that was managing the diamond industry worldwide.”

            That is a remarkable comment and Dr. Tibone really calls a spade a spade: the government acquired its stake in De Beers to “find out” what is really happening; to get a better insight in the transfer pricing mechanisms between Debswana and the DTC in London, and many other issues. The purchase wasn’t inspired by trust – but rather by mistrust. It was more of an “expensive way” to get information than a true strategic investment.

            Tibone says, according to Mineweb, that these reasons are still valid today. That is surprising – but it may not even be relevant. There are compelling other reasons why Botswana should – and, we believe, will – sell its stake.

            In the past, when Debswana was the leading member of the cartel, it was vital to have a stake and say at De Beers to guarantee or underwrite the nation’s ability to pursue sound macroeconomic policies. Membership in the cartel’s marketing mechanism and the artificial management of the world’s diamond industry’s supply and demand situations guaranteed, for almost thirty years, a steady and reliable cash flow in support of the nation’s budget and development projects.

            When De Beers decided to abandon the illegal monopolistic policies to cease the maintenance of its buffer stocks to facilitate market interventions, and to pursue a policy of expediting the sale of current output through enhanced efficiencies in sorting from mine-to-market around 1999, Botswana’s policy makers may not have realized how dramatically this would affect the management of its domestic economy. It wasn’t felt immediately. Between 1999 and 2004, De Beers “dumped” over $5 billion of inventory into the markets – and Botswana benefited.

            Now the benefits of the cartel management have fallen away. From 1998-2006, the Botswana government saw (at least twice) rough diamond prices steeply fluctuating in a band of more than 30 percent in very short time-spans. These vacillations are reflected in a remark made in a budget speech by Botswana’s minister of finance expressing satisfaction that “a significant increase was realized in mineral revenue, which was mainly due to the cumulative 19 percent increase in diamond prices in US dollar terms during the 2005 financial year.” A planned deficit turned into surplus. That sounds good, but it isn’t the way to run a country.

            We believe it wasn’t fully realized that the breaking up of the cartel didn’t just mean that De Beers would now compete with Alrosa, Rio Tinto, BHP Billiton, and others. No, it also provided an opportunity for the individual members in the oligopolistic environment, such as Botswana, to decide whether to pursue the interests of the industry as a whole (which may give higher profitability to all or to a specific subgroup, such as De Beers), and thereby avoids what Harvard Business School strategist Michael Porter calls “inciting competitive reaction,” or to behave in its own narrow interest at the risk of touching retaliation and escalating industry competition to a battle.

            The choice is not easy: choosing strategies that avoid the risk of industry warfare (i.e. opting for maximum cooperation among the players in the oligopoly) may be better for the industry at large – but it may mean that Botswana would give up potential profits and market share.

            Debswana has made its choice. It will position itself in the best possible manner – and the establishment of the DTC Botswana and its own sales and marketing (branding) plans speak for themselves. As the world’s largest diamond producer, with the lowest cost mines, Botswana is at an enormous advantage: in any competitive “warfare” it would outlast any of its competitors – ands would always win.

            Overnight, Botswana has made Debswana the “dominant” player in the diamond business today. It also sets the policies – and, one must add, the policies of South Africa and Namibia only exacerbate the centrality of Debswana and Botswana itself.

            In the past few years the government of Botswana apparently made two distinct diamond related decisions: (a) on the economic front, they made diversification out of diamonds (and beneficiation) a top policy priority; (b) on the company front, they decided to pursue the best interest of Debswana, even if it conflicted with the best interests of De Beers.

            On both fronts, De Beers may not have fully realized or anticipated the far-reaching ramifications of this decision on De Beers, on its Supplier of Choice model, or on its relationship with the producer and its government.

            There had been some tell-tale signs. De Beers executives were quite shocked to learn that the Botswana government had secured the services of an international (value creating) consulting firm, L.E.K. Consultants, to review the diamond market and to advise the government on strategies vis-?-vis De Beers on the eve of the negotiations on the renewal of the Jwaneng mining lease and the renewal of (the always considered automatic) marketing agreement with the DTC. A highly professional multi-ministerial committee was established to conduct the negotiations.

            An even stronger alarm signal was given in 2004 when De Beers suggested to Debswana and/or the Botswana government to take an equity position in the Diamond Trading Company (DTC), which is a 100 percent subsidiary of De Beers. Botswana refused – it didn’t consider the best interests of the DTC to be either complementary to, or consistent with, the best interests of Botswana. On the contrary – they found it a too costly marketing system (costing around $200 million a year to operate) and it didn’t consider the Supplier of Choice mechanism to serve Botswana's best interests.

            Debswana is far more important to De Beers than De Beers is to Botswana. The centrality of Debswana in the total De Beers operations cannot be overstated – though the trend seems to be somewhat declining. Indeed, measured in carats, Botswana currently supplies 66 percent of the combined production of De Beers Consolidated Mines (DBCM), Debswana, and Namdeb. By value, Debswana contributes 70 percent of the total De Beers production. In 2000, 80 percent of revenue came from Debswana.

            Debswana is now going its own way. It wants to sort, sell, and market its own output. Through the DTC Botswana they have got what they wanted. A DTC Botswana may well contribute to the dissolution of the Supplier of Choice marketing strategy as we know it today – but that is of less concern to Debswana and the Botswana government than it is to De Beers and its other partners.

Botswana in Competition with Other Players

            Botswana quite cunningly understands that – in the post cartel environment – it will now compete with other players in the diamond industry, including competing with DBCM (South Africa) and Namdeb.

            The Botswana government now realizes more than ever that it has no choice – it must diversify its economy, to create a manufacturing sector (and culture) and it must use its diamond resources to reap the benefits from vertical downstream integration. It has no other raw materials that lend themselves for beneficiation. It may also need the proceeds of its stake in De Beers to finance further diversification projects.

            As Debswana will now pursue its own best interests, the need for the Botswana government to keep the shareholding in the mother company is largely falling away. Tibone himself went on record last week saying [in reference to holding on to the shares] “the dividend stream would be a deciding factor” and the “country would be more interested in the dividend income, if that dividend were more robust.” The current dividend income is not spectacular and certainly not something that it is not achievable in a normal, well-diversified portfolio. Recalling that the government sols a stake in Anglo American Corporation a few years back (involving around $170 million) to balance a budget deficit, Tibone said “when there is a need to sell, we do sell.”

            So at the end of the day it is clear: When stripped to basics, Botswana holds the De Beers stake mainly for dividends and sees the shares as “instant money” to sell, when the state budget needs the revenue.

The “Nicky Factor” – Seller or Buyer?

            So what is the best time to sell? Why do I think that Botswana will do it sooner rather than later? There is a Nicky factor. When I come to think of it, there is always a Nicky Oppenheimer factor. Oppenheimer runs De Beers by virtue of a management contract between the De Beers parent company, DBI, and Central Holdings Ltd.

            Before getting to the details of the arrangement, there is a more than reasonable likelihood that the seven year management contract, which expires in mid-2008, will not be renewed. Would Nicky Oppenheimer remain interested in De Beers if he had, indirectly, only 20 percent of Debswana, 20 percent of Namdeb and about 29 percent of DBCM? Especially after Debswana’s “independence” – selling and marketing its own output – would there be much excitement in chairing the holding company?

            There are a few scenarios: Oppenheimer may either want to increase his stake (and he may want to buy Botswana’s stake; or, once more, try to purchase the Anglo American part) or sell his 40 percent stake (most likely to Anglo American). There is no doubt that, at the moment, both Anglo American and Central Holdings (Nicky Oppenheimer) might be interested in the Botswana stake. It has a lot of strategic value now. If either one of the main shareholders sell to the other, the 15 percent Botswana stake becomes a kind of “lame duck” – who needs it?

            Botswana needs some careful simulation games and scenario planning. What is known about the management contract of Nicky Oppenheimer? First of all, the contract is between DBI and CHL – so, in theory, it isn’t just with Nicky, as is generally presumed. The contract has “regard to the unique understanding, knowledge, expertise and connections available to CHL in the diamond industry.” So, indeed, it isn’t just for Nicky Oppenheimer, it might apply to others, including Jonathan Oppenheimer – but has always been understood as meaning Nicky Oppenheimer.

             The contract was basically concluded for three purposes: (a) CHL obligates itself to contribute to the strategic development and growth of DBI; (b) CHL contributes to general marketing initiatives of De Beers and relationships with key customers and suppliers; and (c) CHL is responsible for the appointment of senior executives and directors of De Beers. The latter is key.

            In financial terms, CHL is entitled to a management fee of $5 million per year in respect of each of the years 2001 to 2007 (inclusive). Moreover, at the time of the De Beers privatization, CHL received participation certificates from DBI that entitles it to an annual incentive distribution, which is based on performance, of up to $10 million in each of the years 2001 to 2007 (inclusive).

            DBI has the right to terminate the management contract on 12 months’ written notice. However, such notice can only be given after the seventh anniversary of the completion of the privatization, which was completed in mid-2001. So notice can only be given at mid-2008, meaning that in any event Nicky Oppenheimer can still single-handedly manage De Beers until mid-2009.

            However, Anglo American has rights as well. Anglo American has the right to require DBI to give such termination notice (after mid-2008), subject to prior consultation with (not necessarily subject to prior approval of) Debswana.

            In other words: Anglo can terminate the management contract with CHL – and the expectations are that it will avail itself of that option. There is also a clause that would trigger the premature automatic cancellation of the contract: if CHL’s (the Oppenheimer’s’) shareholding dips below 25 percent of holding (ordinary) shares in DBI.

            If the Oppenheimer’s are truly determined to continue a vital (dominant) role in De Beers in the future, it would make sense for them to purchase the 15 percent stake of Botswana. This doesn’t guarantee that Anglo would continue the management contract; it would, however, pre-empt Anglo’s option to assume a controlling interest. Nicky Oppenheimer would manage by virtue of shareholding rather than contract. Conversely, to avoid such a situation, this may be precisely the reason why Anglo American would want to enlarge its stake.

            This sets the parameters of the “window of opportunity” in which Botswana could optimize its sales price and play two leading contenders out against each other.

            In any event, the current Botswana shareholding in De Beers has lost much of its strategic significance (in terms of Botswana finding out what is really happening in a secretive company) and, after 2008, when Sight aggregation is taking place in Botswana and Debswana has its own clients, it makes the mother company– how do I say this nicely – less relevant.

            Debswana and the government of Botswana are very much in charge now of their own destiny. When signing some of the new agreements in December 2005, Nicky Oppenheimer made some nice and polite words to the effect that “Botswana and De Beers are like Siamese twins, locked together, each benefiting from the other.” This may turn out to be much more wishful thinking than reflecting reality. Certainly, they are not even identical twins – they never were. And one of the twins is growing taller by the day.

            Have a nice weekend.