The moment when a leading company decides to float on the stock market is always a moment of uncertainty. All eyes are pointed to its early results, as analysts try to figure out to correctly measure its performance.
Are there competitors in the stock market that could erode the company’s profits? Are these competitors structurally compatible with the company under analysis? Is there any way to compare its performance with those of the competitors?
ALROSA’s potential listing into the stock market makes no exception.
When looking at the diamond business, the stock market is dominated by two company models. The first model is the one of the diversified resources conglomerates, which includes companies that are active in a great number of mineral and metal extractions; among them BHP Billiton and Rio Tinto are the most important examples. Then there are the so-called juniors, which are companies that operate only in the diamond extraction business but, due to their small size, are either risk-oriented or cautious up to the limits of viability in their investments; examples of juniors are Petra Diamonds, Firestone Diamonds, Diamcor and Harry Winston.
Being the largest diamond producer in the World, ALROSA belongs to a different category, the one of the Diamond Majors. The only other company sharing the status of major with ALROSA is De Beers, which despite being owned by resources conglomerate Anglo American, has a largely independent structure and such a relevant history and volume of trade that makes any other classification misleading. De Beers, which has a long history in the financial market, delisted from the Johannesburg stock exchange over a decade ago, after being taken over by Anglo American.
While so far the performance of diamond mining companies could be measured by comparing the share performance of each company, the presence of an actor that produces by itself a quarter of the World’s annual rough output would inevitably produce distortions in the results.
The distortions are due to the fact that major companies attract a different type of investors compared to the ones that would bet on a junior or resources conglomerate enterprise; it is worth looking at the most evident appeal differences between ALROSA and the other models.
Monopoly on extraction activities in Russia
When ALROSA was founded in 1992 it inherited a vast majority of the mines opened during the Soviet era, and since then it has been constantly active in exploration activities. The Russian Federation is today the first producer of rough diamonds in the World, with over 35 million carats mined in 2011. Almost all of these diamonds are extracted by ALROSA. Due to its size, revenues and impact on regional and national economy, the Russian Government considers ALROSA a strategic asset, has large interests in it, and is willing to protect it in tough times.
In the eyes of the investors a company that can count on massive reserves of rough diamonds and strong support from its government is reliable and thus preferred by those who are looking for long-term investments.
Junior companies do not have any of these characteristics. This forces them to chase potential mining areas in several continents, taking risks on purchases, presenting exploration and prospecting reports and hoping to sell their concession or to gather enough funds to start mining operations.
Investors who are looking for relevant, but risky, profits would probably sustain those companies with venture capitals.
Large production volumes
As seen earlier, when a junior mining company discovers new diamond reserves two things may happen: the first is that the concession is sold to a bigger actor, which will then start mining operation; the second is that the junior starts extracting diamonds itself. In both cases, the junior is likely to experience rapid increase in its profits compared to its previous situation, either because of increased rough sales or because of the one-off sale.
When a major discovers a new diamond reserve, things work quite differently. First of all, majors have usually few interests in selling a profitable diamond reserve, since mining diamonds is their primary task and the companies are likely to have enough expertise and equipment to operate it; majors do from time to time sell their concessions to competitors, but that usually happens when they want to concentrate their efforts on more productive assets. Second, the company is unlikely to fully exploit the new reserve, or if it does it will not put the diamonds on sale immediately, because this might impact on the general price of diamonds. The logic behind that is simple: if a company with a small production of rough and finds new reserves, it could exploit them to double its income without producing distortions on the global market. On the contrary, a major that already covers a big portion of the market would not be in the position to increase its share without flooding the system and destroying value. Large diamond companies are therefore unlikely to experience rapid growth rates.
The other face of the medal is that while a junior company might face sudden declines in production volume when its concessions become exhausted, a major can count on strategic reserves and stockpiles.
This means that a major company is expected to have a balanced and steady production, while junior companies would have a swinging one. Again, from the point of view of an investor it is a choice between a solid company or a risky but potentially highly rewarding one.
Trusted and certified buyers
Similarly to the De Beers’ Supplier of Choice mechanism, ALROSA sells large part of its production through long-term contracts. This has a profound impact on the perceived value of the company. Despite the presence of gemological institutions such as the GIA and the IGI, which ensure a standardised grading system, jewellers tend to rely on a restricted group of suppliers that have a proven record of reliability. Being thoroughly checked by diamond companies, these suppliers are also considered reliable by diamond companies, and thus considered eligible for long-term contracts.
On the contrary, junior miners are typically bound to auctioning mechanisms. Auctions are usually more rewarding than long-term contracts in terms of price per carat, but they also present a conspicuous risk of being deserted during troubled times. Juniors do not have the possibility to largely rely on long-term contracts because, due to their small production volume, they cannot guarantee a constant flow of diamonds with a set caratage and quality over time.
Investors would obviously take in account a company’s selling strategy before deciding to buy its stocks.
Focus on one type of product
While major producers such as De Beers and ALROSA are entirely concentrated on the diamond business, conglomerates are not. Rio Tinto has other assets such as iron, aluminium, bauxite and gold; BHP extracts base metals, aluminium and manganese, but also fossil fuels and uranium.
The diamond business accounts only for a portion of these companies’ portfolio, and it is often not a strategic one. Resources conglomerates tend to chase the most profitable activities, and while diamonds have a reputation for strong stability over the long term, they can face periods of decline.
Last year BHP announced that it was planning to scale down diamond production by selling the Ekati diamond mine and the Chidliak exploration project in Canada; shortly after Rio Tinto declared that it was not considering diamond mining one of its core activities anymore and, despite being involved in the development of the US $500 million Bunder Project in India, it was considering the possibility of selling some of its assets.
As it is challenging for a market analyst to discern in what measure diamond production affects the stock value of diversified resources conglomerates, comparisons with a diamond major are not a viable option.
In conclusion, ALROSA’s stocks would probably attract long-term investors who believe that a robust and well functioning company that managed to secure large reserves of a depleting resource is bound to acquire value over time, especially because of growing demand from emerging markets. On the short-to-medium term, though, a diamond major is more prone to the fluctuations of supply and demand and could experience temporary stagnation or decline. Venture capitalists and stock investors looking for either high-potential or short-term stakes in the diamond mining business are more likely to invest in junior miners running risky exploration and extraction operations, or in flexible companies with a large production portfolio.
The aims of these two groups of investors are heterogeneous and not exchangeable. Comparing the future performance of ALROSA with the ones of companies already floating on the stock market is likely to be an impossible task, as the data are produced by a different set of parameters, which appear to be unrelated among them.