To be nice to De Beers, I politely put a question mark in the headline. However, my gut feeling says that it should have been an exclamation mark – maybe even a whole row of exclamation marks. Common sense would say that De Beers Diamond Jewellers should have closed down a long time ago.

De Beers Diamond Jewellers
In all fairness, two points must be noted at the outset: the current De Beers leadership has little input in the management of its joint venture with LVMH; with a few exceptions, current managers “inherited” the De Beers Diamond Jewellers (DBDJ) business, rather than creating it. The other point is that analysts have warned me not to give too much credence to the company’s official balance sheets and annual reports as there is much out there that we may not see. This may be wishful thinking, though it shouldn’t be completely ruled out.

From the beginning, the joint venture’s management, from a De Beers perspective, was outsourced. The European Commission (EC) Competition Authorities’ approval document clearly stated that “the joint venture is based on LVMH’s extensive experience in both developing luxury brands and rolling out premium retail concepts. It will become a key part of the LVMH luxury goods portfolio.” De Beers gives its name; LVMH gives its management skills. With the benefit of hindsight, it should have been the other way around.

Some of the stories insiders tell about the LVMH management are simply not printable. What we do know is that the 2013 figures show that the market share that the partners had said the company would deliver in 10 years is 87 percent below target. That figure should be enough to justify going back to the drawing board to analyze whether there is a 'system bug' in the implementation or whether the strategy was erroneous from the outset.

Performance Measured against Undisclosed Targets
It seems like longer, but it was only 13 years ago, on July 25, 2001 to be precise, that the EC gave the green light to the establishment of the jewelry retail joint venture between LVMH and De Beers when it found this “concentration to be compatible with the common market and the EEA Agreement.” This decision from the competition authorities closed what was then known as “Case No COMP/M.2333 — De Beers/LVMH.” The EC found that this downstream activity would be beneficial to the diamond market and would not harm competition. However, it didn’t address the question of whether the De Beers’ departure from its own name would not end up harming De Beers…

Let that be. In any case, DBDJ was created as the licensee of the De Beers trademark. At the end of 2013, the network numbered 45 stores: 16 in East Asia, 9 across the U.S., 7 in Europe, 9 in Japan, 1 in Canada and 3 in the Middle East. Focusing on the East, DBDJ strengthened its presence in continental China by opening a second store in Shanghai last year, following inaugural store launches in Shanghai, Beijing, Dalian and Tianjin during 2011 and 2012. DBDJ opened a third Hong Kong store in 2013 in Times Square. DBDJ continues to grow its franchise network opening stores in Vancouver, Baku and Malaysia. This year, it plans to open new stores in Ukraine and Canada.

Company management says that “the priority remains to maximize returns from existing stores and to closely manage inventories, costs and working capital levels, with the continued support from its shareholders. The company’s strategy remains to become the definitive diamond jewellery destination for both solitaires and image collections, while growing its credentials in High Jewellery.”

As we’ll point out below, the average annual sale of these 45 stores is $3.9 million per store, or $325,000 per month. Given some of the prime locations of these stores, one wonders if the profits on those goods would be enough to cover rent.

High in Praise; Low in Figures
The current management of De Beers talks in laudatory terms about the brand’s impressive growth, though they rarely – or I should say never – give hard data on the figures. In my mind, any operation that is obsessed with producing sales growth to try to deliver on its promise of capturing market share, and achieves this solely by consistently losing some 33-35 percent on turnover, cannot be considered a “commercially viable” operation. One might dismiss such views by reasoning that this is the “normal” price for developing a global brand. But I don’t buy that. In any case, the failure is the non-delivery of the targets set by the company itself.

This is a sore point because not much transparency exists regarding the targets. I have never seen an estimate about how much money the company is willing to lose and for how long. That may be part of the problem: the joint venture never clearly enunciated what its targets were – not even how much they planned to lose.

When the 2001 EC decision was published, it based all of its projections on the so-called “Project Rapids Business Plan,” dated December 15, 2000. Based on this and other presentations, the EC published a very specific document containing forecasts and expectations concluding that, “as a consequence of the joint venture’s market position, the De Beers brand will be established as a leading brand in branded diamond jewellery.” It also contained clauses detailing the number of stores envisioned to be established in each geographic region and by what dates.

These targets were never publicly announced. However, in 2001, when De Beers was privatized, concrete assumptions were presented to the De Beers (old and new) shareholders. According to the company valuation at the time of privatization, the brand value of the name “De Beers” justified assessing a “net present value range of the initial and preliminary estimates of the future cash flows of approximately $200 million to $500 million for De Beers’ 50 percent interest in the company.” Thus, the not yet operating company carried a value tag of between $400 million to $1 billion.

Target: $1 Billion Global Sales by 2013
In 2001, at the time of the De Beers privatization, De Beers went public with its 10-year expectations and forecasts. Those valuations were presented as part of the package that led Nicky Oppenheimer to buy 40 percent of De Beers, Anglo American 45 percent and the Botswana government 15 percent. (Since then Nicky has sold his parcel back to Anglo.) The investors were told that: “The total global retail market for diamond jewellery (i.e. jewellery pieces containing at least one diamond) is currently [2001] estimated at approximately $56 billion and is estimated to grow over the next 10 years at an average annual rate of 2.5 percent in real terms.”

“It will take the new company up to 10 years to achieve a share of 1.4 percent of the global retail market for diamond jewellery.”

These 10 years have now passed. Global diamond jewelry sales hover in the $73 billion ballpark. If everything had gone according to plan, DBDJ’s stores should have captured by 2013 at least 1.4 percent, or around $1.0 billion in annual diamond jewelry sales. However, in 2013, its best year yet, it just reached 17 percent of that target.

We have said it before and still believe it today: measured by the intentions, the business clearly didn’t perform to expectations. However, those who are willing to ignore what took place in the past and look at the venture today may actually believe that it is well placed to surge ahead. But is that the case?

Disappointing from the Outset
The projected operating results remained a secret – and they have remained a secret until this very day. However, in the early years, management didn’t hide its disappointment. Annual turnover in its first operational year, 2002, was less than $1 million, with sales only in the UK rising to a “disappointing” – to quote the then-De Beers Managing Director Gary Ralfe – $29 million in 2005. Sales peaked in 2008 to $126 million. Then the financial crisis of 2009 hit DBDJ, and global sales at its then-39 stores dipped to $93 million. However, it recovered quickly, and by 2010 it recorded sales of $134 million through a combination of 40 owned stores and franchises.

In 2011, its turnover reached $156 million from 44 sales outlets. Two years later, in 2013, its growth in terms of number of stores has slowed, as it clearly aims at generating sales: 45 stores selling almost $178 million worth of jewelry. Its costs of sales were $96 million, so its gross margin at 46 percent is close to industry average. But the bottom line – losing almost $61 million in 2013 – seems to continue its growing trend: losses grow consistently, slightly faster (16 percent in 2013) than the growth in turnover (14 percent in 2013). [While losses of 30 percent or more over a decade after starting might look good for e-commerce companies, it is difficult to digest for a bricks and mortar company.]

Is this what the “founding fathers” of this partnership set out to achieve? Insiders at the time intimated that there were non-financial motivations: De Beers believed the joint venture would be a “pace maker” inspiring other diamond companies to invest in brands and promote diamonds. After all, that was also the Supplier of Choice concept – to get the industry and trade to advertise. That might have been true at the time, but the “custodian” role was dropped many years ago. De Beers is in the game to make money – and this joint venture is only costing it more and more.

The annual reports of neither De Beers, Anglo American nor LVMH provide financial information on the DBDJ joint venture. As a 50/50 joint venture, neither side has a controlling interest, so they are exempt from disclosing vital statistics.

Still a Start-Up Company; Road to Break-Even
The reports by the company seem to imply that even in its 13th year of operation, its management still considers it as a “start-up” operation. Says the report: “having now set the foundations for success, the company now aims to reach break-even. [Emphasis added.] In order to achieve this, it will continue to deploy select store openings, relevant marketing and targeted customer promotion to build future growth. New stores will open in Ukraine and Canada in 2014. The priority remains to maximize returns from existing stores and to closely manage inventories, costs and working capital levels, with the continued support from its shareholders.”

No information is provided on how management perceives a course of correction to profitability. Having followed the annual results of the venture for well over a decade, I must say that this is the first time a reference is made to policies that will lead to break-even points. But, surely, breaking even cannot be the objective of any business. Moreover, the “break-even” objective is set at a time when the trend clearly still runs in the opposite direction.

Maybe, just maybe, it would have been better for De Beers if the EC had not approved the establishment of this venture. De Beers “lost” the benefit of its own De Beers name for its own (growing) downstream activities. But mostly, the management skills for this retail brand came from LVMH people, or at least that was the original intention. The deal never seemed to me like a good one for De Beers, but who am I to say?

There are different ways to analyze the figures. The mark-ups, the retail margins, remain fairly consistent at 46 percent, which seems quite normal. The problem seems to be that the company continues to close stores, open other ones, and doesn’t seem able to control its costs. The bottom line is that from its inception the joint venture sold $1.1 billion worth of diamond jewelry at an operating loss of almost $0.5 billion – which is losing 43 percent of one’s turnover.

Shareholders Pour in More Funds
In 2013, for example, shareholders invested an additional $97 million to pay back the BNP/PARIBAS loan and to finance the operations of the business. Remarkably, at the end of 2013, the DBDJ balance sheet shows no banking debts. Not even an overdraft. In a way, it is good that there is no banking debt, as such a venture might not warrant finance from even the most optimistic banker. So far, the total capital invested comes to $553.8 million; the accumulated deficit totals $424.3 million.

The company website reminds us that “the art of knowing diamonds, eternal and divine, based on 125 years of expertise. Discover our fusion of timelessly elegant designs with meticulous craftsmanship as we bring to life the diamond dream of eternally feminine jewellery.” The art of selling the jewelry in a profitable manner may remain an elusive dream for many years to come. The company hasn’t yet made the U-turn that is required to start that journey…

The Only Store for Diamonds Only
The research that was conducted before the launch of the DBDJ concept was a faulty comparison with stores like Tiffany & Co., Cartier, Bulgari and other well-known brands. It was ignored, however, that a large part of these brands’ profits came from colored stones rather than diamonds. De Beers has positioned itself as the ONLY jewelry retail brand that doesn’t offer a wider product mix. While other major jewelry brands are increasingly widening their product mix, De Beers has almost “religiously” forfeited not only major potential profit drivers, but also an added attraction for consumers to enter the stores. DIB is not aware whether the product mix is being reconsidered at this time.

Penchant for Unfortunate Location Choices
A few years ago, LVMH Chairman Bernard Arnault thought that DBDJ’s focus in the early years on the United States was a flawed strategy, and he urged the company to look toward the Far East. In 2008, a year in which the number of stores rose from 25 to 43, five additions were in the United States. In 2009, after many closings, 11 out of the 39 were in America. When opening stores, this normally necessitates signing long-term leases, considerable renovation and start-up expenses, which should pay off in the long run. Premature closings and getting out of lease agreements are enormously costly. New locations are always loudly announced; closures are generally done quietly. By our back-of-the envelope calculations there must have been at least a dozen closures, if not more. Among the greatest location mistake was the De Beers store at “the wrong side” of Rodeo Drive in Los Angeles. After just three years of operations, DBDJ was “rescued” when another LVMH brand (Louis Vuitton) was willing to take over the lease. The also very prestigious Place Vendome location in Paris was likewise passed on to Bulgari. Current management has a “going East” orientation. Today, there are only 9 locations left in the USA (Dallas was the latest to close) out of its 45 store global network.