About three months after BHP Billiton announced it was reviewing the future of its diamonds business with a view to selling it, Rio Tinto has followed suit with its own strategic review.
The decisions of both of the big miners to question the future of diamonds within their portfolios might, at face value, appear odd.
The fundamentals for the sector appear quite solid, with rising demand and little new supply. Demand for diamonds tends to grow with living standards and therefore they lag peaks in demand for hard commodities like iron ore or copper. Rio itself expects demand from India and China to double by the end of this decade.
So why sell? The reality for both Rio and BHP is that, while they both hold major positions in the industry, their diamond interests are relatively small components of their portfolios of resources and the dearth of opportunities to grow their presence in the sector means they are likely to remain sub-scale relative to the core commodities in those portfolios.
That’s not to say they are small businesses. Rio’s diamond and minerals operations generated revenue of $US3.22 billion last year and underlying earnings of $US252 million. They had net assets of $US3.6 billion. The underground development of its original Argyle mine will ultimately cost more than $US2 billion and extend its life through to the end of the decade.
In the context of a group that had underlying earnings of $US15.5 billion last year, however, the diamond business – Rio’s operations are fully integrated, from mines to marketing – is immaterial.
The Rio review is about portfolio management rather than any need for cash, despite the massive capital expenditures Rio is committed to – it spent more than $US13 billion last year. It is consistent with the decision Rio took last year to restructure its aluminium division to put its lower-returning Australia assets into a new vehicle to be either sold or spun out and to earmark seven businesses in the UK and Europe for sale.
Like BHP, Rio wants to focus its attention and dollars on a relatively small number of very large, high-quality, low-cost and long-life assets. Rio is pursuing its portfolio cleansing, however, more aggressively than BHP, although BHP’s Marius Kloppers has strengthened the rhetoric around exiting the less strategic and lower-returning projects in his portfolio in recent months.
Rio is pouring billions of dollars into expanding its core Pilbara iron ore operations and also has, in the Oyu Tolgoi copper-gold project in Mongolia, the Simandou iron ore project in Guinea and the Riversdale coking coal business in Mozambique a group of very large and very expensive developments underway. While it isn’t short of cash, it makes sense to cash out its shorter-life, sub-scale assets to devote its balance sheet and management attention to those big new projects.
Rio’s diamond portfolio includes the Argyle mine which broke the De Beers stranglehold on the industry in the 1990s and the cutting and polishing facilities and sales and marketing support that were necessary once Rio decided not to market through the De Beers system.
It also has a 60 per cent interest in the Divak mine in Canada’s Northwest Territories (where BHP’s 80 per cent-owned EKATI mine is located and De Beers has a project), a 78 per cent interest in the Murowa mine in Zimbabwe and a 100 per cent interest in an advanced prospect, Bunder, in India.
It will be interesting to see whether anyone seeks to put the Rio and BHP diamond interests together to create a very sizeable new business.
One assumes there would be regulatory obstacles to any De Beers involvement in the sales but if Rio and BHP were struggling to find buyers for their operations at reasonable prices it would be open to them to merge their interests to create an entity with scale and subsequently spin it off.