/ 11 November 2011

Carats to Carrots: De Beers no longer jewel in crown

Carats To Carrots: De Beers No Longer Jewel In Crown

Why did the Oppenheimers end their 94-year hold on the world’s largest diamond miner to go farming in Africa? And why was Anglo American willing to pay its founder $5.1-billion for a further 40% control of De Beers?

The Oppenheimers’ main breadline, De Beers, has been under siege for the past 10 years, wallowing in debt. Its earnings have yo-yoed since 1990 as diamonds have become a more cyclical business in recent years.

In the financial crisis between 2007 and 2009, for example, when diamond prices were nose-diving, De Beers’s net debt position was almost constant at about $4-billion a year. It looked like there was no immediate respite: returning to the $1.35-billion net cash position it last enjoyed in 2000 seemed a tall order.

And the board of Anglo, which has 45% in De Beers until the deal is vetted by necessary regulators, felt that De Beers chairman Nicky Oppenheimer didn’t have the gravitas of his grandfather Ernest to pull the company out of its debt doldrums. Neither did they have faith in Nicky’s son, Jonathan, to steer De Beers to a brighter future.

Anglo was being used as a bank for the Oppenheimers, pumping large sums of money (covering almost half the debt, according to their loan positions in its financials) just to keep the asset liquid. Tony Trahar, the chief executive of Anglo in the early 2000s, negotiated loans at an interest rate premium to the banks. But shareholders were frustrated by this under-performing diamond asset. “Of all of Anglo’s holdings, this was a misfit,” said a former board member.

So, when Cynthia Carroll came into the hot seat in 2007, she was instructed to break this “sentimental mould”. Insiders said it “grated on the nerves” of Carroll and shareholders that they were constantly “bailing out” the Oppenheimers without having full control of the diamond asset.

In 2008 and 2009 Anglo’s net debt hit a high at above $11-billion and no dividends were declared. It improved in 2010 but at the end of June it was $6.8-billion. De Beers’ net debt, however, has reduced from $2.5-billion in 2010 to about $1.2-billion now. “Cynthia has wanted to take out Nicky for the past four years,” said Cadiz mining consultant Peter Major.

At the time, the financial crisis was in full swing and close associates of the Oppenheimer family told the Mail & Guardian this week that Nicky’s sister, Mary Slack, was putting pressure on him to sell.

‘Whittling down their shares’
The Oppenheimers have, over the years, slowly been whittling down their shares in Anglo. In 2006 they sold 1.13% of the company to billionaire Larry Yung’s China Vision Resources for about $803-million. Last year they sold a further $102-million of Anglo shares. The family still retains a stake of about 2% in Anglo.

“Nicky is 66 and he wasn’t having fun anymore being told what to do by Carroll. He couldn’t force the board to make Jonathan chairman because it felt he didn’t have enough clout,” said the family associate.

“But Nicky was also playing hardball because he knew he wouldn’t be able to negotiate a good price with Anglo. There was no way he was willing to sell the family jewels in 2008 and 2009 when diamond prices were so low. In June, prices were insane, at a peak, so he did his family well.”

Diamonds as a slice of Anglo’s earnings (before tax) were nearly 20% in 2003. But by 2009, the percentage fell to almost 0%. Rough diamond prices hit an all-time high in mid-2008, fell 30% to 40% in the next 12 months, but then rose 40% to 45% by June this year. Currently, average prices are down about 15% from the June peak.

“Profit margins are not as high as they used to be and the lows are lower than they used to be,” said Major. “Times are changing — you’ve got big competitors, like Russia, Canada, Australia, Angola and Botswana, wanting a bigger say in things and Anglo is losing out.”

So, it makes sense for the Oppenheimers to divest out of diamonds — at the top of the price cycle. Even Nicky admitted in a Moneyweb interview: “You’ve got to move on and now’s the time to look to the future and think what exciting things we can do in Africa in the future.”

But what’s exciting about this deal for Anglo?

Anglo is a diversified mining house across bulk, base and precious commodities, but with a focus on iron ore, coal, copper, nickel and platinum. So, buying control of De Beers — the other 15% is held by the Botswana government — appears to be a shift in strategy.

But analysts believe that if Anglo controls a production unit, diamonds could contribute about 12% to 13% of Anglo’s earnings.

“I don’t think Anglo overpaid,” said Major. “If it has control it can clean up its holdings and make sure it is the driver of the asset. It is called full access to cashflow. All it gets now, with the 45% stake, is the dividend yield, while De Beers and the

Botswana government rake in the full benefit. Anglo was not happy with the situation.”

Anglo’s strategic portfolio
Carroll has always insisted that diamonds fall within Anglo’s strategic portfolio of commodities. At the time of the announcement of the deal she told media that the diamond industry had strong long-term prospects, with rising demand from China and other Asian economies expected to outstrip scarce supply in the next 10 years. She said that almost every bride in Beijing was now buying diamonds.

Anglo spokesman James Wyatt-Tilbey echoed this: “Diamonds are core to our strategy and we’ve been keen to increase our holding for some time.”

Insiders say Carroll wants to rationalise all head-office costs, simplify the reporting structure, and make De Beers a leaner operation.

“The thinking in head office is that it was stuck with this asset anyway. So the plan is to build up the profitability, then list it in the medium term and exit at a premium.”

But Wyatt-Tilbey said Anglo had “no intention” of listing De Beers. “We’re focused on building the business, allowing it to capitalise on the benefits of being part of Anglo and helping it capture the full potential of the fast-evolving diamond market through its exceptional downstream business.”

De Beers profit margins hit a peak of 45% in the late 1970s and then drifted to a low of 14% in 1998. By 2000, it was back to 25% but fell to 4% in 2009. Margins are currently about 22%.

RBC Capital Markets puts the $5.1-billion price for De Beers at 30% below its valuation. It doesn’t see the deal as being a strain on Anglo, saying it has about $4.5-billion in cash and $3.5-billion in debt facilities.

Where to now for the Oppenheimers empire
A fourth generation of the De Beers dynasty, Jonathan Oppenheimer, saw the signs early: diamonds were leaving a debt hole in the family’s fortunes.

So, about four years ago, when diamond prices were starting to plunge at the onset of the financial crisis, Jonathan started sowing the seeds of the family’s next big ticket: an African venture rooted in agriculture and fast-moving consumer goods.

At the time, Anglo American, which owned 45% of De Beers, had rejected his father Nicky Oppenheimer’s suggestion that Jonathan replace him as chairman on the board of the United Kingdom-headquartered parent when he retired.

The family’s think-tank Brenthurst Foundation was already doing advocacy and policy development work on the African continent and it was probably through engagement with the different governments on how best to grow their economies that the foundation spotted that diamonds would eventually be a dead-end investment.

On this advice Jonathan set out to build his own empire, devoid of diamonds, using E Oppenheimer & Son Group, the family’s investment holdings arm, as the conduit.

“Given the fresh focus on making new investments in Africa, there are greater complementarities today between the foundation and the family’s continental business interests,” said Greg Mills, director of the foundation.

“Although there is a necessary executive separation between the activities of an applied-policy institution like Brenthurst, we share a common vision and aim: to enable growth, employment and entrepreneurship across the continent. This is especially true as the focus of the family shifts its investment bias from the diamond era to a new, more diversified yet still Africa-led one.”

The idea was to snap up substantial stakes in private companies on the African continent in which they would be actively involved on the boards and in strategy to extract best shareholder value in the long term. The sectors targeted were agriculture, consumer, media, healthcare and education, with a view to holding the assets for between five to 10 years.

“This strategy has nothing to do with De Beers. It was a strategy developed by Jonathan,” the managing director of E Oppenheimer & Son, James Teeger, told the M&G this week. “He felt the African continent presented a huge opportunity, especially as we already have a deep understanding and strong networks of business.”

Jonathan had two teams of about 10 people with consulting, accounting and investment banking backgrounds scout the continent for opportunities.

In 2006, the investment arm bagged its first substantive stake in a powdered milk company in Nigeria and in 2008 a palm oil and rubber company in Gabon, Ghana and Côte d’Ivoire, which it sold last year when palm-oil prices were extremely attractive.

But capital was an issue. “We want to commit huge amounts of capital on the continent. But we haven’t taken a big-bang approach, mostly because we didn’t have the capital to do that,” Teeger said.

At the height of the financial crisis there was already discussion among members of the Oppenheimer family about selling its remaining 40% stake to Anglo, so Jonathan and E Oppenheimer & Son needed to find a way to rev up its Africa ambitions.

In August this year, when diamond prices were at new peaks after the financial crisis and Nicky was looking to cash in the family’s diamond assets, Jonathan found a joint partner in Singapore government-backed investor Temasek to launch the $300-million Tana Africa Capital investment fund.

The fund plans to buy stakes of between 25% and 50% in companies, investing between $40-million and $50-million a deal. For now, Tana will scout for about five or six companies in the agriculture and consumer-goods markets, including listed companies and South African firms expanding into the rest of Africa. “We’re opportunistic for deals in the bigger economies, such as Nigeria, Egypt, Ghana and Kenya,” said Teeger. “If you look at the demographics of Africa, consumer goods and agriculture are the new diamonds.”

In the consumer sector, Tana Africa Capital will focus on companies well positioned to meet the consumption needs of Africa’s young, energetic and growing population. It will invest in the agricultural value chain from agricultural inputs to downstream opportunities in processing, storage and logistics. Given Africa’s growing population of more than one billion, Jonathan believes the investment will benefit from the fact that economies are growing with the emergence of a middle class with an increasing disposable income.

Although both parties initially invested equal amounts of cash, the Oppenheimer family will invest in Africa the bulk of the $5.1-billion it gets from the 40% sale of De Beers to Anglo. “This deal has happened too quickly in terms of an agreed grand plan. In the next few months we will focus on a new investment plan,” said Teeger.

A deal is already on the horizon in the next two months. “We are working on a specific transaction that we have been negotiating for the past three to four months,” said Teeger. “We’re a private company so you won’t see any public announcements about it. It’s the way the family likes to do business — quietly and discreetly.”

In South Africa, E Oppenheimer & Son has a Stockdale Street Capital fund which focuses on investing in medium-size companies in South Africa, except for resources and property. Nicky will not be involved in the new push.

“Jonathan will be driving this new focus. Nicky hopes that, from time to time, people will consult him. He is humble but he has sound investment advice,” said Teeger.