Botswana: Crisis Opens a Window of Opportunities
February 12, 09 by Chaim Even-Zohar
A few hours at the 2009 Mining Indaba conference in Cape Town was sufficient to hear enough De Beers-related gossip to keep any investigative journalist busy for months researching whether or not there is fire burning under all the smoke.
Here is just a taste of the rumor mill: word has it that a parcel of 10 percent of De Beers is “on the market;” that the Botswana government is contemplating an increase in ownership in the Debswana mining company from 50 percent to 80 percent; that Chairman Nicky Oppenheimer’s family company struggled to find $300 million to cover a debt maturation that the Dresdner Bank refused to roll-over; that De Beers wants Namibia’s Namdeb overdraft of N$650 million to be paid immediately in equal parts by the shareholders and that De Beers’ mother company, De Beers Investments, needs to roll-over debts in excess of $1.2 billion in March – and may have problems doing so.
These are examples of, what I would call, “the lighter chatter” I heard at the mining conference. The heavier chatter I also heard comprises whispers that De Beers might be in violation of its contractual arrangements with Botswana and that the British VAT and Tax Revenue authorities are having “issues” with De Beers. Don’t be overly alarmed – De Beers is really not singled out. What financial institutions said about Gem Diamonds’ Clifford Elphick is not even printable.
The 4,000 participants at Indaba, most of whom paid a $1,300 entrance fee just to be able to be there and to be seen, were generating mountains of verbiage. Rumor and hearsay among serious and well-connected industry players were surely the hottest commodities at Africa’s largest annual mining event. The active participation of 15 ministers of mining and minerals added an additional dimension to the information flow.
De Beers and Botswana
By far the most intriguing speculation I heard centers on the relationship between De Beers and the Botswana government. In the present global credit crunch, the Botswana government has something that has become very rare in the diamond pipeline: money and plenty of it (though its foreign reserves have taken a hit). What is good about Botswana’s privileged position is that its government is willing to use the accumulated diamond wealth to support the diamond business as a way to survive the crisis period relatively unscathed. It isn’t clear, however, how this will play out.
During a short visit to Gaborone this week, I learnt that the staff at DTC Botswana has agreed to take a 20 percent pay cut and shifted to a four-day workweek that finishes every day at 2.30 pm. The two football field-sized sorting rooms, created to sort well over 50 million carats a year, processed “only” 30 million carats in 2008. The DTC Botswana building is undoubtedly one of Africa’s most beautiful and impressive architectural landmarks, exuding transparency, openness, equality and immense pride in the diamond product. It is almost a piece of art with many decorative internal water pools and artwork with unique reflections of light anywhere one looks. The magnificent of the building doesn’t distract, however, from the gloom felt (and highlighted by local press) about the nation’s diamond future.
Two of the country’s mines are closed for the entire year and the unions are still negotiating the plight of the workers. This is an explosive subject, especially since it is an election year in Botswana. Diamonds are the nation’s single largest revenue source and export segment. Batswana will have their word at the voting booth. Their government is expected to act.
On the beneficiation side, out of the 16 diamond cutting plants, one has closed and another one has extended the summer vacation by another month. Almost all have retrenched workers. Many have opted for a shorter workweek. The government knows, as we all do, that the global financial crisis will be temporary but severe. Also, when the market sentiments shift for the better, mines will be the first to prosper again.
DTC Botswana Managing Director Brian MacDonald confirms that last year’s target of $360 million worth of rough sales to domestic industry has been met. The target for 2009 is $550 million. The contractually agreed beneficiation employment threshold is 3,300 workers; this must be met otherwise De Beers will have to pay a penalty. The agreement between De Beers and the government regarding beneficiation contains a force majeure clause in respect to unforeseen changes in the world economic conditions. Surely, the targets for 2009 will need to be renegotiated.
A Greater Stake in Debswana for Botswana?
Debswana has already decided to reduce output by some 25 percent in 2009, though that figure may have to be revised upwards through the year. Assuming a 20 percent-25 percent decline in rough diamond prices, Botswana potentially faces a revenue fall of 50 percent, i.e. $1.6-$1.7 billion, though it might be more. A little-publicized provision in the sales contract between Debswana and De Beers states that DTC International can “request” that Debswana retains in inventory such (categories of) diamonds for which there is a short-term reduction in demand.
Although there are presently no formal production quotas as were used in the cartel days, clearly De Beers continues to have the tools in place to have Debswana revert to the inventory stockpiling measures of the past. There is a difference, however. In any event, diamonds first need to be sorted and valued by DTC Botswana. But instead of being subsequently sold to DTC International, they go back to Debswana, which sounds awfully familiar. It also means the fall in revenues becomes quite unpredictable.
The reduction in diamond output has far-reaching ramifications. Botswana’s GDP will be negatively impacted and will push the nation into a recession, i.e. into negative growth. Analysts tend to look at an economy’s growth figures – the reason for reduced growth is less relevant. This decline in GDP may, in turn, result in a downgrading of Botswana’s sovereign credit ratings. This must come as a blow to the nation.
Clearly, in spite of the considerable retrenchments, cost-cutting measures and postponements of expenditures, Debswana cannot reduce expenses enough to match the lost revenues. A back-of-the-envelope exercise indicates that Debswana will need a capital injection of $1.2 billion.
One cannot simply inject cash into Botswana; this would ruin the country’s budget and force it into widening its budget deficits. From a Debswana perspective, taking on more loans would only increase its debt burden, which would also seriously impact its financial standing in the market.
So how will it be done? One influential financial expert, who has the ear of President Ian Khama, observed that the government cannot just give money. It needs to get some assets in return. What could these assets be? Possibly a greater stake in Debswana.
This reasoning is fueling the rumors that the government will want to increase its shareholding in Debswana. This would inject cash into the coffers of De Beers and De Beers Investments, the highly indebted holding company of the diamond mining group. From a Botswana perspective, this would cushion the fall in revenues, as it would collect a greater part of the annual Debswana dividend.
What I find puzzling is why there is so much talk about increasing the government’s share to 80 percent and not 100 percent. The latter option would make the most sense, at least from a Botswana government perspective.
Botswana Lost Attraction for De Beers?
Historically, Botswana was the greatest revenue earner for De Beers. The country used to host the world’s lowest-cost mines. Gradually, however, the government’s share of pre-tax earnings has climbed to 80 percent-82 percent. In the less transparent days of De Beers, the company’s de facto control of valuations, export pricing, selling assortments, etc. enabled it to cream off some 30 percent (maybe more) from the top. The highest echelons of the Botswana government were aware of this but accepted it anyway, as it still got a very good deal. This is no longer the case.
With diamond sorting, valuations and aggregation moving to Botswana, the mining business has become fully transparent, fully accountable, with the various functions carried out with unprecedented corporate integrity. This should be a source of great pride and satisfaction to the current management of De Beers.
Ironically, almost sadly, this has made Botswana a far less exciting and interesting place for De Beers from a revenue perspective. And it will only get worse. This is not only because Botswana’s diamond resources are depleting and costs rising, but also because tens of millions of carats in the years ahead will come from reprocessing tailings. The value of these goods will be much lower than the current average values.
There may be advantages for De Beers in having a chance to “walk away.” Currently, the Debswana production is valued and then sold at 90 percent of the so-called Standard Selling Values to the Botswana DTC. The latter will do the sorting and then sell the entire output at 95 percent to DTC International, which then sells to its worldwide Sightholders, including the Botswana Sightholders.
Technically, the Sightholders in Botswana get their allocations from DTC Botswana – it may not be realized that in this function, the DTC Botswana merely acts as “agents” for DTC International. This structure still allows a nice margin to De Beers/DTC International.
The Botswana government has learned how to negotiate. Formally speaking, DTC Botswana is a joint venture between the DTC and De Beers on one side and the government of Botswana and the DTC Botswana (Propietary) Ltd. on the other side. It is a 50/50 joint venture, but the construction and equipping (!) of the DTC Botswana building, which was fully paid for by De Beers, including the purchase of the land, was solely for the account of De Beers – even though the building is owned by joined venture partners.
For the government of Botswana to have 80 percent of Debswana would still allow for the operations of all the sorting, valuations and aggregation functions of the De Beers Group. It would also leave intact the Debswana obligation to sell ONLY to Botswana DTC, and the latter will sell only to DTC International (and to Sightholders on behalf of DTC International). If Debswana were 100 percent in the hands of the government of Botswana, it is unlikely that De Beers would continue to avail itself of all these structures.
There are some interested parties that would like Debswana to become more like BHP Billiton with a marketing model consisting both of auctions and contractual sales (with prices adjusted in accordance with auction results). Those advocates would have an interest in Debswana gaining the flexibility of setting its own marketing structures.
There are alternatives. Botswana could also increase its 15 percent stake in De Beers Investments to 25 percent or more, and thus invest at a higher level. The financial pressures on the Oppenheimer Family’s Central Holdings, on De Beers Investments and even on Anglo American may well see the transfer of funds from the “haves” (Botswana) to the “haves-less;” this, of course, is all relatively speaking.
Brian MacDonald, who happens to be the oldest (tenure-wise) executive of De Beers, rejects these rumors as totally baseless. We respect his view – but would invite him to reread this column six months from now.
Infringement of Contract
Another hot topic from all the Indaba gossip is the issue of contract infringement. This, I found out, is related to the delay in moving the “aggregation function” (i.e. the mixing of all the various De Beers mining output into selling assortments) from London to Gaborone.
It had been assumed that the decision to postpone moving the aggregation function to Botswana was because De Beers wasn’t convinced that those being trained to do the aggregation were ready to take on the challenge. However, while in Botswana, it was confirmed to me that the real cause for the delay was a disagreement with the tax and VAT authorities. Initially, I naively construed this as being a matter between De Beers and DTC Botswana that could be easily fixed. However, I soon discovered that the dispute holding up aggregation in Botswana is actually between De Beers and the tax authorities in London.
For years, the DTC’s tax payments in London were based on an assumed profit of 2 percent of DTC turnover. If the DTC’s main activities move away from London, this is bound to impact the taxation arrangements between DTC International and Her Majesty’s tax department. Apparently, the latter is now learning of the new arrangements and is studying their ramifications. De Beers spokeswoman Lynette Gould says De Beers has “identified a small number of issues that we believe are ‘right for success’ and that need to be resolved before aggregation can move to Botswana.” She is hopeful it will happen in 2009.
Thus, it is clear that the delay in moving aggregation to Botswana is, technically, an infringement of the agreements between the parties. My sources didn’t want to speculate as to how much patience President Khama will have in this matter.
Smoke with Merit
To return to my opening idiom, of whether or not the “smoke” at Indaba was fueled by real fires, we certainly believe it is “quite hot there under the smoke,” and the real issues associated with the chatter and gossip are serious.
Clearly, the global financial crisis is impacting Botswana. However, people I talked to view all these issues as challenges and opportunities rather than as problems. Botswana always had the diamonds; now they have diamonds and money. The country’s government will have to explore how the required “rescue money” can be applied in a manner that best serves the Botswana economy at large.
Have a nice weekend.