Bashing De Beers at the Wrong Time and for the Wrong Reasons
December 03, 09For the diamond industry, the days between Thanksgiving and Christmas are crucial to gauge where we are and where we are going. Whatever views one may hold on the state of the global economy, these are days of hope and expectation as well as anxiety and trepidation.
The global financial and general press seems to have picked these days to bash De Beers and fill the market with conjecture and speculation, which may contain some grains of truth, but they are largely presented in an incoherent, disturbing and certainly unhelpful manner – because of their timing.
Speculating on the De Beers Cash Flows
For instance, one highly respected writer (and I mean that) published a blaring headline: “Living on Handouts. Yesterday’s Top Story: Poor Old De Beers.” Underneath the title, it reads, “With cash flows from hell, the once mighty diamond miner is on its knees.” Another eye-catching headline, announcing that De Beers’ shareholders agreed to a $1 billion injection, could be found on the front page of the Financial Times companies section.
These stories seem keen to highlight the fact that the operating cash flow of De Beers in the first half of this year was slightly negative. De Beers had $31 million negative operating cash flow in the first half of this year as compared to $455 million positive cash flow in the first half of 2008. In recent years, annual operating cash flow had always been $700-$850 million positive.
All the articles I’m referring to speculate about De Beers’ $1.5 billion credit facility that needs to be renewed in March 2010. In a war of nerve, they all quote sources from the consortium of 20 lenders who have been negotiating for many months to renew all of the facility. The argument is on what the ultimate financing terms will be.
Some writers seek more behind this. As calls seem to be made on shareholders’ funds, it is conjectured that “the end of the historic association between the Oppenheimer family and Anglo American, the mighty corporate empire, which once controlled two-thirds of the Johannesburg stock exchange, [may] be in sight.” It is assumed that Anglo American (which holds 45 percent of De Beers) may want to rethink its stake in the company.
All these articles on games that shareholders play seem to be so removed from the De Beers business itself. Even the Financial Times is hedging its headlines with remarks like “new equity could account for up to $1 billion of the $1.5 billion required debt refinancing. It could also fall to $750 million or below.” Vive le Difference! Of course, the $1 billion figure makes for a juicier headline than merely saying it could be below $750 million. Maybe it will only be $500 million – or none at all. And, of course, all the articles quote unnamed sources.
Setting the Story Straight
Some of these writers have fantastic sources. But so do we. My story sheds a totally different light on all the market conjecture. My reading of the situation is as follows:
- Anyone that has a pencil, an envelope and is familiar with what De Beers has done in the second half of 2009 will know that the company will have a not insignificant positive cash flow in 2009. The company is not in any need for an injection of new capital in order to keep it going. To the contrary, De Beers is sitting on cash. It has all the resources to go through 2010 without any need for outside capital injections. It is as simple as that!
- Early this year, when there was still great uncertainty as to how the global financial crisis and the recession would evolve, shareholders loaned some $500 million to De Beers. This was a measure mostly reflecting cautious and prudent management. The company wanted to have the money on hand to meet any possible contingency. As of now, to the best of my understanding, De Beers hasn’t had a need for that money. The company has a positive cash flow without withdrawing on that $500 million facility.
- True, in the middle of the year, there was a remote possibility that some conditions of the lending covenants might theoretically trigger a technical default of a few provisions. This was related to ratios involving levels of sales and debts, etc. De Beers paid a one-time payment of $10 million to the lenders to get a waiver of those potential, problematic provisions. It could have saved itself that money because it never happened. None of the relevant provisions in the lending agreement occurred. The payment was mainly to hedge itself against possible contingencies.
So what is all the noise in the press about? The management of De Beers believes, we think, that the lending consortium is exaggerating its demands. It is only natural that the borrowing terms have deteriorated – welcome to the club. I find it hard to come up with any corporate example where terms are getting better, but let’s leave that aside.
The way I understand it is that the shareholders of De Beers themselves have the luxury to decide what they consider is the optimum debt-to-equity ratio for De Beers to go forward. The renewal of the $1.5 billion facility has long ceased to be an issue. That is agreed in principle. It is the terms that are still not finalized. A better debt-to-equity ratio would enable management to negotiate better terms. That, we believe, is what it is all about.
It may well be that the lending consortium, or people claiming to be close to the consortium, may be interested in the plethora of recent press articles in order to put more pressure on De Beers. It is a lot of money, and Anglo American and the Botswana government each have shareholders and stakeholders that will read all of these articles.
Questionable Shareholding Assertions
De Beers Managing Director Gareth Penny has gone on record many times in the last few weeks saying that the company has not only reduced its sales by some 50 percent but has also been successful in reducing its expenses by just as much. If anything, that is almost a miraculous performance by management.
This doesn’t stop South Africa’s The Daily Maverick to suggest that because Nicky Oppenheimer’s family company has a management contract of De Beers, and Anglo American doesn’t have management control, this may be an additional reason for it to opt out of the shareholding altogether. Such an assertion doesn’t make sense as Anglo American can cancel that management agreement at any time; it only needs to give a one-year notice. If Anglo American wants out it can only be because it gets a relatively modest part of the profits.
Changes in Shareholding
The articles in the press link a possible decision to turn shareholders’ debt into equity as an opportunity to change the shareholding balance between Anglo American (45 percent), the Oppenheimer family (40 percent) and the government of Botswana (15 percent). The possibility of such changes has already been raised a while ago and was one of the reasons the Botswana government took the services of LEK Consulting Company to make recommendations. One option on the table was actually for De Beers to take a greater share in the Debswana joint venture, and for Botswana to take a greater share in De Beers.
At every occasion, Cynthia Carroll, the CEO of Anglo American, has publicly confirmed that its ownership in De Beers is a core holding of the company. You don’t make those statements if you are about to sell parts or all of your holding in a company. However, having said that, I cannot disagree with the observation made by one writer that “Anglo, under new chairmanship and with a bunch of new faces on the board, is looking at a problem asset, which may or may not have great long-term potential.” Problem asset?
The reference to the long-term potential may well be based on the expected declining resource base and the higher mining costs that will be incurred mostly in Botswana but also in other properties. It also has to do with the fact that the Botswana government takes well over 80 percent (through dividends, taxes, etc.) of Debswana’s profits. So, in terms of percentages, there isn’t a great deal left for the other shareholders, but in real money, it is still a lot of money.
No Need for Injection of Money
All of the press speculation is done under the question mark of whether a company that has a net debt of some $3.5 billion may face liquidity problems if a credit facility will not be renewed. To this, the answer has been given: The renewal is a certainty. The terms are not yet final but can be improved if shareholders turn the existing $748 million shareholders’ debt into equity. If all shareholder loans are turned into equity and no new money is brought in, Nicky Oppenheimer’s share in De Beers may actually slightly grow because he has given more loans, relatively speaking, than the two other shareholders.
Nothing of this diminishes any of the main, hard fact: De Beers does not need a cash injection into the company. Its current and next year’s budget can be fully financed from current facilities. Based on our forecasts that the cutting centers will have at least 25 percent higher polished sales in 2010 than in 2009, and that the rough requirements to the global market in 2010 will rise from $7.5 billion in 2009 to $12.5 billion next year, there is no way that De Beers will not have a good year ahead of it. None of the articles that I have seen even hint to this.
For the diamond producers – including De Beers – the worst is well behind them and this “festive season” is certainly not the right time to put so many question marks around the future of De Beers. Especially, as there seems to be no reason for concern – it’s mainly and purely a matter among three shareholders.
Have a nice weekend