Lacking the carat, Rio sticks with its diamonds

When Rio Tinto put its diamond business on the market over a year ago it looked like a sensible decision to cash out a non-strategic suite of assets within its portfolio. It looked even more compelling once Sam Walsh was appointed chief executive earlier this year and made it clear he wanted to up the urgency in divesting non-core assets.

Today’s announcement that Rio would retain the business, however, probably shouldn’t have come as any great surprise given that it had become increasingly clear that there was really only one obvious buyer; that that buyer was really interested in only one asset and that it had negotiating leverage in any discussions about that asset.

The two big assets within Rio’s diamond businesses are the Argyle mine in Western Australia and Rio’s 60 per cent interest in Canada’s Diavik mine. With its 78 per cent interest in the Murowa mine in Zimbabwe the diamond interests have been valued by analysts at more than $2 billion.

The problem for Rio was that the owner of the other 40 per cent of Diavik is Dominion Diamond Corp (formerly Harry Winston Diamond Corp), which last year acquired BHP Billiton’s Ekati diamond mine, also in Canada’s Northwest Territories.

One of Dominion’s predecessor companies, Aber Corp, discovered diamonds on an island in Lac de Gras during the diamonds rush in the territories in the 1980s and early 1990s. Rio’s Kennecott Canada unit, which had joint ventured Aber Corp’s exploration efforts, was brought in as a partner to help develop the mine.

Dominion, which has pre-emptive rights over Rio’s Diavik interest, made it clear it was both interested in acquiring it and had the capacity to do so after it raised $1 billion in January by selling the Harry Winston diamond jewellery and watch division to Switzerland’s Swatch group.

Rio’s problem was that Dominion was only interested in Diavik – it had no interest in Argyle or Murowa, preferring to maintain a pure and easier-to-manage exposure to the Northwest Territories. It also made it clear that while it would like to acquire Rio’s interest in Diavik it had no interest in overpaying for an asset over which it already had pre-emptive rights.

Rio’s original rationale for putting the diamond mines on the block was that the business wasn’t sufficiently large or the mine lives sufficiently long to have any material impact on its portfolio, despite the fact that the business is solidly profitable and the larger industry has solid prospects.

At present the business is fully-integrated – Rio mines, cuts and polishes the stones and has its own sales and marketing functions.

Selling only the Diavik interest for a non-strategic price would have left it with an even more sub-scale business and it would appear reasonable to conclude, 15 months or so after the businesses were put up for sale, that it has been unable to put together a group of buyers for the suite of assets at acceptable prices.

Rio also considered a float of the diamond business but has now ruled it out, which may be related to the slump in commodity prices and resource stocks but which may also have been complicated by Dominion’s Diavik rights.

While it’s not a major setback to retain what are quite attractive businesses Walsh has made it clear he wants a large-scale rationalisation of the Rio portfolio to simplify the group, get a better focus on its core assets and to generate cash to pay down debt.

It has been looking at how to exit the worst-performing exposures it has to aluminium, having put those assets into the Pacific Aluminium vehicle back in October 2011 in preparation for a sale or float. The structural downturn in that sector and the current market conditions, however, make any sale or spin-off of those businesses problematic.

Walsh is also thought to have a list of other assets on his 'for sale' list, including Iron Ore Co of Canada, some of its coal interests and the Northparkes copper-gold mine in NSW, but is unlikely to embark on a fire sale in conditions that don’t favour vendors.

The decision to retain the diamond business signals that Rio isn’t going to sacrifice longer term shareholder value by simply accepting what a buyer’s market has to offer.