Botswana’s Decision

Avi Krawitz

There’s a dark horse lurking in the shadows of the diamond industry in the form of the ‎Botswana government. Not only is it about to become a major rough diamond supplier in ‎its own right – that is, independent of the Diamond Trading Company (DTC) – but it may ‎soon gain more of a say at De Beers.‎

The government has an option to raise its stake in De Beers from 15 percent to 25 ‎percent when Anglo American closes its buyout of the Oppenheimer family, which is ‎expected in the third quarter. The government will therefore have to decide in the coming ‎months whether or not to take the shares.‎

There are valid arguments either way regarding whether it should proceed with the deal. ‎De Beers has long been a cash cow for the country, and given Botswana’s vast but ‎limited diamond resources, the government should possibly milk as much out of the ‎industry as it can, while it can. ‎

The government is well aware of its confines. It has successfully embarked on a ‎‎“diamond hub” program to ease its reliance on the mining sector and bring additional ‎diamond-related activity to the country. Today, 21 sightholders either operate or are ‎setting up cutting facilities in Botswana. The DTC is in the process of transferring its ‎London sights to Gaborone and numerous ancillary services, such as banks, freight ‎companies, brokers and laboratories, have likewise set up shop there (see forthcoming ‎July edition of the Rapaport Magazine for an extensive review of Botswana’s burgeoning ‎industry). ‎

The next phase of diversification to introduce rough trading is imminent, even if it is ‎undergoing some growing pains and delays. The newly formed Okavango Diamond ‎Trading Company is still negotiating a contract to appoint a chief executive officer (CEO) ‎and the company is expected to launch sales by the end of the year, it hopes, more than ‎a year late. ‎

Still, diversification is well underway and attention now turns to the Anglo deal. In ‎November, the mining giant agreed to acquire the Oppenheimers’ 40 percent stake in De ‎Beers for $5.1 billion, thus raising its own stake to 85 percent. As part of the agreement, ‎the government has the right to increase its interest in De Beers from 15 percent to 25 ‎percent, in which case Anglo’s stake would be 75 percent.‎

Little has been revealed about the terms of the option agreement. One assumes the ‎government is being offered the same price for which Anglo bought the Oppenheimer ‎stake. It would therefore have to pay about $1.3 billion for the extra 10 percent.‎

Des Kilalea, an analyst at RBC Capital Markets, suggested to Rapaport News that the ‎government’s consideration therefore would probably be purely budgetary. Does the ‎government recognize De Beers as a good way to spend $1.3 billion or would those ‎funds be better spent elsewhere? ‎

In his budget speech given in February, O.K. Matambo, Botswana’s minister of finance ‎and development planning, acknowledged the constrained budget under which he ‎operates and outlined government’s main concerns for the year.‎

‎“Government priorities for the 2012-13 budget continue to focus on service delivery and ‎maintenance of existing infrastructure, while completing on-going projects, such as ‎energy generation, dams, roads and self-liquidating projects with high rates of return,” he ‎said. “These priority areas are expected to improve efficiency, create employment ‎opportunities and foster private sector growth.”‎

Frankly speaking, the prospective De Beers investment would not contribute to ‎employment creation, nor would it encourage private sector growth. On the contrary, it ‎would raise the already inflated public sector holdings. The treasury will also be reluctant ‎to raise its debt position to fund the acquisition in the current economic environment. ‎
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Given the weak global economy, the government may also consider whether increasing ‎its exposure to diamonds is such a good idea. Matambo warned that if projections for flat ‎growth in the volume of diamond sales in 2012 hold true – those projections may have ‎become even bleaker since February – the consequences may be dire for the local ‎economy. ‎

‎“Should the global economy experience a double-dip recession, and given that the ‎country is still in debt, quick and full recovery in the domestic economy might prove ‎difficult, in which case we all have to be prepared to make sacrifices,” he said.‎

Of course, the converse holds true; an upturn would prove a windfall for the budget and ‎the government will surely have the proverbial De Beers long-term supply-shortage-‎rising-demand curve scenario in mind when making the decision.‎

Botswana has a complicated ownership structure in De Beers. In addition to the 15 ‎percent stake in the holding company, it is also an equal joint-venture partner with De ‎Beers in Debswana, the local diamond mining company, and in DTC Botswana, the local ‎rough distribution arm. The structure dictates that an estimated 80 cents of every dollar ‎worth of diamonds sold by De Beers is accrued by the government. ‎

As a result, the extra revenue it will gain via the additional 10 percent is difficult to ‎quantify from the outside. Kilalea notes that the shares would help diversify the ‎government’s holding in mining operations outside of Botswana, given De Beers South ‎African, Namibian and Canadian operations. The deal would also raise its exposure to the ‎company’s retail and industrial synthetics programs.‎

However, an equally pertinent question revolves around the government’s relationship ‎with Anglo. While Nicky Oppenheimer was considered the De Beers go-to guy for the ‎government, his family’s divestment presents a new, more corporate dynamic for ‎Botswana – one which may throw the government out of its comfort zone. ‎

Ultimately, with or without the 10 percent, the government will be the minority partner in ‎the business. Should it feel that it can exert more influence on the decision-making ‎process with more shares, this may tilt its decision in favor of the deal.‎

This is unlikely, however, and the decision should not depend on this factor. As Kilalea ‎states, the decision is likely to be a budgetary one. Essentially, the government should ‎consider whether the long-term benefit substantiates the cost.‎

However, the decision should also accommodate the country’s long-term economic ‎strategy. The government has done well to position itself to further benefit from its ‎diamond resources. Ultimately, its hub program, and the pending developments therein, ‎offer better prospects and more excitement to its projected role in the industry. Not that ‎the two are mutually exclusive. But whether the Anglo deal will provide additional benefit ‎to the strategy seems improbable. ‎

Source Rapaport