KKR plays a Rio-BHP diamond double

Rio Tinto and BHP have their diamond assets on the market, and should KKR snaffle them both it could create the world's largest pure diamond play with attractive float options down the line.

When Rio Tinto followed BHP Billiton in putting its diamond business on the market earlier this year it created an obvious opportunity for someone to put the two businesses together to form one of the world’s largest pure diamond plays. If UK reports are correct, that someone could be private equity giant KKR.

The Sunday Times reported at the weekend that KKR is in a bidding competition with at least two other groups for BHP’s Ekati mine in Canada as part of a plan to also acquire Rio’s diamond assets and merge both businesses into the world’s number three diamond producer behind De Beers and Russia’s Alrosa. It described KKR as being in "pole position" to acquire Ekati.
BHP announced its decision to quit diamonds last November. Ekati is a highly profitable operation. It contributed the bulk of the $US1.5 billion of revenue and $US587 million of earnings before interest and tax generated by BHP’s diamonds and specialty products division last year. It didn’t, however, fit BHP's core criteria for its assets that they should be large, long-life and expandable projects.

Rio's strategic review of its diamond business is based on very similar thinking and is part of a wider rationalisation of the Rio portfolio to focus on a smaller number of big, clearly tier one assets.

Both groups have vast capital spending plans for their core assets and it makes considerable sense for them to focus their resources – both cash and management – on projects that can make a difference to their bottom lines and where they are among the market leaders. Separately, their diamond businesses are relatively junior players in a sector dominated by De Beers.
It was noted here at the time of the Rio announcement that the coincidence of having two of the major diamond producers on the market at the same time created an opportunity for a third party to combine them, or for BHP and Rio to do that themselves. It appears KKR came to the same conclusion.

Despite the desire of BHP and Rio to offload their diamond operations, they are good businesses supported by strong market fundamentals.

As the developing countries in Asia and other emerging economies become more affluent, already rising demand should strengthen further – demand for diamonds rises with living standards. Rio has said it expects demand from India and China to double by the end of this decade.

Yet the production of gem quality diamonds has been sliding and the cost of mining them rising. That suggests there is an attractive opportunity for a deep-pocketed buyer with a medium to long-term view of the market, a description which fits KKR’s investment philosophy. KKR isn’t a firm that buys businesses with the intention of flicking them on hurriedly for a quick profit.

In Qantas chairman Leigh Clifford, a former Rio Tinto chief executive, KKR also has an adviser with an intimate understanding of Rio’s assets, which includes the Argyle mine in Western Australia and a 60 per cent interest in the Divak mine in Canada, relatively close to Ekati. Rio’s diamond business is integrated, with its own cutting and polishing operations and marketing system.

There would presumably be some synergies in combing the two businesses, but the larger appeal in a combination would be the scale that would achieve and the pure play nature of the business, which should provide a successful buyer of both with a very attractive float option should it want to exit the business at some point in the future.