MARKETS SPECTATOR: Rio's diamond dilemma

On the face of it Rio Tinto is not desperate to sell its diamond business which covers three continents, is valued at $1.65 billion and produces about a fifth of the world’s rough diamonds.

Morgan Stanley, Rio’s banker, has probably received offers for the company’s diamond business but Rio is not in “fire sale mode", says UBS analyst Glyn Lawcock. He values Rio’s diamond business at $1.65 billion.

The most valuable part of Rio’s diamond business is the Argyle mine in the Kimberly region of Western Australia that produced 8.47 million carats last year, according to the company’s annual report. It has disgorged white, champagne and pink colored diamonds.

Rio owns 60 per cent of Canada’s Diavik diamond mine, 220km south of the Arctic Circle. That produced 7.23 million carats in 2012, according to Rio. Rio also owns 78 per cent of Murowa, an open pit diamond mine in southern Zimbabwe, which produced 403,000 carats last year, says the company.

The problem for Rio is that an interested buyer may want only part of its diamond business. The most valuable part is thought to be Argyle.

Canada’s Dominion Diamond Corp., which owns 40 per cent of Diavik, may only want the Canadian asset and or Arglye. De Beers, which accounts for about 35 per cent of the world’s diamond supply, may run into antitrust and regulatory problems if it decided to bid for any of Rio’s diamond business. Authorities are perhaps mindful of the company’s previous effort to control the supply and price of diamonds during the Cold War.

So that may leave Rio contemplating an initial public offering of its diamond business. Existing shareholders could receive stock in the new company at its IPO based on the number of shares they hold in Rio. Investors could then choose to sell or buy more of the newly listed diamond stock. Rio could also sell new stock in the diamond business with the company’s existing shareholders automatically entitled to stock in the diamond company IPO based on their existing Rio shareholding.

All this is a boon to bankers at Morgan Stanley. If Rio is determined to get rid of its diamond business, Morgan Stanley bankers will get paid for whatever sale scheme they can successfully execute. For an IPO to succeed in this environment, however, the optimism surrounding stock markets needs to be maintained or stoked by the investment banks. They have never been shy to do so when they have needed to execute a deal.

Today Rio’s shares today fell $1.38, or 2.5 per cent, to $53.80. The stock has gained 1.7 per cent in the last 12 months but has dropped 19 per cent this year.

The benchmark S&P/ASX200 Index today fell 38.269, or 0.8 per cent, to 4,888.30. It has gained 21 per cent in the last 12 months and 5.2 per cent this year.