Mining giant Rio Tinto (NYSE:RIO) is exploring various strategic options, including the divestment of its diamond business. Rio’s announcement follows in the footsteps of its major competitor BHP Billiton (NYSE:BHP) which put its diamond assets on the block last November. The company believes it can create more value through its lucrative iron ore business even as the outlook for diamonds sparkles. Apart from diamonds, Rio Tinto’s product portfolio spans basic metals like iron ore, copper and aluminum to energy products like coal and uranium. Its also competes with mining giants such as Vale (NYSE:VALE) and Freeport McMoran (NYSE:FCX). We are in the process of revising our price estimate for the company.

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Rio Could Drop Diamonds, Sees More Value in Iron Ore

Rio Tinto is reviewing whether its diamond business fits with its bigger strategy of operating large scale, long-lived, expandable assets. The company is, however, bullish on the diamond market with rising demand and lack of new discoveries widening the demand-supply deficit.^[1] The company may fetch about $2.5 billion in a sale of its diamond assets, according to Bank of America’s valuation this month.^[2]

Rio Tinto’s plans, however, could muck things up for BHP Billiton, which is also in the fray to sell its diamond assets. BHP Billiton has already sold a part of the business, and its Ekati diamond mine in Canada is rumored to be the next target. Such moves from these giants are more about scaling up their businesses rather than peaking demand.

Last year, as part of its aluminum divestiture, the company spun off its higher-cost aluminum assets in Australia and New Zealand into Pacific Aluminum, a distinct entity from Rio Tinto Alcan. Many are speculating that it could exercise the same strategy for its diamond business, while retaining some part of it. Both steps are seen as Rio Tinto’s bid to increase its focus on iron ore, which contributes 40% to our current price estimate for the company.

In its earnings announcement last month, Rio Tinto recorded a loss of $76 million in the diamond business for 2011 due to a $344 million one-time charge for the $2.1 billion expansion of the Argyle mine in Australia. Rio Tinto operates three diamond mines, including Argyle in Australia (100% interest), Diavik in Canada (60% interest) and Murowa in Zimbabwe (78% interest). Rio Tinto also has a 100% stake in Bunder, an advanced diamond project in India.

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