Harry Winston Diamond Corp. (HW)’s $1 billion sale of a luxury unit to Swatch Group AG (UHR) provides the cash to invest more in diamond mining, a business that last year was more than twice as profitable as jewelry.
Chairman and Chief Executive Officer Robert Gannicott said yesterday the Toronto-based company is interested in buying the 60 percent stake of the Diavik mine it doesn’t already own from Rio Tinto Group.
“The margins you can generate at the mining level are better than they’ve been achieving at the retail level,” said Edward Sterck, a London-based analyst at BMO Capital Markets. As minority shareholders in Diavik in northern Canada, “they have quite good visibility of the outlook and I guess that they view it as being something that potentially would be more profitable in the near to midterm.”
The sale of the luxury unit could make the company more attractive to investors looking for exposure to diamond mining, said Des Kilalea, an analyst at RBC Capital Markets in London.
“If you were a mining investor who was a bit irritated with the confusion of the luxury brand, this is something that would suit you,” Kilalea said yesterday by phone. “Suddenly you have a Canadian-focused diamond producer, and you don’t have a focused diamond producer at all in Canada at the moment.”
Harry Winston has been looking to expand its diamond assets after BHP Billiton Ltd. (BHP) and Rio Tinto, the world’s two biggest mining companies, announced they would consider getting out of the industry. Harry Winston agreed in November to buy BHP’s 80 percent stake in the Ekati mine in northern Canada as well as its global sales and sorting operations.
Buying Ekati would boost Harry Winston’s production to make it the fourth-biggest diamond miner by sales in 2013, up from seventh place, according to BMO forecasts. The company may rise to third place, behind industry leaders De Beers and OAO Alrosa, if it bought Rio Tinto’s Diavik stake, Sterck said.
Harry Winston rose 4.4 percent yesterday in Toronto, the most since November, after the deal was announced. The shares increased 0.6 percent to close today at C$14.99, bringing their gain in the past 12 months to 39 percent.
The company reported sales of $290.1 million and operating profit of $48.7 million for its mining unit in the fiscal year ended Jan. 31, compared with $411.9 million and $19.4 million for the jewelry business.
Harry Winston will sell its luxury retail unit to Swatch for $750 million and as much as $250 million in assumed debt, it said yesterday in a statement. The company, which renamed itself from Aber Diamond Corp. in 2007 after acquiring the luxury jewelry brand a year earlier, said it will be known as Dominion Diamond Corp. when the Swatch transaction closes.
The sale will enable it to complete the Ekati acquisition “debt free,” Gannicott, 65, said yesterday in a phone interview.
“It gives us headroom in our credit facility to do another transaction as well, so we are certainly going to be looking for other things to do,” Gannicott said. Rio’s stake in Diavik is “an obvious one for us to look at as long as the price is right.”
Rio said in March it would consider options for its diamond assets, which include its Diavik stake, the Argyle mine in Australia and 78 percent of Murowa in Zimbabwe, because the mines no longer fit its strategy. Harry Winston, which has a right of first refusal on Rio’s stake in Diavik, is less interested in the company’s Australian and African assets, Gannicott said.
“We are more focused in the part of the world that we know best, which is northern Canada,” he said.
Harry Winston reported today that the Diavik mine plan under review for calendar 2013 forecasts production of about 6 million carats, which compares with 7.2 million last year.
Yesterday’s announcement probably makes Harry Winston a frontrunner to buy Rio’s stake in Diavik, said BMO’s Sterck.
It’s difficult to see who the other buyers would be, given that De Beers, a unit of London-based Anglo American Plc (AAL), “has got quite a few different pots on the boil at the moment,” while Mirny, Siberia-based Alrosa is probably more focused on investing in Russian assets, he said.
“It kind of ends up being Harry Winston or perhaps a surprise third party,” Sterck said.
Alrosa isn’t interested in buying Rio Tinto’s diamond assets, said Jane Kozenko, a spokeswoman for Russia’s diamond mining monopoly. Alrosa has studied Rio and BHP’s diamond assets and “found them not interesting” as the mines are near the end of their lives and extensions will be expensive and technically complicated, Kozenko said.
A London-based spokesman for Rio Tinto declined to comment yesterday on Gannicott’s statements. David Prager, a De Beers spokesman, declined to comment today on whether the company would consider new acquisitions in Canada.
Harry Winston’s renewed focus on mining may position it as an alternative to De Beers for diamond explorers seeking partners, said John Kaiser, owner of Kaiser Research Online, a Moraga, California-based mining information service.
Mountain Province Diamonds Inc. (MPV)’s 49 percent stake in the Gahcho Kue diamond project in Canada’s Northwest Territories may be of interest to Harry Winston, Kaiser said. De Beers operates the mining development.
“Harry Winston will now be under pressure to replace its depleting diamond resource,” Kaiser said yesterday by telephone. “It can no longer just rely on, well, ’when we run out of diamonds we can still be Harry Winston the jewelry retailer.’”
Mountain Province will evaluate any proposals from third parties “on their merit” and decide whether they are in the interest of shareholders, Patrick Evans, CEO of the Toronto- based company, said by phone today.
“If Harry Winston or, as it’s going to be called, Dominion Diamonds, decides once it’s closed its transaction with Swatch that it does want to make a proposal to us, we would be happy to consider it once the value of our asset has been fully defined, which we expect will be in the course of the next six months,” he said.
Harry Winston is prepared to look at other acquisition opportunities, Gannicott said.
“There’s nothing else that is actually looking for a buyer at the moment,” he said yesterday. “But we’d always be interested in other things where we have got the relevant skill set.”
Rough diamond prices fell 16 percent last year after three consecutive annual gains, according to an index from data provider PolishedPrices.com, as purchases were delayed because of high inventory levels and a lack of available credit.
Prices are still “relatively elevated” on a historical basis and will probably rise over the rest of the decade, Sterck said.
While demand for diamonds in Europe remains “a little bit shaky,” key markets including the U.S. and Japan remain stable and consumption is rising in emerging markets, especially China and India, Sterck said.
The sale of Harry Winston’s jewelry unit makes sense given that the company got a “pretty good price,” RBC’s Kilalea said.
“You’ve got two so totally discrete investment universes that it was hard always to see the correct value coming through in the share,” Kilalea said. “Ultimately a split in the company I think was inevitable.”
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