Harry Winston Sees Diamond M&A as Prices Fall

Harry Winston Diamond Corp. (HW), the only gem producer and jewelry retailer in Canada, is seeking more mining assets including Rio Tinto Group’s share of a joint venture as two of the world’s largest miners consider quitting diamonds.
Rio and BHP Billiton Ltd. (BHP) are weighing a sale of their respective diamond interests as commodity prices decline and the companies turn their attention to investing in other materials such as iron ore and copper. That may offer an opportunity for Toronto-based Harry Winston to boost production ahead of what Chairman and Chief Executive Officer Bob Gannicott sees as a looming shortage.

 

Harry Winston Diamond Corp. Chief Executive Officer Bob Gannicott said in an interview, “There are opportunities on the mining side where there haven’t been reasonable opportunities in my view for the last 15 years or so.” Photographer: Norm Betts/Bloomberg

“There are opportunities on the mining side where there haven’t been reasonable opportunities in my view for the last 15 years or so,” Gannicott said in a June 13 telephone interview from London.
Prices for rough diamonds on average have declined about 15 percent this year, according to Gannicott, 65. Demand for higher-value stones has weakened as polishers who use European banks find it more difficult to obtain credit, he said. While the outlook for the rest of year is “pretty chaotic” as Europe is gripped by economic turmoil, demand will outpace supply in the longer term, Gannicott said.
“I think that when things do start to improve it’s actually likely to look a lot better perhaps faster than people might be expecting now,” he said. “The beginnings of this recession, if you like, are a long time behind us now.”

Strategic Review

Harry Winston slipped 0.1 percent to C$12.29 at the close in Toronto. The shares have gained 13 percent this year compared with the 3 percent decline in the S&P/TSX Composite Index. That was also the biggest gain among six Canadian diamond companies with a market value of $50 million or more, according to data compiled by Bloomberg.
Harry Winston posted net income of $11.6 million on sales of $192.5 million in the quarter through April 30. Profit excluding one-time items has missed analysts’ estimates four of the last five quarters, according to data compiled by Bloomberg.
De Beers, 45 percent-owned by London-based Anglo American Plc (AAL), is the largest diamond producer, with output of 31.3 million carats in 2011. Harry Winston’s share of production at Diavik, its only source of rough gems, was 2.7 million carats last year.
Rio, the world’s third-largest mining company, said in March that as part of a strategic review it’s weighing a sale of diamond mines including the Diavik mine in Canada’s Northwest Territory.

BHP Bids

Harry Winston, which owns 40 percent of Diavik, has the right of first refusal on Rio’s 60 percent stake and would “be interested in putting that to work,” Gannicott said. Illtud Harri, a spokesman for London-based Rio, declined to comment.
BHP, the world’s biggest miner, has sought bids for its diamond assets including the Ekati mine, which is also in the Northwest Territories. Harry Winston and groups led by private- equity firms KKR & Co. and Apollo Global Management LLC (APO) were in talks to buy Ekati, two people with knowledge of the matter said in March. Gannicott declined to comment on Ekati.
BHP and Rio together accounted for about 16 percent of global production by value in 2010.
“They tried to build a critical mass in the diamond space,” Edward Sterck, an analyst at BMO Capital Markets, said in a phone interview from London. “Rio’s been more successful than BHP, but they just haven’t been able to gain the market share that they have in other commodities.”

Merger Opportunities

Exploration companies searching for deposits and developers of existing diamond projects find it difficult to raise funds as investors stay away from risky investments, Gannicott said.
Shares of junior diamond stocks are lower than they have been for some time, which could create potential merger and acquisition opportunities in the sector, Sterck said.
“Uncertainty around Europe does seem to be weighing on sentiment in the diamond space and we’ll probably see prices remain at current levels throughout the rest of 2012,” he said.
In the longer term, a lack of new supply and strong demand growth for diamonds, particularly from developing markets including India and China, mean that the outlook is “extremely positive,” Sterck said. Diamond production probably peaked in 2006 at 162 million carats, he said in a report dated June 7.
“There’s simply been no significant discovery since the early 90s really, and that’s despite an awful lot of effort going into exploration,” Sterck said in the interview.

Retail Unit

Like De Beers, Harry Winston is a consumer brand as well as a miner. The Canadian company sells luxury jewelry and watches through a separate retail unit, which operates stores from Paris to Dubai.
Gannicott, a geologist, was appointed CEO of Canada’s Aber Resources Ltd. in 1999 and renamed the company in 2007 after acquiring the Harry Winston jewelry brand. While the mining and retail operations run as separate units, the involvement on both sides of the business means Harry Winston has insight into pricing and market conditions for both rough and polished gems, Gannicott said.
Retail demand for polished-diamond products remains “generally very good” although Italy, an important European market for diamonds, has contracted, Gannicott said.
“The Italian economy is really feeling the pain and so there isn’t really much domestic consumption of diamond products in Italy at the moment,” he said. “Although it’s not one of the bigger ones in the world it’s certainly the biggest consumer in Europe,” he said.

Bank Loans

The difficulties diamond polishers face in obtaining loans mirrors the situation during the financial crisis in 2008 and 2009, according to Oliver Chen, a New York-based Citigroup Inc. analyst, said in a telephone interview. The situation is probably more temporary though, especially as demand for diamond jewelry has held up relatively well, he said.
Polished-diamond prices declined 13 percent in 2008 and 2009, according to an index from data provider PolishedPrices.com. Lack of credit is delaying purchases by polishers, Gannicott said.
“That’s thrown them into a fair bit of chaos so they’re really trying to minimize the amount that they are taking through their system while they sell their stock,” he said.